Qantas/Emirates partnership to reshape competitive landscape

The full-year FY2011/12 financial results of Australian flag carrier Qantas Airways paint of a bleak picture, as the flying kangaroo posted its first after-tax loss of A$244 million (US$254.8 million) since its privatisation in 1995, amid record high jet fuel prices and intense competition from Gulf carriers on the lucrative Australia-Europe, or “kangaroo route”. In response, Qantas cancelled its firm order for 35 Boeing 787-9 Dreamliners in order to rein in its capital expenditure and entered into a wide-ranging partnership deal with Dubai-based Emirates Airline that was once thought as impossible.

The Qantas/Emirates co-operation deal, pending regulatory approval from the Australian Competition and Consumer Commission (ACCC), is likely to alter the competitive landscape in international travel to and from Australia and level the playing field against the existing Virgin Australia/Etihad Airways partnership after the international unit of Australia’s biggest airline lost A$450 million (US$461 million) in FY2011/12.

While the Qantas/Emirates partnership is undoubtedly a step in the right direction with a 6.67% intra-day rise in its share price to close at A$1.2 a share, Qantas will still be facing headwinds on multiple fronts in the foreseeable future as domestic competition ratchets up, fuel price remains at record high despite a sluggish global economic recovery or the lack thereof and the self-inflicted damage done to Qantas International by cancelling all firm orders for the revolutionary 787-9 aircraft that could turn previously economically unfeasible routes into sustainable ones and tap into the rising international air travel demand from emerging economies in Asia.

Image Courtesy of Andrew McLaughlin

First-ever loss since privatisation
The Australian airline recorded a A$95 million underlying profit before tax (PBT), an 83% plunge from the A$552 million recorded in FY2010/11. This was against the backdrop of record earnings for its frequent flyer programme (FFP) and its wholly-owned low-cost carrier (LCC) Jetstar Airways as the financial results were dragged down by the loss in its namesake unit which was compounded by an unprecedented grounding of its entire fleet last October.

The namesake Qantas unit lost A$21 million in FY11/12, versus an earning before interest and tax (EBIT) of A$228 million in the prior fiscal year, which was weighed down by a A$194 million charge against industrial actions and an underlying EBIT loss of A$450 million at Qantas International whereas the combined domestic network of Qantas and Jetstar recorded an underlying EBIT of around A$600 million.

Revenue at the Qantas unit grew by 4.6%, although this was dwarfed by a 17% rise in fuel costs while unit cost measured in cost per available seat kilometre (CASK) without fuel largely remained stable at 0.7% higher despite a 1.1% growth in passenger capacity measured in available seat kilometre (ASK). The unit realised A$404 million in QFuture benefits despite the industrial action, which amounted to a A$1.4 billion cost saving across the last 3 financial years.

It also renewed 171 corporate accounts and won 48 new accounts, including 9 as preferred airline while losing 4 during the period.

In stark contrast to the Qantas unit’s dismal financial results, Jetstar and Qantas Frequent Flyers were the shining stars in the group.

Its Jetstar unit reported a strong 20% increase in earnings before interest and tax (EBIT) to a record A$203 million from A$169 million in the year-earlier period with ancillary revenues soaring by 27% from A$24.1 per passenger a year ago to A$30.6 per passenger this year and unit cost, measured in CASK without fuel, being at a record low which was a 2% year-on-year improvement and a 4% reduction from two years ago in FY2009/2010. Yield or revenue per revenue passenger kilometre (RPK), in the meantime, increased by 10% despite a 14% rise in capacity, or available seat kilometre (ASK), outstripping a 13% rise in passenger traffic in RPK.

