Qantas sets sights on Asian growth despite challenges

Notwithstanding a 52% drop in Australian flag carrier Qantas Airways’ financial year FY2011/12 first-half underlying profit before tax (PBT) from A$417 million in the prior year period to this year’s A$202 million (US$216 million), which resulted from a 26% increase, or A$444 million, in the underlying fuel cost from a year ago in addition to a special charge of A$194 million related to an unprecedented grounding of its worldwide fleet in response to escalating industrial actions, the oneworld alliance member sets its sights on Asian growth in air travel demand buoyed by burgeoning economies in the region to help improve its profitability.

Revenue of the Qantas Group grew 6% from A$7.6 billion in FY2010/11 to A$8 billion (US$8.6 billion) in the six months ending 31st December 2011, which was outpaced by a 9% increase in expenses to A$7.8 billion (US$8.3 billion) from A$7.1 billion in the corresponding period a year ago, leading to a 39% decline in the Qantas Group’s underlying earnings before interest and tax (EBIT) to A$277 million (US$296 million) in FY2011/12 from A$452 million in the prior year period.

Its low-cost unit Jetstar and its lucrative frequent flier programme once again contributed to the majority of Qantas Group’s profits, with Jetstar accounting for 53% of the airline group’s underlying earnings before interest and tax (EBIT) by posting a 3% increase in EBIT from A$143 million a year earlier to this year’s A$147 million whereas Qantas Frequent Flyer’s A$119 million EBIT during the six-month period accounted for 43% of the airline group’s earnings. Earnings before interest and tax (EBIT) at the namesake Qantas unit, meanwhile, plunged 60% from A$165 million in the prior year period to A$66 million in the first-half of FY2011/12, mainly owing to the higher fuel prices and fleet grounding during the period.

“Overall our business is strong, we are exerting financial discipline, and we are well placed to handle this complex economic and competitive environment. The results I have announced today show the resilience of the Qantas Group and our readiness for the future,” Qantas chief executive Alan Joyce said.

“We need to be ready to take tough decisions, and we must become more flexible and productive,” Joyce commented.

In response to Moody’s downgrade of the carrier’s credit rating in January as a result of soaring jet fuel prices, strong international competition and a challenging operating environment, Qantas has announced new measures to slash 500 jobs in light of its high maintenance cost which is “at least 30% higher than those of our competitors”, the decision not to renew the lease of Qantas QCatering facility in Adelaide, as well as a reduction in Qantas’ capital expenditure in 2012 and 2013 to A$2.3 billion from the respective A$2.5 billion and A$2.8 billion originally envisioned.

Moreover, the airline will cut unprofitable routes from Singapore to Mumbai and Auckland to Los Angeles from May onwards in addition to the previously announced termination of the Bangkok and Hong Kong to London Heathrow International Airport routes, replace the Boeing 747-400 aircraft being deployed on the Sydney to Bangkok route with Airbus A330 aircraft and the Sydney to Auckland routes with the Boeing 737-800 instead of the A330 currently being deployed, retire 2 additional 747-400 aircraft in addition to the 4 retirements of the ageing aircraft that were previously planned.

“Our savings will come from a range of initiatives including: reductions in non-aircraft capex [capital expenditure], deferral of B787-8 aircraft due to manufacturer delays, reductions in capacity growth requirements in the domestic market in financial year 2013 (bringing capacity growth in line with our long term demand estimate of 5%), and utilisation of a capital-lite model for any premium airline investment in Asia,” Joyce said.

Image Courtesy of timdath

Significant opportunities for Qantas’ Kuala Lumpur-based premium carrier
While negotiations on establishing Qantas’ Asia-based premium carrier are believed to be taking considerably longer than originally anticipated, and that the premium carrier, provisionally dubbed as “RedQ”, has evolved from being an Airbus A320 operator featuring “a top premium” product that is “better than the A380s” and gives “a private-jet feel” to business travellers to a capital-lite Kuala Lumpur-based joint venture (JV) with fellow oneworld member Malaysia Airlines (MAS) operating Airbus A330s, RedQ nevertheless has a bright and promising future in the rapidly-growing Asia/Pacific region should the challenges facing the carrier during the initial set-up process be successfully overcome.

In fact, the Kuala Lumpur-based premium regional carrier could potentially become a mutually beneficial endeavour for both Qantas, Malaysia Airlines (MAS) and to a lesser extent low-cost carrier (LCC) AirAsia, of which the two Malaysian carriers have reached a breakthrough deal in August 2011 to swap shares and start collaborating on the network strategy of the two carriers, thereby hopefully ending the bitter-sweet relationship that the two carriers previously had.

