Qantas' withdrawal from a series of international routes promises the single largest benefit to its loss-making international division, delivering AUD100-120 million (USD101-122 million) in annual benefits, with the majority to be realised in FY2013. But with the international division reporting a loss of AUD216 million (USD219 million) in FY2012, Qantas will continue to operate a number of unprofitable routes, primarily to Europe and Asia.
Qantas expects to reduce those losses through the reconfiguration of its Boeing 747-400 and A380 fleets, which when complete towards the second half of FY2014 will deliver AUD70-90 million (USD71-91 million) of benefits annually. Qantas previously put those retrofit changes at a cost of AUD400 million (USD406 million). They include reconfiguring nine 747-400s to have no first class while 12 A380s have a reduced number of business class seats but more economy and premium economy seats.
Qantas International change benefit timeline: FY2012 to FY2014
Reducing heavy maintenance and engineering, corresponding to the reduced fleet count, is projected to save AUD70-100 million (USD70-100 million) annually. This saving, however, will not be indefinite as Qantas in the long-term will need a maintenance strategy for its 787s. While the work could be outsourced, this will still increase costs, as will more intensive A380 maintenance as the aircraft age.
Qantas over the past 18 months has grown closer to some of its oneworld partners, and this will bring a modest AUD20-30 million (USD20-30 million) annually of additional revenue from FY2014. Qantas has received approval for a joint business agreement with trans-Pacific partner American Airlines, a move largely in response to its competitors consolidating and strengthening: Delta and Virgin Australia received anti-trust immunity while United Airlines gained scale and leverage across North America through its merger with Continental. Although American is currently in bankruptcy protection, it has stressed the importance of its international operations and partnerships.
Qantas is codesharing with Chile's LAN on its new Sydney-Santiago service that replaced an unprofitable route to Buenos Aires. Qantas' timing was off there; it reinstated the route while the Argentinean economy was performing well and had planned to codeshare with LAN affiliate, locally established LAN Argentina. But the move was blocked by a protectionist Argentinean Government at the same time as the Chilean economy began to outpace Argentina's.
Qantas included British Airways (BA) in that partner segment, even though BA's contribution has been a net reduction of service, ending Bangkok-Sydney although up-gauging Singapore-Sydney from 777-200 to 747-400 while increasing frequencies to Hong Kong. These latter have, however, since lapsed as London traffic appears to be experiencing a delayed effect of the recession.
Summary of Qantas International network changes: 2012
|Bangkok-London||Daily service cancelled||Mar-2012|
|Hong Kong-London||Daily service cancelled||Mar-2012|
|Sydney-Buenos Aires||Three times weekly service ended||Mar-2012|
|Sydney-Santiago||Three times weekly service commenced||Mar-2012|
|Sydney-Hong Kong||A380 on four-weekly routes||Jan-2012|
|Sydney-Bangkok||747-400 downgauged to A330-300||Jun-2012|
|Sydney-Tokyo||Sole A330 service replaced with 747-400||Jun-2012|
|Melbourne-Hong Kong||747-400 downgauged to A330-300||Mar-2012|
|Los-Angeles-New York||Daily A330-200 upgauged to 747-400||May-2012|
|Melbourne-Auckland-Los Angeles||Daily service Cancelled||May-2012|
Further benefits are to come from changing catering and airport operations, for an annual benefit in FY2014 of AUD20-25 million (USD20-25 million). Qantas' catering business, as CAPA reported in Feb-2012, has excess capacity and can be consolidated. It is not clear, however, why these are categorised strictly as international benefits when they also affect domestic operations.
These changes do not come without costs and Qantas in 1H2012 spent AUD118 million (USD119 million) on international transformation expenses and expects to spend a further AUD200-300 million (USD200-300 million), including AUD200-225 million (USD200-225 million) in 2H2012. With benefits outweighing costs starting in FY2013, the net position of Qantas mainline should start to improve, in line with Qantas' objective to return Qantas International to profitability by FY2015 and for the division by FY2017 to exceed the cost of capital.
