Qantas should refocus on Asia from Emirates codeshare distraction

Since the emergence of media reports on Dubai-based Emirates Airline’s talks with the struggling international unit of Qantas Airways on a potential codeshare accord, the share price of the flying kangaroo has soared from a bottom level at 99 Australian cents on 25th July, a day before the codeshare talk between the carriers was first reported, to as high as A$1.14 on July 31st, it has been hailed by industry analysts as a deal that will reduce Qantas International’s loss and free up its capital resources to focus on its expansion in Asia.

An Emirates codeshare deal with Qantas International, a Macquarie Group analyst said, will add over 40 one-stop destinations in Europe and will reduce Qantas International’s costs by as much as A$600 million by suspending its route to Frankfurt.

“We’ve been engaging with them for some time. The objective is to eventually see Qantas fly through Dubai,” Emirates chairman Sheikh Ahmed bin Saeed al-Maktoum said.

Qantas currently only serves London Heathrow and Frankfurt via Singapore while relying on a two-stop product offering to European destinations such as Paris, Rome, Milan, Brussels, Munich, Amsterdam and more via a codeshare with fellow oneworld alliance member British Airways (BA) at its hub in London Heathrow.

In comparison, Emirates not only has flights to major European capital cities, but it also has direct flights from Dubai to smaller cities such as Lyon, Nice, Venice, Manchester, Glasgow, Newcastle, Dublin, Birmingham, Prague, Warsaw, Hamburg and many more.

“Qantas today confirmed it is in discussions with a number of airlines about potential alliances. These airlines include Emirates, among others. Strengthening alliance partnerships is one of the four pillars of the Qantas Group’s five-year strategy,” Qantas said in a July 26th statement to the Australian Stock Exchange (ASX).

Image Courtesy of timdath

Singapore likely to continue to be strong hub for Qantas
The talk on a potential codeshare deal with Dubai-based Emirates is Qantas’ latest effort to stem the loss at its struggling international unit, which is expected to reach A$450 million and drag down Qantas Group’s FY2011/12 full-year profit before tax (PBT) by 90% to A$50-100 million and record a first-ever net loss since the airline’s public listing in 1995 (“Qantas on a wing and a prayer“, 19th Jun, 12).

The Qantas-Emirates codeshare deal would bring more European destinations than the Virgin Australia-Etihad Airways alliance in which the Abu Dhabi-based carrier holds 4.99% shares of the second-largest Australian carrier and is cleared by the Australian government’s Foreign Investment Review Board (FIRB) to increase the stake to a maximum of 10%. The Virgin Australia-Eithad Airways alliance serves around 30 European destinations whereas the potential Qantas-Emirates offers around 40 destinations.

Such a Qantas-Emirates codeshare deal would involve shifting flights from Singapore to Dubai, a Middle Eastern destination Qantas does not currently serve, and would undermine the Australian carrier’s strong partnership with British Airways (BA) as well as hurt one of Qantas’ fiercest international competitors – Singapore Airlines, analysts say.

For instance, a Qantas-Emirates codeshare partnership would provide more than 55,000 outbound weekly seats from Australia/New Zealand to Europe, versus Singapore Airlines’ 40,000 weekly seats and Qantas’ existing capacity of 28,000 weekly seats, according to an analyst research by Bank of America Merrill Lynch analyst Matthew Spence.

As 25% of the air traffic from Australia to Europe shifted from Asia to the Middle East in the past few years, Singapore Airlines (SIA) would face increasing price pressure to lure passengers to continue to transit through the Southeast Asian city-state from which the Australia-Europe traffic accounts for just over 25% of the Singaporean flag carrier’s passenger revenues (“Singapore Airlines needs a strategic rethink“, 1st Aug, 12).

However, Singapore is likely to remain as Qantas’ primary hub in Southeast Asia. While Dubai does offer a geographically advantageous proposition mid-way on the Kangaroo Route, Singapore is strategically much closer to high-growth air travel markets in Indonesia, The Philippines, China and India, in which China’s steady growth in its economy would spur an increase in air travel demand and the rise in the number of middle class would spur more demand for full-service air travel.

Singapore-based Jetstar Asia also has a strong presence in Singapore, where the combined Jetstar Group operates 520 of 6,200 weekly flights at Singapore Changi and plans to launch routes to European destinations when it takes delivery of its first batch of Boeing 787-8 Dreamliner beginning in August 2013. Jetstar Group has a capacity share of 7% at Singapore Changi whereas Qantas only has a 4.6% share or 130 weekly flights at the airport.

As Jetstar takes delivery of its Boeing 787-8 Dreamliner next year, the low-cost carrier (LCC) would be able to launch new flights to destinations in inner China such as Chengdu, Chongqing, Urumqi and northeastern ports Tianjin, Qingdao as well as tap into the low-cost travel demand of other Asian cities such as Busan and Seoul in South Korea, where the Northeast Asian LCC penetration rate remains low with Japan’s LCC penetration rate at 9.1% compared to 38.1% for Southeast Asia.