For struggling Malaysia Airlines (MAS) which is currently undergoing restructuring to return the carrier to profitability by 2013, the new premium regional carrier could enable MAS to focus on lucrative long-haul routes while the Qantas joint venture, regardless of whether the identity of RedQ will be retained or not at the time of launch, takes over the regional routes with a lower cost base made possible by the significantly lower airport charges and labour costs at Kuala Lumpur International Airport when compared to those at Singapore Changi Airport.

Most importantly, a strong alliance between fellow oneworld members British Airways (BA), Qantas and Malaysia Airlines (MAS), with a Kuala Lumpur-based RedQ focusing on intra-Asia premium traffic, coupled with oneworld’s existing strong Hong Kong hub where the alliance has a 37.1% of capacity share by the number of seats, or 51.8% of capacity share when taking into account oneworld affiliates’ seats offered, according to Innovata data, Qantas could be a main driver in developing and transforming Kuala Lumpur into an oneworld hub competing origin and destination (O&D) traffic between Europe and Australasia with Singapore Changi.

Admittedly, while developing Kuala Lumpur into a viable alternative long-haul transit hub takes much effort in co-ordinating schedules between oneworld members and requires many years to build it into a competitive one, particularly given the intensifying competition posed by the rapid expansion of Middle Eastern carriers with their hubs located between Europe and Asia, Kuala Lumpur has more room for Qantas’ RedQ premium carrier to grow than in Singapore, albeit the initial lower yields in traffic feeding into the Malaysian capital hub.

Singapore, which has long been the more popular transit hub than Kuala Lumpur, is an increasingly crowded marketplace amid growing low-cost competition. Low-cost carriers (LCCs) currently account for 26% of the capacity offered at Singapore Changi and this share is destined to grow further as Singapore Airlines’ wholly-owned low-cost subsidiary Scoot Airlines starts its operations this June or July and Qantas’ Singapore-based low-cost unit Jetstar Asia grows as it starts receiving the Boeing 787-8 Dreamliner in mid-2013.

Jetstar currently has 6.3% of capacity share at Singapore Changi and Qantas has 4.2%, whereas Malaysia-based AirAsia and Malaysia Airlines (MAS) have 8% and 2.3% shares, respectively. Tiger Airways and Singapore Airlines along with its SilkAir wholly-owned subsidiary, meanwhile, have 7.6% and 39.4% capacity shares at Singapore Changi, respectively.

Furthermore, developing Kuala Lumpur into a oneworld premium hub will arguably be complementary to Jetstar Asia’s existing hub at Singapore, since Malaysia Airlines and AirAsia could co-ordinate their route networks and schedules at Kuala Lumpur International Airport (KLIA) while Jetstar Asia and AirAsia continues to grow and compete at Singapore Changi.

In doing so, not only could RedQ maximise its yields by avoiding revenue cannibalisation and yield erosion at Kuala Lumpur through co-ordination with AirAsia, it could also enable Qantas to compete with Singapore Airlines (SIA) effectively in origin and destination (O&D) traffic, which is “missing out” a quarter of passengers at Singapore Changi, Scoot’s chief executive Campbell Wilson told Bloomberg.

“Strengthening the long-haul capability of the Singapore hub is key to tapping into growing markets across Asia and linking to our other networks, like Jetstar Japan,” Jetstar Group chief executive Bruce Buchanan said.

Coupled with the fact that the continuous expansion of Jetstar Asia and Scoot Airlines at Singapore is likely to make Singapore Airlines (SIA) facing a growing competitive pressure from low-cost carriers (LCCs) in the foreseeable future, which results in a slower growth in its premium traffic than low-cost traffic at other LCCs, building Kuala Lumpur into a stronghold for oneworld members Qantas and Malaysia Airlines (MAS) is achievable over the longer term and could secure more growth potential in premium traffic for RedQ going forward at a less competitive hub.

Image Courtesy of Bloomberg

Qantas needs to do more in the long-term on long-haul network
While Qantas’ Asia strategy is likely to pay off and bring solid profitability in the medium-term to Australia’s biggest carrier, Qantas needs to do more to address the shortcomings in its long-haul network to Europe and North America and make its international unit more competitive in light of lower cost international competitors such as Middle Eastern carriers Emirates Airline, Etihad Airways, Cathay Pacific and Singapore Airlines (SIA). Qantas only carries 18% of international traffic to and from Australia, a stark contrast to its 65% dominant domestic market share in Australia.

“Qantas International remains a weakness and a key focus. The reality is that even the strengths of the rest of our business will not be able to compensate for this issue over the long term,” Qantas chief executive Alan Joyce acknowledged.

“We face high competitor capacity growth into Australia. While we have a strong outbound travel market, the inbound market is flat and in particular there is a softening of demand for travel out of the UK and Europe,” Joyce conceded.