Jetstar has achieved a staggering 38% compound annual growth rate (CAGR) over the past 5 quarters from 2.189 billion ASK in the second half of FY2009/10 to 4.181 billion ASK in the second half of FY2011/12. During the 12-month period, Jetstar established a new partnership with Vietnam Airlines for Jetstar Pacific and launched Jetstar Japan 5 months ahead of schedule, a joint venture (JV) in which Qantas Group and its oneworld partner Japan Airlines (JAL) each hold 33.3% of shares. It has carried 110,000 passengers with an 86% load factor from 3rd July to 21st August and its existing fleet of 4 Airbus A320s will grow to 13 by June 2013 with capital committed to basing 24 aircraft at the Japanese low-cost unit. It will commence international operations in the second half of FY2012/13 and its weekly departures will grow to 495 by end-FY2012/13 from 78 now. Its Jetstar Hong Kong joint venture (JV) with Shanghai-based China Eastern Airlines (CEA), meanwhile, is scheduled to start operations in mid-2013, pending regulatory approval.

Its Qantas Frequent Flyer unit, on the other hand, reported a 14% increase in normalised EBIT from A$202 million in FY10/11 to A$231 million in FY11/12 backed by a 9% increase in membership to 8.6 million from 7.9 million a year ago, whereas Qantas Freight’s EBIT declined by 27% year-over-year from A$62 million in FY2009/10 to A$45 million this fiscal year.

“Qantas has been through an exceptional period in its history over the past 12 months. Over the course of the year we made significant progress in advancing the Group’s strategy – building on our strong domestic business and frequent flyer programme and growing Jetstar across Asia. Qantas’ international turnaround plan is on track and set for improvement in 2012/13,” Qantas Group chief executive Alan Joyce said.

Overall, the Qantas Group registered a 6% growth in revenue from A$14.9 billion last financial year to A$15.7 billion in FY2011/12, which was outweighed by an 8% increase in expenses from A$14.3 billion last year to A$15.5 billion this year, including an 18% soar in fuel cost to A$4.3 billion from A$3.68 billion a year ago.

The Group as a whole flew 111.7 billion revenue passenger kilometres (RPKs), up 5% from 106.8 RPKs a year ago and matching the 5% increase in capacity, measured in available seat kilometres (ASKs) to 139.4 billion from 133.3 billion in the prior year period, thereby maintaining a passenger load factor at 80.1%. Yield, measured in revenue per RPK, rose 3% in the period to 10.99 Australian cents from 10.71 cents a year earlier, while comparable cost per ASK (CASK) including fuel and adjusted for the industrial action was down 3% to 5.37 Australian cents from 5.53 cents 12 months earlier.

Qantas’ balance sheet remained strong with a net debt to equity ratio of 0.608 times, although this ratio would amount to 1.29 times or 129% should off-balance sheet debt be included. Free cash flow (FCF) improved from -A$678 million in the first half of FY2011/12 to the second half’s A$206 million, albeit the overall cash position at the end of FY2011/12 still weakened from a year earlier by 3% to A$3.398 billion from A$3.496 billion at end FY10/11.

Though questions linger not least because of the 1.29 times net debt-to-equity ratio including off balance sheet debt, but also because the Qantas unit bore the brunt of the increase in fuel cost at 17% at the same time Jetstar’s unit cost sank by 2% year-over-year and a strong Australian dollar which should have provided a natural shield to the airline. Had Qantas taken advantage of the strong Australian dollar position, which strengthened by 4.4% during the period, its net fuel exposure would have declined by around US$350 million and saved the airline around A$150 million, according to Qantas’ former chief economist Tony Webber.

Image Courtesy of Bloomberg

Partnership with Emirates a step in the right direction
Nonetheless turning around the loss-making Qantas International unit remains the key to improving the profitability of the Qantas Group (“Qantas backpedals on poor results“, 28th Jun, 12).

As an important part of the Qantas International restructuring, Qantas has entered into a wide-ranging partnership with Dubai-based Emirates Airline that will see the flying kangaroo ditch its joint services agreement with its longtime partner British Airways (BA), switch its European flights from Singapore to Dubai and suspend the struggling Singapore-Frankfurt route while tapping into Emirates’ extensive European, Middle Eastern and North African networks.

“The 10-year partnership will go beyond codesharing and includes integrated network collaboration with co-ordinated pricing, sales and scheduling as well as a benefit-sharing model. Neither airline will take equity in the other,” Australia’s biggest airline said in a statement.

