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Qantas needs to fix its international woes

Qantas CEO, Alan Joyce
Qantas CEO, Alan Joyce

Qantas has provided a revised outlook for FY2010/2011 (ending 30-Jun-2011) of an underlying profit before tax (PBT) in the range of AUD500 million to AUD550 million. It is a wide range for a period that ends in just over a week, but reflects the challenges the group is currently facing with the Chilean volcano, which "remains a material variable" to the final result.

The group was already putting the cost of the disruptions caused by volcanic ash at AUD21 million at the beginning of this week, which was prior to significant shutdowns across its domestic and international networks the last two days.

It has been a difficult summer for Australian aviation. Most of the Qantas' expected full year profit was earned in the first half (PBT of AUD417 million in the six months to 31-Dec-2010) and the airline estimates a combined impact on the business of over AUD200 million from the series of significant weather events and natural disasters, including the latest ash-related disruptions. Offsetting this will be a AUD95 million settlement with Rolls-Royce plc - reached on 22-Jun-2011 - in relation to the QF32 incident last year, which grounded the airline's fleet of A380s for up to six weeks (the aircraft involved remains grounded for repairs until Feb-2012).

In Feb-2011, Qantas said that underlying PBT for FY2011 would be "materially stronger" than FY2010's AUD377 million. The latest guidance sees a 33-46% increase above the previous year's result. Mr Joyce said, "Considering the challenges facing the aviation industry, this is a very good result - the Qantas Group's best since the global financial crisis." But it is certainly a far cry from Qantas' pre-GFC performance.

Qantas' underlying profit before tax: FY2006 to FY2011F

Qantas International performance to worsen

Qantas Group’s second half financial performance also reflects "a more challenging operating environment", with significantly higher fuel prices than in the first half. Qantas' frequent flyer and domestic mainland businesses are performing well and its two-brand flying strategy with Jetstar has "enabled us to withstand a number of major events affecting our performance".

Qantas International however continues to struggle. It is forecast to generate a loss before interest and tax of approximately AUD200 million, with a weaker result expected next year. According to Qantas CEO Alan Joyce "Qantas International is the Group’s weakest business – it has achieved required returns only three times in the past 15 years.  Clearly the situation is not sustainable." Qantas is developing a long-term strategy aimed at restoring competitiveness and profitability, part of which may include future cooperation with Malaysia Airlines, which was foreshadowed at the IATA AGM earlier this month. More details will be announced regarding Qantas International's "strategic renewal" at the airline FY results in Aug-2011.

IATA this week said that worldwide premium (First and Business) travel demand on international routes is expected to remain "soft" in coming months. The relevant markets for Qantas (in IATA's 'Southwest Pacific' region) show a mixed performance, with strong growth across the board in April, with the exception of intra-regional routes (ie to New Zealand). However, the European market was enhanced by last year's weak comparison from the European ash cloud crisis. Europe-Southwest Pacific premium traffic for the year-to-date is up a more modest 5.2%.

'The Middle East-Southwest Pacific premium market, dominated by Gulf carriers is showing growth of just 3.8%, while Asian demand ('Far East-SW Pacific') are growing at close to 9%, with a similar story across the Pacific to North America ('South Pacific'). The trans-Tasman markets are subdued following the Christchurch earthquake and Australia's economic slowdown, related to the series of weather-related events that has affected Qantas' bottomline.

Premium traffic growth to/from Southwest Pacific: Apr-2011 vs Apr-2010 and year to date (YTD)

Route region Share of Total Premium: Premium Traffic Growth
Traffic Revenues Apr 2011 vs. Apr 10
YTD 2011 vs. YTD 2010*
Europe-SW Pacific 0.1% 0.2% 21.7% 5.2%
Within SW Pacific 0.3% 0.2% -16.8% -18.7%
Middle East-SW Pacific 0.4% 0.8% 9.9% 3.8%
Far East-SW Pacific 1.9% 2.9% 13.5% 8.8%
South Pacific 0.5% 1.0% 4.0% 8.5%

Qantas' international landscape is far from sanguine, with rising fuel costs and intensifying competition from abroad and at home. Virgin Australia's 'virtual airline' strategy of building alliances with carriers serving the key markets of Europe and the Middle East (with Etihad), Asia (Singapore Airlines), the Americas (Delta), New Zealand and the Pacific (Air New Zealand) and domestic Australia (Skywest) will make it more relevant to the crucial corporate travel market over the next 12 months than ever before.

Qantas international route map

But the international market also offers Qantas' greatest opportunity for growth. Situated favourably with a massive travel growth engine to the north, Qantas is well positioned, with Jetstar, to capitalise on Asia's considerable market potential. The execution of its strategy to tap into these markets (which commenced under former CEO Geoff Dixon) has not been aided by delays and problems with its new fleet platform, the B787 and A380, respectively, as well as the impact of the GFC and various external events.

It is clear however that Qantas, as an end-of-the-line carrier, cannot solve its problems and capture its opportunities by itself. It will require effective partnerships, as well as ongoing investment in its own core infrastructure (such as its fleet and offshore bases and hubs, such as Singapore, where it is considering basing a long-haul premium offshoot, in addition to growing Jetstar on long-haul routes). But it must also continue to transition to lower cost operating platforms to remain competitive. Jetstar has proven valuable in this respect and will show up again in the FY2011 numbers as a strong contributor, along with the frequent flyer business.

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