Aspire Aviation thinks Qantas’ Asia strategy is the proper one to address Qantas International’s issues in the medium term, as Qantas’ existing fleet does not have the capability to feasibly expand into European and North American destinations and that Qantas should put its mouth in where the money is. In addition, given the European sovereign debt crisis putting pressure on every airline’s European passenger business and long time needed for struggling European economies to conduct painful and deeply unpopular labour market reforms before their eventual economic recoveries, Qantas should seize on this opportunity to expand its Asia network first, before the arrival of next-generation long-haul aircraft enables it to expand its European and North American network to destinations whose business cases used to be unjustified and unfeasible.

Indeed, Asia holds a promising future for Qantas, especially as Asian economies continue to expand in spite of the economic malaise in Europe. For instance, Qantas has to strengthen its Asia network to key destinations such as Beijing which it currently serves through Jetstar Asia’s connecting flights from Singapore whereas Air China offers non-stop offering on the route.

Other potential destinations include non-stop routes from Sydney to Ho Chi Minh City, Hanoi in Vietnam, Mumbai instead of one-stop service in Singapore, Bangalore, Delhi, Chennai in India, Taipei in Taiwan, Osaka, Nagoya in Japan as well as Kuala Lumpur to bolster the Kuala Lumpur RedQ hub. Coupled with strengthened partnership between Qantas and Kingfisher Airlines, Japan Airlines (JAL) from these destinations onwards, this will position Qantas as a business airline favourably to tap into the rapidly-growing business travel demand to these countries with unparalleled economic growth.

However, in the longer term, Qantas has to utilise its long-range 787 Dreamliners on order to launch new routes to various key European business destinations, such as Paris, Rome, Zurich, Brussels, Amsterdam which Qantas passengers could only travel to by transiting at London Heathrow and fly eastwards on British Airways’ codeshare flights to these destinations that is time-consuming and inconvenient. The uncompetitive offering by Qantas on these routes put it into a disadvantageous position and that Qantas should utilise RedQ’s would-be Kuala Lumpur hub to reach these destinations that become commercially feasible by the arrival of new fuel efficient long-haul aircraft such as the Boeing 787. By the same token, Qantas could fly its fuel efficient 787s to new North American destinations such as San Francisco, Chicago, Vancouver and Toronto that also become viable once again by the arrival of next-generation aircraft.

Meanwhile, further cost-cutting is paramount to achieving profitability at Qantas International. According to Aspire Aviation‘s calculation based on Geneva-based industry body International Air Transport Association (IATA) guidelines, Qantas’ cost per available seat kilometre (CASK) is 50% higher than Singapore Airlines’ (SIA), 79% higher than Thai Airways International’s and a staggering 106% higher than Emirates’, highlighting the cost issue that Qantas International suffers from. According to Bloomberg, Qantas’ personnel costs as a percentage of sales have reached 28.6%, whereas similar figures for Cathay Pacific and Singapore Airlines stand at 15.4% and 14%, respectively at the end of June 2011, the latest figures available for all three aforementioned carriers.

Therefore eliminating redundant maintenance personnel in Australia makes sense as a result of the significantly reduced demand for maintenance by new long-haul aircraft and an attempt to trim costs. In addition, changes to the Qantas Sales Act unfairly penalise Qantas and the Act itself contains unfair regulations that no other Australian carriers have to face that are in sharp contrast to increasingly liberalised global aviation marketplace that sees cross-border mergers such as Air France-KLM, International Airlines Group (IAG) being formed by a merger between British Airways (BA) and Spanish carrier Iberia, the merger between Brazil’s Tam and Chile’s LAN Airlines that forms LATAM taking place.

In addition, while preserving capitals is necessary to maintain a strong balance sheet, Qantas should invest where appropriate towards its fleet renewal programme and the RedQ joint venture which could help develop Kuala Lumpur as an alternative, lower-cost hub competing with Singapore that has much more room for growth in premium traffic than Singapore, and make RedQ a true premium carrier with premium products and services.

Last but not least, Qantas’ strong financial performance, coupled with continuous cost reductions, will enable the flying kangaroo to capitalise on the growth in Asian travel demand with Jetstar Japan and RedQ being its latest endeavours and invest in a fuel-efficient fleet such as ordering or leasing more Boeing 787-9 Dreamliners that could not only substantially improve fuel efficiency and lower cost, but also enable Qantas to launch new routes to European and North American destinations that were previously not commercially feasible in the long term. Should Qantas stay the course despite short-term challenges and invest appropriately towards RedQ and a new long-haul fleet instead of delaying or cancelling new aircraft orders, the Australian flag carrier will be able to prosper and thrive with a focus on Asia.

Image Courtesy of Craig Hall