“This is the most significant partnership the Qantas Group has ever formed with another airline, moving past the traditional alliance model to a new level. It will deliver benefits to all parts of the Group,” Qantas Group chief executive Alan Joyce commented.

“The partnership delivers on all four pillars of the Qantas Group’s international strategy: it will see us fly to the global gateway city of Dubai, provide some of the world’s best travel experiences through both Qantas and Emirates, improve our network in Asia, and, crucially, help build a strong Qantas International business for the long term,” Joyce emphasised.

From next April onwards, Qantas will fly its daily A380 services from Sydney and Melbourne to London Heathrow via Dubai International Airport’s Terminal 3 purposely built for the Airbus A380, and Qantas will gain 33 one-stop destinations in Europe, including daily Emirates A380 flights to Paris, Rome, Munich, Amsterdam, Manchester and Moscow, in addition to 31 one-stop destinations in the Middle East and North Africa.

On a combined basis, Emirates and Qantas will offer 98 weekly services between Australia and Dubai and offer more than 55,000 weekly seats, even more than the 40,000 outbound seats offered by Singapore Airlines (SIA) on the kangaroo route, which derives just over 25% of its passenger revenue from the Australia-Europe flights, according to a research by the Bank of America Merrill Lynch in July.

The markets responded to the tie-up positively, with its share price soaring by another 5% to end at A$1.26 after rising another 6.67% a day earlier.

Analysts concurred and said the deal will improve Qantas’ underlying profit before tax (PBT) by A$80 million-A$90 million in FY2012/13 and by A$155 million to A$530 million in FY2013/14, according to Macquarie analyst Russell Shaw, whereas Credit Suisse forecasts a 7.2% rise in PBT in FY2013/14 to A$779.4 million in addition to Macquarie predicting a A$130 million and Deutsche Bank A$193 million improvement to PBT in FY2013/14.

“We believe an Emirates deal is the missing piece in the earnings bridge recovering mainline international for the A$450 million loss in the 2012 financial year to break-even by the end of the 2014 financial year,” Macquarie analyst Russell Shaw said.

As part of the deal, Qantas will by 31st March, 2013 end its joint services agreement (JSA) with International Airlines Group (IAG) which started in 1995, in addition to ending the codeshare agreements with Cathay Pacific and Air France on the Hong Kong-Rome and Hong Kong-Paris routes, respectively, while maintaining its codeshare agreement with Finnair on the Singapore-Helsinki route.

“Over the past 17 years the joint business with British Airways has been central to the Qantas network. However, global operating conditions have changed and partnership with Emirates is the right strategy for Qantas,” Qantas Group chief executive Alan Joyce acknowledged.

“We’re ending the joint business on amicable terms and support Qantas’ decision to work with Emirates. The world has changed since 1995 when the joint business started. This is a small part of our overall network and this move fits in with changes in our global strategy. Asia has become a key market focus for IAG and we’re talking to a number of airlines about alternative options for us. Qantas has made it clear that its international performance has been weak and the termination of the joint business won’t have any negative impact on IAG’s financial targets. The good relationship that we have with Qantas CEO Alan Joyce and his team will continue through our joint membership of oneworld,” said Willie Walsh, chief executive of International Airlines Group (IAG), parent of British Airways (BA).

Aspire Aviation thinks the Qantas/Emirates deal is a step in the right direction, as it offers the Australian carrier great value in gaining access to 33 new one-stop European destinations such as Paris, Amsterdam, Frankfurt, Rome, Madrid, Barcelona, Moscow, Munich, Zurich, Geneva, Lisbon and more, but also to smaller cities such as Lyon, Nice, Vienna, Prague, Hamburg, Birmingham, Newcastle, Glasgow, etc.

Moreover, the Qantas/Emirates deal more than levels the playing field and will reshape the competitive landscape once it is approved by the Australian Competition and Consumer Commission (ACCC), as its 33 new one-stop European destinations and another 31 new destinations in the Middle East and North Africa would easily surpass Virgin Australia/Etihad Airways’ existing partnership covering around 30 European destinations.