In consolidating around the hub of Singapore Changi, this will further strengthen Jetstar’s network and bode well for Jetstar to face competition such as Singapore Airlines’ wholly-owned low-cost long-haul subsidiary Scoot Airlines as Jetstar has already established a stranglehold in Changi with numerous destinations such as Kuala Lumpur, Medan, Yagon, Penang, Phuket, Jakarta, Surabaya, Denpasar, Ho Chi Minh City, Taipei, Siem Riep, Da Nang, Hanoi, Shantou, Nanning, Hangzhou, Haikou, Ningbo, etc., that are expected to show strong growth as low-cost travel takes flights in the region which makes air travel affordable and feasible for many Asians who could previously not have flown on an airline.

Moreover, Singapore is likely to further receive Qantas’ investment in premium travel. Not only is Qantas spending US$8 million to upgrade its first class passenger lounge in Singapore Changi’s Terminal 1, any intra-Asian premium carrier which operates a wide First Class cabin with an economy class onboard an Airbus A320 and re-engined A320neo (new engine option) aircraft is likely to be based in Singapore Changi for a myriad of reasons.

First of all, Singapore is a premium hub from which airlines such as Qantas can derive higher yields, despite the considerably higher cost than neighbouring Kuala Lumpur. This is evidenced by the fact that Singapore remains Australia’s top transit hub for Europe with 17.2% of passenger movements, followed by Hong Kong with 8% of passenger movements excluding Auckland in 2011, according to the annual international airline activity report released by the Australian government’s Bureau of Infrastructure, Transport and Regional Economics (BITRE).

Next, while creating a oneworld hub in Kuala Lumpur is a feasible solution over the long term, it demands much closer co-operation between fellow oneworld members British Airways (BA), Qantas and Malaysia Airlines (MAS). Neither British Airways (BA) nor Qantas currently serve Kuala Lumpur whereas only Malaysia Airlines flies non-stop from Kuala Lumpur to London Heathrow. Coupled with Malaysia Airlines breaking away from Qantas’ RedQ potential partnership talks which Aspire Aviation understands as being impeded by Malaysian government bureaucracy, Aspire Aviation believes the window of possibility for a Kuala Lumpur-based intra-Asia premium carrier, RedQ, is all but gone.

Growth in passenger movement from Australia to/via Singapore remains robust at a 27.2% rate in 2011 versus 2010, with 6.23 million passengers being carried, up from 4.9 million in the prior year, despite a proportionately faster 29.7% growth in passenger movement between Australia and Malaysia from 2.0 million passengers in 2010 to 2.59 million in 2011.

According to Aspire Aviation‘s calculations using BITRE figures, Malaysia Airlines has shown a significant weakness in the number of passengers being carried to Australia, recording an 8.8% decline in number of passengers from 491,971 to 448,898 in the first 5 months of 2012. This is against a backdrop when Singapore Airlines (SIA) grew the number of passengers carried significantly by 24.6% from 1,023,853 to 1,275,931 in the 5-month period, as well as Emirates’ staggering 26.3% growth in passenger number to Australia from 780,890 to 986,270 in the 5-month period. Eithad Airways and Qantas’ numbers of passengers, in the meantime, grew by 17% and just 3.6%, respectively.

“Giving up Changi Airport is just too risky for Qantas,” UOB Kay Hian aviation analyst K. Ajith commented.

Nonetheless Aspire Aviation believes Qantas should launch flights from Sydney to Kuala Lumpur and enter into a codeshare agreement with Malaysia Airlines (MAS) as MAS would add Amsterdam, Brussels, Paris, Oslo, Stockholm, Copenhagen, Helsinki, Bergen, Stavanger and Gothenburg to Qantas’ Australia-Europe one-stop offering. In addition, a Qantas-MAS codeshare agreement would satisfy the medium-term needs for one-stop product offering to Europe via Kuala Lumpur before a Singapore-based RedQ expands internationally and taps into the lower cost base of Singapore than in Australia for Qantas-branded flights on the Kangaroo Route.

Image Courtesy of Keith McInnes

Refocus on Asia
As the Emirates codeshare talk does show Qantas’ intention to alleviate some of the European network deficiencies previously highlighted by Aspire Aviation (“Qantas sets sight on Asian growth despite challenges“, 23rd Feb, 12), Qantas has to refocus on its foremost expansion in Asia as scarce capital resources imply a relatively high opportunity cost in not utilising the capital resources for better return on investment (ROI) in Asia.

