THE DISTILLERY: Qantas pincer

One jotter sees Qantas squeezing rivals from two sides, while another asks if Australia's banking sector may be dragging down the economy.

Qantas Airways is but one of a several famous Australian corporates set to hand down results this week. But the carrier’s iconicity as well as its challenges with the federal government, local unions and international competitors make it a favourite of the commentators. This morning, The Australian Financial Review’s Andrew Clearly gives a broader context to Qantas’ strategy at home, while The Australian’s John Durie shares some details of the airline’s movements away.

Also in this edition of The Distillery we have some reflections on QBE’s latest results, along with a story about one of the ways Australian investment banks are making a dollar in a flat market – hybrid securities.

Firstly, The Australian Financial Review’s Andrew Clearly gets top marks for explaining the domestic strategy of Qantas as more than just meeting Virgin Australia on price. It’s subtler than that.

"For all the talk of the Jetstarisation of Qantas, the premium brand has actually been taking back key peak-hour slots from its low-cost offspring in Sydney and Melbourne. In short, Joyce has watched Virgin’s rapid growth and is now setting out to defend his turf with a Qantas-Jetstar pincer movement and smash his rival’s profitability along the way. With Qantas attacking from the top, and Jetstar bringing down fares in the leisure market that still accounts for 80 per cent of Virgin’s revenue, the aim is to squeeze the middle man into submission. But when airline capacity enters a market ahead of demand, there is only one way to fill seats: discounting. So what investors will be waiting to see, when Qantas reports its first statutory loss since privatisation this Thursday, is not how badly the troubled international business is doing (Qantas has already said it will be $450 million in the red), but the extent to which domestic yields are suffering as a result of the capacity war between the Flying Kangaroo and its newly nimble competitor.”

Of course, one of the reasons why commentators tend to gloss over the subtleties of Qantas’ domestic battle is its greatest and most complex challenge is the international market. The Australian’s John Durie has a couple of details as to how that’s going beyond what might be coaxed out in the airline’s results.

"Talks with Emirates about a commercial link are well advanced but some time away from any formal confirmation with all the details still to be signed off, which could take a month or two. Joyce will be heading off to Shanghai after his results presentation to continue talking to the folk from China Eastern, but these talks are only in early stages. The model is clear – to run a virtual international airline backed by selected Qantas metal (airline jargon for a plane) supporting its highly profitable frequent-flyer program and market-leading domestic network. The similarities with Virgin are readily seen, but in reality the model in some form has been around since 1935, when a deal was reached with Imperial Airways (now called BA) to fly passengers from Singapore to London.”

Meanwhile, The Australian Financial Review’s Chanticleer columnist Tony Boyd investigates a market legend that former QBE chief executive Frank O’Halloran had a black box that held the secrets to the insurer’s profitability throughout most of his tenure.

"The key to O’Halloran’s performance was the hugely risky decision in 2001, following the terrorist attacks on the World Trade Centre, to buy portfolios of risk. At a time when most insurers pulled their heads in, QBE captured a large amount of high-margin business. One question mark over the O’Halloran strategy was in relation to reserves. The buying spree made it harder to understand movements in QBE’s reserves. When new chief executive John Neal, who used to be QBE’s chief underwriter, delivered his first profit report on Friday, he started to lift the lid on O’Halloran’s black box. The market was underwhelmed when Neal said net profit was $760 million compared with market consensus of $795 million. The insurance margin, which is a measure of profit made on risks underwritten, was 13 per cent compared with analyst expectations of 14.3 per cent.”

And Fairfax’s Adele Ferguson writes that the dour market conditions over the last year have given investment banks an opportunity to advise big corporates to issue high-yielding hybrid securities.

"In the past year, companies have paid out almost $60 billion in dividends – the payout ratio has risen to 67 per cent – and they have issued more than $8 billion of hybrid securities as they have seen the merits of a financial instrument that gives them a capital injection but doesn't jeopardise their credit rating or dilute equity. Issues of hybrid securities are expected to rise in the next few months as investors continue to favour high-yielding products. In the past two weeks, three offers have hit the market – from Caltex, APA Group and Crown – totalling more than $1.5 billion. Commonwealth Bank is rumoured to be looking at launching a hybrid issue to refinance its $1.4 billion Perls IV tier-one hybrid offer. AMP is also believed to be considering a hybrid issue to boost its capital, as are several other companies. These hybrid securities are pitched at retail investors as a high-yielding return at a time when the interest rates for term deposits have fallen from up to 7 per cent six months ago to 5 per cent or less, and cash management trusts are offering even less. If the Reserve Bank continues to cut official interest rates, term deposits will fall even further.”

Speaking of Australian corporates more generally, Fairfax’s Elizabeth Sexton gives perhaps the best account of Australian boards and executives turning down big pay increases as results fail to fire the market. Indeed, Qantas’ Alan Joyce has become the latest.

In related news, Fairfax’s Marc Moncrief has conducted an analysis of public company directorships and concludes that Lindsay Maxsted could be the most influential Australian corporate personality. It’s an interesting read, kind of in the spirit of Private Media’s The Power Index.

In other company news, The Australian’s Robin Bromby explains how Newcrest Mining has been dropped from the top shelves of gold mining investors.

Elsewhere, The Australian’s Paul Garvey brings word from CLP Holdings chief executive Andrew Brandler, who delayed the TRUenergy float last week because of the flat IPO market, is concerned that India won’t deliver on its growth potential.

Speaking of India, The Australian Financial Review’s economics editor Alan Mitchell does his readers the favour of not just looking at Australia’s growth prospects through the prism of China, but through the world’s largest and most complex democracy.

In domestic political news, over the weekend Fairfax’s Ross Gittins examined the practicalities of corporate tax rates in a world where a large amount of capital is controlled by increasingly mobile multinationals. This morning, Gittins writes that Treasury secretary Martin Parkinson has given the electorate the last piece of decent budgetary advice they’re likely to receive before the federal election.

Meanwhile, The Australian Financial Review’s Jennifer Hewett argues that it’s impossible to ignore the new statements from a former Slater & Gordon partner about the details surrounding Prime Minister Julia Gillard’s departure from the firm before her career in politics.

And Fairfax’s Ian Verrender starts off his discussion about the dire state of economic debate in Australia by quoting Joseph Goebbels, the Minister for Propaganda in the Third Reich, and immediately isolates a bunch of readers by doing so.

With an eye on the horizon, Fairfax’s Malcolm Maiden looks at some of the looming important dates for the banking sector.

And finally, The Australian’s economics editor David Uren flips through some worrying research from the Bank of International Settlements that suggests the Australian banking sector might be so large that it’s dragging down our economy.

The Distillery dealt with a similar story last week, but regrettably only to boast about Australia’s strength in the wake of the London Olympics. That joke was in questionable taste for two reasons.

Firstly, it’s far too glib about the performance of Australia’s athletes at the Olympics. They did, as always, a tremendous job in the face of unrivalled pressure.

Secondly, it’s far too glib about what could amount to a serious problem for the Australian economy.

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