Most importantly, the Qantas/Emirates partnership deal will free up scarce capital resources to be diverted from Europe which is plagued by the ensuing sovereign debt crisis to refocus on its growth in Asia, as the soaring income and growing middle class spur premium air travel demand into which Qantas could tap the potential demand and seek better return on invested capital (ROIC). It also offers Qantas the flexibility to grow once again to numerous European destinations via Dubai a few years from now, although not until at least 2016 or so.

“Emirates is the ideal partner for Qantas. It has a wonderful brand, a modern fleet, an uncompromising approach to quality and it flies to the A-list of international destinations. As the world’s largest international airline, with a network that perfectly complements our own, Emirates will help us give our customers across Australia a dramatically expanded range of travel options,” Qantas Group chief executive Alan Joyce applauded Emirates Airline’s achievements.

“Together with Emirates, Qantas will provide a unique ‘one-stop’ hub service, as well as deeply integrated frequent flyer and customer benefits,” Joyce reiterated.

Image Courtesy of Bloomberg

Focusing on Asian expansion would allay shrinking concern
While the Qantas/Emirates partnership provides instant access to more than 70 European, Middle Eastern and North African destinations from 1st April next year onwards pending regulatory approval, which grants Qantas a significant flexibility in expanding its European network via Dubai once the European economy grows again while relying on Emirates for European access in the interim via a capital-lite business model, many concerns surrounding the future of Qantas International remain to be addressed.

First of all, the deal has to be approved by the Australian Competition and Consumer Commission (ACCC), since the revenue-sharing accord will result in a de facto elimination of a large competitor in the Australia-Europe market by having a combined 55,000 weekly seats.

“Obviously we will look very closely at any deal which sees Emirates fares move closer to the higher Qantas fares,” the Australian Competition and Consumer Commission (ACCC) chief Rod Sim told The Australian.

Unlike the Virgin Australia/Etihad Airways alliance which is up and running and helps propel the interline and codeshare revenue at Australia’s second-biggest carrier increasing 158% in FY2011/12 versus the prior financial year, the financial benefits of the full roll-out of the Qantas/Emirates alliance will take time to fully realise and what the final alliance would look like still hinges on ACCC’s regulatory approval, as Emirates’ fares may increase and match Qantas’ premium fares on the Falcon Route.

Furthermore, the Qantas/Emirates alliance is likely to see Qantas International shrinking further in the next 2.5 years until it breaks even by FY2015, unless Qantas International grabs the tremendous opportunities offered by the emerging economies in the Asia/Pacific region.

For instance, Qantas says its tie-up with Emirates would lead to a rescheduling of its Asia services and an increase in capacity to Singapore to significantly improve the timing of its price/service offerings.

“We currently have an Asian flying schedule based on travelling via Asia to Europe. But our Australian business customers want better access to Asia, and we have been looking to address this for some time,” Qantas Group chief executive Alan Joyce admits.

“With European services transiting through Dubai, Qantas’ Asian services will no longer be a subsidiary of the ‘Kangaroo Route’. Instead they will be dedicated to connecting Australians with our region, and Asian visitors to Australia. We will increase dedicated capacity to Singapore and re-time flights to Singapore and Hong Kong to enable more ‘same day’ connections across Asia. We believe this will significantly improve the economics of our Asian operations,” Joyce said.

Qantas says it will increase the connections from Singapore by 25% and increase the number of available seats from Australia to Asia by 40%.

In doing so, this would bode well for Qantas International in Asia as fast-growing economies such as Vietnam, Indonesia and the Philippines, as well as China and India, are still burgeoning despite an economic slowdown primarily owing to a decline in foreign exports to Western economies. And keeping the lounge upgrades at Singapore Changi and Hong Kong International Airport is unquestionably a right move for Qantas’ premium brand that further increases its appeal to business travellers.

However, Aspire Aviation believes the Boeing 787-9 Dreamliner would have helped turn around Qantas International much faster, after Qantas cancelled the firm commitments, or firm orders for 35 787-9s while bringing forward 50 options and purchase rights by 2 years to 2016, citing “significantly changed circumstances”.