Indeed, Qantas has plenty of reasons to focus on an Asian expansion, not least because the European market is a mature one and the continent is deeply mired in a sovereign debt crisis whose end has been hoped for and failed in vain for the past 2 years without any drastic measures taken by European policy-makers, but also Asia is a growth market where every airline in the world wants a bigger portion of the larger and larger pie.

Therefore an Emirates-Qantas codeshare deal is primarily a shift in the mid-way hub in an existing business, rather than creating new business in strong growth markets such as China and India.

Importantly, Chinese carriers have been growing their numbers of passengers to Australia strongly since the start of 2012, with China Southern being the leader of the “Big Three” as the Guangzhou-based carrier’s number of passengers being carried rose by 27.9% from 197,998 to 253,207 in the first 5 months of 2012. China Eastern (CEA) followed with a 27% growth in its passenger numbers to Australia from 108,317 to 137,598 in the 5-month period year-over-year. Air China recorded a marginal 1% growth in the figure from 124,860 to 126,180 in the 5-month period in 2012.

Whereas the Chinese carriers and Hong Kong-based Cathay Pacific, of which the latter has a 8.4% solid growth in number of passengers to/from Australia from 570,520 to 618,563 in the 5 months of 2012 year-over-year, Qantas’ Australia-China operation to Shanghai Pudong only managed to grow by 1.7% from 58,875 passengers in January-May 2011 to 59,900 in the same period in 2012.

The aforementioned figures also showed that Qantas’ China operation is a full 4 times smaller than those of China Southern, around 2 times smaller than those of Air China and China Eastern when only taking Qantas’ operation in Mainland China into account, and 2.6 times smaller than Cathay’s 618,563 passengers carried in first 5 months of 2012 versus Qantas’ 237,235 passengers when only their Hong Kong operations are considered.

As Australia’s mining boom attracts significant investment from Chinese businesses and spurs leisure in addition to business travel demand, Qantas should have capitalised on the opportunity China brings much better. One example is launching non-stop flights between Beijing and Sydney, a route which only Air China  currently serves. Qantas did launch a thrice-weekly Beijing-Sydney non-stop flights in January 2006 on an Airbus A330-300 but suspended the route in 2009, opting to boost frequencies to Shanghai from 5 times a week to daily, which was followed by Air New Zealand (ANZ) in suspending its Auckland-Beijing non-stop route earlier this year.

While suspending the routes and focusing on business-heavy non-stop route to Shanghai in the interim make sense, Aspire Aviation continues to believe Qantas should relaunch the non-stop Sydney-Beijing routes as soon as the game-changing Boeing 787 Dreamliner aircraft enters into its fleet, which will open new markets in the long-haul thin routes whose business cases were previously not feasible. Other examples include Kunming, a strong premium Chinese hub, Urumqi, Chengdu, Chongqing, etc.

Image Courtesy of JUBES747

Virgin Australia better placed for international growth
While Qantas has an established brand and a very strong domestic Australian business with a 65% market share, Virgin Australia is arguably better placed for international growth with a capital-lite business model that establishes a solid foundation from which to grow when Australia’s second-largest carrier launches new non-stop flights to Asia, most probably to Hong Kong as its first step albeit with limitations in air traffic rights between Hong Kong and Australia, Aspire Aviation has learned.

Virgin Australia’s shareholders include Air New Zealand at 19.9%, UK multibillionaire Richard Branson’s Virgin Group at 26% and Etihad Airways’ 5.99%, with the permission to raise the Abu Dhabi-based carrier’s stake to 10% which drew significant criticisms from Qantas.

“As a very proud Australian, I know that this is not representative of the market or the country or the people. It is a great shame the business [Qantas] has used this as a tactic. The UAE has a great relationship with Australia in trade, defence and in a whole range of areas. In other markets, we have not seen these sorts of reactions from national carriers. To see it being used to mask their own real issues is disappointing,” Etihad Airways chief executive James Hogan told The Australian.

“What we won’t do is get into a position where it means we take control of the business. We can’t run an Australian airline from Abu Dhabi, nor do we intend to,” Hogan stressed, despite saying Etihad would review whether to raise its stake beyond the 10% level to as high as 19% in Virgin Australia.

“There’s a lot of misinformation and a lot of jumping at shadows in the market. I think people should take a cold shower,” Virgin Australia chief executive John Borghetti concurred.

“The equity investment doesn’t really impact the alliance that we have because it’s such a strong alliance, and it’s been working very well for both of us,” Borghetti reiterated.

Importantly, while Qantas has sold part of its catering business and is likely to sell other non-core businesses such as Star Track Express, Australian Air Express and Jetset Travelworld, Virgin Australia is more operationally efficient and has a lower cost base, with the turnarounds at Sydney and Melbourne at 35 minutes versus Qantas’ 55 minutes.

