Will Q-Day add salt to Qantas wounds?

There is a growing sense of expectation (and frenzied speculation) as Qantas approaches Thursday’s ‘Q Day’. Some of those expectations may not be met this week, but it is obvious that Alan Joyce is going to have to make some very unpleasant announcements.

While the speculation about job losses ranges from 2000 to 5000, it is clear there are going to have to be major job losses if Qantas is to meet its stated target of reducing its cost base by another $2 billion over the next three years. That’s after near-continuous cost-cutting that has seen its unit costs cut by almost 20 per cent in the past five years.

Joyce has no choice but to try to structurally rebase Qantas’ costs after the group slid into the red in the second half of last year and then foreshadowed heavy and unsustainable losses of between $250 million and $300 million in the first half of this financial year. The extent of those losses will be revealed on Thursday.

Qantas is still grappling with losses within its international business, where the industry has been transformed by the emergence of the Middle Eastern airlines with their new fleets and their access to capital. The sector will be transformed again as China’s carriers spread their wings.

It is also battling against a resurgent and ambitious Virgin in the domestic market.

Backed by three Qantas competitors – Air New Zealand, Singapore Airlines and Etihad Airways – former Qantas long-standing executive John Borghetti has significantly expanded the group and added control of Tiger Australia and SkyWest to the Virgin portfolio. He is also aggressively attacking Qantas’ former dominance of full-fare and premium seats and the higher yields they generate.

Given Virgin’s significant cost advantage – estimates range from just over 10 per cent to about 18 per cent – Virgin’s onslaught represents an existential threat to Qantas unless it can narrow that cost disadvantage.

In trying to defend its yield premium – which is the point of its 65 per cent market share ‘line in the sand’ – Qantas has been pushed into losses. Meanwhile, Virgin has continued, with some success, to position itself as a viable option for business travellers. 

The $350 million recapitalisation of Virgin, largely by its three strategic shareholders, shook Qantas’ conviction that Borghetti would be unable to sustain his attack on its core franchise. It forced the new and inevitably brutal review of its costs, triggered a strategic review of its portfolio in which no options have been ruled out and caused it to ask Canberra for help.

Those expecting the results of the strategic review to be unveiled on Thursday may be disappointed. It is possible that Qantas will announce the sale of one or more of its terminals: it is said to be in advanced negotiations over its Brisbane and Melbourne terminals, but at a less developed stage in relation to its Sydney terminal. However, the investigation of options like the spinning-out or partial sale of its Frequent Flyer program or Jetstar brand are thought to be in their development phase (and are unlikely anyway). Selling the terminals could raise up to $1 billion.

The Abbott government has made it clear that Qantas has to demonstrate a commitment to significantly improving its own conditions and addressing its legacy costs structure if it is to receive help from Canberra.

Transport Minister Warren Truss said today that the government would seek to amend the Qantas Sale Act to “level the playing field” by removing specific restrictions on the foreign ownership of Qantas and the requirement that dictates that the majority of its operations are based in Australia.

The politics of the Senate make it most unlikely that the government will be able to get those amendments through Parliament. Un any case, to the extent that they would provide any benefit to Qantas, those benefits would be longer term.

There’s unlikely to be a queue of foreign airlines or investors lining up to buy big slice of the group. Qantas would be unlikely to want to issue strategic slabs of equity at or around its current share price. Opening up its register to higher levels of foreign ownership would probably only make it more vulnerable to a private equity break-up play.

What Qantas really wants – and what Joe Hockey has indicated it will get if it can commit to improving its competitiveness and profitability on Thursday – is a government-guaranteed line of credit.

The government has made it clear that any such facility would come at an extremely punitive cost if it were drawn on. However, the point of the facility would be to convince credit ratings agencies to restore Qantas’ investment grade rating and lower its overall cost of debt by being able to point to access to the facility in an emergency.

Qantas also sees the creation of such a facility as a signal to Virgin’s government-owned shareholders to ensure that competition in the domestic market – which is a duopoly – is rational and commercial.

In the longer term, it knows it has to reduce the cost advantage Virgin enjoys while maintaining its yield premium in the domestic market. This also implies that it needs not necessarily to have a minimum 65 per cent market share, but to at least retain the disproportionate share of the market it has built on its frequency advantage.

Virgin has effectively acknowledged that it too is losing money. It said that its first half result was likely to be “materially in line” with the median forecast of analysts of a loss of around $49 million. That excludes the losses of its 60 per cent-owned Tiger Australia business and ‘one-off’ restructuring costs.

It is an indication of how irrational the settings within the industry have become: with a domestic profit pool estimated at between $500 million and $1 billion a year depending on the state of the economy, the duopolists are likely to lose around $300 million between them in a six-month period.

With Qantas unveiling its survival plan on Thursday and Virgin producing its results on Friday, we’ll get a better chance to see whether there is any near-term prospect that the shredding of earnings and capital could abate.