“Qantas continues to practise disciplined capital management and, in the context of returning Qantas International to profit, this is a prudent decision. The B787 is an excellent aircraft and remains an important part of our future. However, circumstances have changed significantly since our order several years ago. It is vital that we allocate capital carefully across all parts of the Group,” Qantas Group chief executive Alan Joyce asserted.

“50 B787-9s will remain available to the Group from 2016, in line with the timeframe of the Qantas International turnaround plan. We have the right fleet strategy to deliver continued customer satisfaction and position us for sustainable growth over the long term, while enabling us to retain flexibility and manage our capital requirements appropriately,” Joyce stressed.

As a result of the order cancellation, capital expenditure will reduce by US$8.5 billion at list price and Qantas will receive a total cash influx of US$433 million, US$355 million of which will be realised in FY2012/13, including US$140 million in the first half.

Image Courtesy of Qantas

With Qantas chief executive Alan Joyce indicating a change in fleet mix on its Asia flights, Qantas does have a much greater need for the 15 Boeing 787-8 Dreamliner aircraft scheduled to be delivered to Jetstar in the second half of 2013 than the LCC subsidiary, in order to tap into the niche long-haul thin routes to destinations in emerging economies in Asia.

Most importantly, the Australia-Asia origin and destination (O&D) market is traditionally served by an intermediate hub such as Singapore Changi, with it being a large O&D hub for transit traffic to India and Southeast Asia. With the game-changing 787-8 which will reduce block fuel burn by 20% and a 15% lower operating cost (“Boeing 787 Dreamliner programme starts to soar“, 23rd Aug, 12), Aspire Aviation thinks shifting the 787-8 from Jetstar to Qantas would indicate that Jetstar has not overtaken Qantas’ needs and that Qantas is not being overlooked at and neglected as the track record in the past few years may prove otherwise.

The 787-8 will open up new long-haul, thin markets that will bypass a stop-over with Air India launching new non-stop routes from Delhi to both Melbourne and Sydney later this year. Likewise, Qantas International should deploy the 787-8 to reinstate its non-stop flights to Beijing which it launched in January 2006 and suspended in 2009 as the air travel demand to Beijing and Shanghai is more directional with passengers flying into Shanghai and flying out from Beijing, and vice versa, a lower-yield market with a larger leisure composition in passenger traffic.

In doing so, Qantas would serve both cities with the 787-8 without which the Beijing service would have been economically unfeasible. Other similar cities include Seoul in South Korea, Hanoi and Ho Chi Minh City in Vietnam, Bangalore and Mumbai in India, Chengdu and Kunming in China and fellow oneworld member Malaysia Airlines’ hub in Kuala Lumpur.

Growing in Asia is paramount for the long-term future of Qantas and Qantas’ management should be keenly aware of this (“Qantas should refocus on Asia from Emirates codeshare distraction“, 7th Aug, 12). Yet Qantas is being left behind in the first 6 months of 2012 in the growing air travel market between Asia and Australia, particularly in China. According to Aspire Aviation‘s calculation using the Bureau of Infrastructure, Transport and Regional Economics (BITRE) monthly data, Qantas’ Australia-China operation excluding Hong Kong only grew by 1.27% from 69,358 passengers carried in the first 6 months of 2011 to 70,242 passengers in the same period this year.

In stark contrast, Guangzhou-based China Southern Airlines witnessed a growth of 26.5% in the number of passengers carried in the same period from 237,880 a year ago to 300,813 this year. Similarly, Shanghai-based China Eastern Airlines (CEA) enjoyed a 30.4% growth in the same measure in the first half of 2012 from 126,285 in 2011 first-half to 164,656 in 2012 first-half, though Air China only has had a 2.2% growth in the number of passengers carried from 146,044 in 2011 first-half to 149,291 in 2012 first-half.

Expanding in the world’s second-largest economy again would symbolise that Jetstar is no longer growing at the expense of Qantas International and that Qantas International is making the most efficient use of scarce capital resources to maximise its return on investment (ROI) with the emphasis shifting from Europe to Asia as focusing on its European operation given the disastrous state of the Eurozone economy carries too high an opportunity cost.