Qantas’ cost is around 20% higher than Virgin Australia yet it used to command a 35%-40% yield premium, which has virtually been fully eroded in recent dramatic decline in domestic business fare to the lowest level since 1996 and is 40% lower than just one year ago.

“We’re comfortable with that level but we’ll be competitive, and if the fares drop further we’ll be competitive in that market. There was no competition at the top end since Ansett stopped flying, so we deliberately entered that market. We knew the fares were very high and we could bring competition at lower fares with better service. That’s exactly what we have done and I think you’ll find that the fares have dropped more than 20%,” Virgin Australia chief executive John Borghetti told ABC’s Inside Business programme.

Instead of shrinking its international business further and slashing cost by grounding its entire fleet last year whose decision is generally supported by Australia’s business community, Virgin Australia is relying on superior product and service offerings on the transcontinental market to lure business travellers to it and help it reach a 20% share in the domestic premium market, in which Virgin Australia is exceeding its expectations so far.

“We are not interested in fare wars or capacity wars. If it does get to that state, we have a significantly lower cost base than Qantas. We think we have opportunities to even widen that gap further. If you get down that road where people think you can turn the market with lower fares or excess capacity, usually a lower cost provider wins that game,” Virgin Australia chief operating officer (COO) Sean Donohue said.

“The volumes have been very very strong. We are not too worried about the capacity on those two markets. The question we will look at over the next couple of years is Brisbane-Perth. Having worked in the US industry for 24 years, I have seen what a singular focus on market share can do to airlines – it can put a lot of airlines in bankruptcy. Our focus is not a line in the sand about market share,” Donohue commented.

Image Courtesy of flyertalk

An interesting tie-up for Virgin Australia, in Aspire Aviation‘s opinion, would be Hong Kong-based Cathay Pacific Airways’ wholly-owned subsidiary Dragonair. First of all, Cathay Pacific has a very strong operation to Hong Kong with a 8.4% year-over-year growth in passengers number to/from Australia ending May 2012. Moreover, codesharing with Cathay Pacific on Hong Kong-Sydney route and Dragonair from Hong Kong-China routes would grant instant access to many secondary Chinese destinations that are unmatched even by Singapore Airlines and SilkAir.

Dragonair operates flights to Wuhan, Qingdao, Xi’an, Chengdu, Chongqing, Guilin, Hangzhou, Changsha, Kunming, Xiamen, Fuzhou, Ningbo, Sanya, Shanghai, Beijing, Guangzhou, Fuzhou in China, Fukuoka and Okinawa in Japan, Jeju, Busan in South Korea, Taipei, Taichung and Kaohsiung in Taiwan.

In comparison, SilkAir only serves Wuhan, Changsha, Kunming, Shenzhen, Xiamen, Chongqing and Chengdu in China, implying a codeshare with Dragonair would add 18 more new destinations to Virgin Australia than a codeshare with SilkAir would. While Virgin Australia’s sister airline, Virgin Atlantic, does operate a single Hong Kong-Sydney daily flight, the competition with Cathay Pacific is minimal as the latter has a significantly bigger operation with 4 daily flights.

Above all, Virgin Australia and Cathay Pacific have one thing in common: Qantas. Qantas and China Eastern Airlines (CEA) plan to start Jetstar Hong Kong from as early as first half of 2013, although its air operator’s certificate (AOC) application is still in review process and has yet to be granted approval.

Cathay Pacific has had very little co-operation with Qantas with no codeshare between the two on Hong Kong-Australia routes and is very likely to oppose Jetstar Hong Kong’s AOC application.

“It is also possible that conditions may be imposed on any approval given in Hong Kong. Accordingly, it may be difficult for the ACCC to authorise the proposed conduct in relation to Hong Kong if it is unclear whether Jetstar will be granted approval to operate flights within Hong Kong and, if it is granted approval, what the conditions of that approval may be,” Cathay Pacific wrote in a letter to the Australian Competition and Consumer Commission (ACCC).

While Virgin Australia does have a strong partnership with Singapore Airlines (SIA) and does not have talks with Cathay Pacific before, such a tie-up along with Virgin Australia launching flights to Hong Kong would be worthwhile in exploring.

Last but not least, Qantas International chief executive Simon Hickey said in a staff memo that “of course, as we transform, we’ve got to keep our existing customers and attract new ones and we’ll be aggressively competing for every dollar of revenue. With all the media coverage about how much money international is losing, it’s easy to forget we actually have solid foundation from which to build”.

Quite frankly, Aspire Aviation agrees and it is time that Qantas International grow again with Qantas-branded flights in Asia, along with its oneworld partners Malaysia Airlines (MAS) and British Airways (BA), something it should focus on instead of being distracted by an Emirates codeshare deal that will benefit more to the Dubai-based carrier than to the flying kangaroo.