“Qantas is one of only two companies it and Telstra where Australians see them as a reflection of themselves. Qantas now is undergoing a crisis of management because a wrong decision was made about a chief executive. There is nothing good about Qantas anymore: the marketing is wrong, its advertising is wrong and the persona of the company is wrong,” advertising mogul John Singleton told The Australian in an interview, whose “I Still Call Australia Home” advertising campaign is his brainchild.

“When they start announcing record losses instead of record profits and the solution is no new planes, you know they haven’t got a clue,” Singleton lamented.

“If Borghetti and Joyce swapped airlines, the Qantas share price would go up and Virgin’s would go down, no question,” Singleton asserted.

Indeed, not only does Qantas have to shift the emphasis of its international operation from Europe to Asia, but also has to change its short-term management style to the one with a long-term vision.

In cancelling the 35 787-9 firm orders, while it helps the bottom line in the short-term with the US$433 million cash inflow, Qantas will have to exercise its 35 or more of its 50 787-9 options sooner rather than later, as the 787-9 carries 40 more passengers and can fly 300nm (nautical miles) longer than the 787-9, which would be suitable for those fast-growing secondary Asian destinations by 2016. Had Qantas kept the 35 787-9 firm orders, it would have offered Qantas more flexibility in its fleet plan to match demand with capacity more accurately, in addition to retiring the remaining Boeing 747-400 aircraft much faster, thereby saving a significant amount of fuel.

“That aircraft [Boeing 787-9 Dreamliner] is a phenomenal aircraft for a range of destinations through the Dubai hub into Europe,” Qantas chief executive Alan Joyce said.

“That gives a real growth opportunity so you can absolutely see this deal in the long run being extremely positive for jobs in Qantas, extremely positive for the growth of Qantas International. And the ability for us to work together on things like that through this venture is absolutely massive,” Joyce commented.

The Boeing 747-400 burns 3.5 litres of fuel per passenger per 100 kilometre, whereas the 787-8 and 787-9 burn 2.6L and 2.4L, respectively.

Qantas now plans to refresh the interiors on 16 of its 23 Boeing 767-300ER aircraft, of which its entire 767 fleet will be retired by 2015. It retired 5 Boeing 747-400s, 2 767-300ERs and 7 737-400s in FY2011/12 and plans to retire another 5 747-400s, 5 737-400s and 1 767-300ER in FY2012/13.

Image Courtesy of flyertalk

‘Game On’ with Virgin Australia
While the Qantas/Emirates alliance is a right decision, the Standard & Poor’s downgrade of the carrier to BBB- with a stable outlook, the lowest investment grade above junk status, speaks volume of the challenges Qantas is going to face in the foreseeable future, with Qantas Domestic being besieged in the domestic battleground.

Its arch-rival Brisbane-based Virgin Australia has achieved the target of having 20% of its domestic revenue from the corporate and government market 1 year ahead of schedule and plans to increase its domestic capacity, measured in available seat kilometres (ASKs) by 8%-9% in the first half of FY2012/13, after growing domestic ASK by 9.6% in FY2011/12, whereas Qantas Domestic plans to increase capacity by 9%-11% in the first half of FY2012/13, with a 3%-4% overall growth in group capacity.

“I have been around a long time – 40 years, and I haven’t seen discounting to this level since way before Ansett stopped flying. There is a lot of aggressive competition but frankly we were expecting it and we will be as competitive as we can be to ensure we hold our position. We do have a cost advantage on our side,” Virgin Australia chief executive John Borghetti commented.

Still, Virgin Australia managed to turn around its domestic business with a A$115.6 million earnings before interest and tax (EBIT) in FY2011/12, reversed from a A$36.4 million loss in the prior year period even with the increased capacity and domestic yield surged by 12.2% against a 1% drop in domestic load factor to 79% from 80% as the 9.6% addition in capacity from 22.2 billion ASK in the year-earlier period to 24.3 billion this year outpaced a 5.6% rise in the number of domestic passengers from 16 million in FY2010/11 to 16.9 million in FY2011/12.

“Our progress in attracting higher yielding corporate and government customers has been a key driver of our improved profitability. This segment now makes up 20% of our domestic revenue and, encouragingly, over the last three months we have averaged above this level,” Virgin Australia chief executive John Borghetti says.

“Importantly, reaching the 20% target is a tipping point which we believe effectively creates a new competitive norm,” Borghetti believes.

However, Qantas is virtually locked in matching Virgin Australia’s increase in capacity in order to maintain the “profit-maximising” 65% domestic market share, thereby giving Virgin Australia a significant strategic advantage in the domestic market. Qantas has already seen softening signs in its domestic business, with the number of domestic passengers carried in July 2012 declining 2.6% year-over-year and the load factor sinking 4.3% to 77.7%. According to BITRE’s domestic airfare index, the domestic business class fare has fallen 24.8% year-over-year in August 2012 and the best discounted economy fare was 9.4% lower than a year ago. The restricted economy fare saw a marginal 1.76% increase in the same period.

Qantas said it enjoyed a 30%-40% revenue premium despite a 20% cost disadvantage against its domestic competitors, but the softening domestic yields at Qantas, coupled with the 24.8% drop in average business class fare, indicate that the revenue premium is likely to be more than halved, if not wiped out altogether.

Source: BITRE

The robust domestic business of Virgin Australia lays a strong foundation and positions it well for international expansion, as it has the flexibility of redeploying its domestic capacity overseas should the overcapacity issue in the domestic market worsen. Its international unit saw its earnings before interest and tax (EBIT) improved by 58% to A$35.4 million in FY2011/12 along with a 158% increase in interline and codeshare revenue. This was achieved even when the international unit carried marginally less passengers from 2.6 million to 2.5 million and was against a 3.4% increase in capacity which led to a 2.2% drop in international load factor to 77.4%.

Meanwhile, Qantas’ cancellation of 35 firm 787-9 orders has yielded considerable advantage to Virgin Australia internationally as it shortens the early-mover advantage Qantas International retains to just 1-2 years instead of 2-3 years should it exercise 35 or more of the 787-9s on options and purchase rights which will start arriving from 2016 onwards, while Virgin Australia evaluates its widebody needs beyond 2017, unless Qantas decides to allocate the 15 787-8s originally destined for Jetstar to Qantas International as Aspire Aviation proposed.

“We’ve got a good fleet composition now that will take us in terms of widebody well into 2017 and slightly past that. But I think it is fair to say that sometime within 12 months we’d like to make a call,” Virgin Australia chief executive John Borghetti said.

“They’re clearly the next generation aircraft and you have to do a proper evaluation of that but we’re in the early stages of this. It’ll be over the next 12 months but we’re not rushing it; it’s better to take your time and make the right decision than make the wrong decision,” Borghetti commented on the timing of a potential Boeing 787 Dreamliner or Airbus A350 order.

”As soon as we heard that [Qantas’ cancellation of 787-9 order], we did ring Boeing to see whether or not we could get our hands on some of them… but unfortunately, when we spoke to them those slots had been taken. There must be high demand for them if those slots were taken within literally hours of us calling,” Borghetti told The Sydney Morning Herald.

Should Virgin Australia opt to expand internationally, it could feasibly do so by leasing additional Airbus A330-200s and Boeing 777-300ERs in the short to medium term and launch flights to Singapore and Hong Kong, both of which are hubs or destinations served by its codeshare partners – Singapore Airlines (SIA) and Virgin Atlantic, respectively.

It could then codeshare with Singapore Airlines on flights onto India, Southeast Asia and China while entering into a joint maintenance and training pact with Singapore Airlines (SIA) or Eithad Airways in order to reduce expenses similar to the one signed by Eithad Airways and Air Berlin on the induction of Boeing 787-8 and -9 Dreamliners into their fleets. Once Virgin Australia decides on purchasing either the Airbus A350 or Boeing 787 Dreamliner, it could rely on virtually all of its partners for introducing the new aircraft type into its fleet as Air New Zealand (ANZ) is a 787-9 launch customer, whereas both Singapore Airlines and Etihad Airways have 787-9 and A350s on order, thereby reducing costs and ensuring a smooth introduction, or even helping secure early delivery slots.

Interestingly, Qantas chief executive Alan Joyce indicated the possibility of launching new trans-Tasman flights to previously unserved destinations in New Zealand, with Aviation Week reporting a codeshare with Emirates on the trans-Tasman market will initially be entered into and an application for scheduling co-ordination will be subsequently filed while mulling a revenue-sharing pact.

“Our trans-Tasman customers will benefit through greater frequencies and the potential for new routes,” Joyce said.

“Qantas and Emirates are willing to offer a formal commitment not to reduce overall trans-Tasman capacity, to address any potential residual concern that the partnership might lead to reduced capacity on the trans-Tasman. Qantas is also considering introducing flights on routes it doesn’t currently fly including Adelaide-Auckland and Perth-Auckland,” Qantas said in a statement on 10th September in submitting the application for an ACCC approval.

This would require Virgin Australia and Air New Zealand to up the ante by flying new 777-300ER or aircraft equipped with the highly-reclaimed Skycouch Economy Class seat and Premium Economy Class seat by Air New Zealand, or Virgin Australia flying its transcontinental A330-200 with complimentary hot meals and beverage on the trans-Tasman routes to compete with Emirates’ A380 services from Sydney to Auckland.

Nevertheless Virgin Australia has a strong foundation from which to grow, with a stringent cost control which saw only a 4.5% increase in unit cost measured in cost per available seat kilometre (CASK) excluding fuel yet the group revenue soared by 19.8% from A$3.27 billion in FY2010/11 to A$3.92 billion in FY2011/12, producing an earnings before interest and tax (EBIT) of A$151 million, an underlying profit before tax (PBT) of A$82.5 million and an underlying profit after tax of A$22.8 million, versus a pre-tax and after-tax loss of A$66.6 million and A$68.7 million, respectively a year ago.

Looking ahead, Virgin Australia will build upon the success it has with the “Game On” phase of its game change programme, a repositioning which increased the number of high-yield fares by 113% and the number of Velocity frequent flyer programme members from 2.5 million last year to 3.2 million this year. It will introduce an onboard Wi-Fi system later this calendar year and implement a shift to the Sabre reservations systems in early 2013, thereby enabling it to integrate the DJ International Air Transport Association (IATA) code into the VA code.

In order to widen its cost advantage, Virgin Australia will implement a cost-cutting programme totalling A$400 million over 2 years, in addition to improving its interline and codeshare revenue by A$150 million and grow the membership base of its Velocity frequent flyer programme to over 5 million by the end of FY2015.

Last but not least, the game-changing Qantas/Emirates tie-up has the potential to provide significant flexibility for Qantas International to expand in Asia by freeing up scarce capital resources, should it be structured properly and the pre-requisite of transferring the 15 Boeing 787-8 Dreamliners earmarked for Jetstar to Qantas International to launch new long-haul thin-routes to Asia be fulfilled. Given Qantas’ track record, it is a tall order to fulfil and Qantas Group should dedicate more resources and attention at the namesake unit beyond simply focusing on Jetstar’s tremendous growth.

“This isn’t just about Emirates growing its business into Australia, it’s about in the future Qantas growing its metal over Dubai into points in Europe and re-entering those cities that it served many, many years ago,” Emirates president Tim Clark conceded.

It is indeed “Game On” for Qantas to live up to the promises of reshaping the competitive landscape and help it compete with an increasingly stronger Virgin Australia and restore the heydays of the flying kangaroo.

Image Courtesy of JUBES747

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  1. [...] unit which lost A$450 million (US$461 million) with the Qantas/Emirates partnership (“Qantas/Emirates partnership to reshape competitive landscape“, 10th Sep, 12) while defending its home turf against an aspiring rival in Virgin [...] Reply
  2. [...] centrepiece of the turnaround strategy is the Qantas/Emirates alliance (“Qantas/Emirates alliance to reshape competitive landscape“, 10 Sep, 12), of which the Australian Competition and Consumer Commission (ACCC) has given [...] Reply

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