Capital expenditure reduction surprises some, but expected move keeps Group strong
Qantas in early May-2012 announced further reductions in capital expenditure, which the Group has been decreasing since Aug-2011. The latest change – delivery postponement of two A380s from 2013 to FY2017 – reduces FY2013 capital expenditure by AUD400 million (USD400 million) and was foreshadowed in Feb-2012 when CEO Alan Joyce strongly hinted at further capital expenditure decreases. As CAPA reported at the time:
CFO Gareth Evans stressed Qantas was “actively” seeking additional capital expenditure reductions. Such reductions could come from near-term fleet changes, such as not renewing leases or postponing new deliveries. Qantas routinely notes its leased fleet permits flexibility. Mr Joyce emphasised Qantas’ relationships with aircraft manufacturers and said any possible further fleet changes would be “orderly” – all but guaranteeing further capital expenditure reductions.
The Group's remaining aircraft orders are for 737s and A320s going to Qantas mainline and Jetstar, respectively, each of which is profitable and unlikely to see aircraft order deferrals or reductions. 787s on order will go to both Qantas and Jetstar. While 787s are allocated to Qantas mainline for deployment internationally – an area Qantas to which does not intend to devote capital expenditure until it is profitable – the 787 deployment will facilitate international-focused A330s replacing domestic 767-300s, which are ageing.
There is a reason to curtail capital expenditure. A heavy burden in this area at a time of uncertainty and change affects the Group's credit rating, which was downgraded to Baa3/stable in Jan-2012. Qantas intends to use its rating advantageously as it pursues high growth in Asia with its Jetstar subsidiary. The credit rating affords confidence to investors who, amongst other causes, Qantas pulls in to take stakes in Jetstar subsidiaries.
Qantas' Asian joint venture strategy is the perfect way to monetise valued brands, while limiting the need for capital expenditure
One recent example of this is with Century Tokyo Leasing Corporation taking a stake in Jetstar Japan, a process Mr Joyce said reflected positively on the Qantas Group. "The response to our search for a fourth shareholder was extremely strong, with more than 100 companies – including very well-credential firms – interested in investing in the Jetstar brand."
The latest Jetstar subsidiary, Jetstar Hong Kong, is also likely to bring investors in as Qantas and/or China Eastern dilute their 50% stakes (as they must, to conform to local ownership requirements). The initial formation and announcement of a new subsidiary is a delightful formula, essentially leveraging the value of the brand(s). It is low on costs but attracts investors who support the carrier before it launches. That reduces the investment of Qantas Group without significantly diluting revenue streams as the Qantas Group (appropriately) charges the local Jetstar subsidiary for overheads, guaranteeing a revenue stream as investors effectively pay Qantas to use the Jetstar brand while shouldering start-up costs and risk – close to the dream equation for aviation. That, combined with forthcoming positive return on capital at Qantas mainline, significantly bolsters the Group's financial standing.
Meanwhile the world is changing; Qantas' change process will need to be constant
Qantas' announced cost reduction measures relate necessarily to areas over which it has some control. But, as an end of the line carrier in a world undergoing remarkable change, there are many challenges to come, as other airlines moves come thick and fast. Longstanding partner, British Airways, for example, no longer offers the cornerstone relationship of 15 years ago when the British flag owned a quarter of Qantas; the flying kangaroo – and the leaping Jetstar – are now refocused on Asia, while the relevance of Australia to BA's core strategy has dimmed greatly. Closer to home, Singapore Airlines – which does have Australia as a key focus – is struggling to redefine its future direction and Virgin Australia is a revitalised and increasingly threatening competitor. China's major airlines and some smaller ones are expanding in Australia, at the same time as the Gulf carriers are each intriguingly entering new phases of their development.
Qantas' adjustments here are moves in the right direction. They do, however, renew the need to ensure that a restless employee base recognises the new priorities – and will also be ready to continue to adjust as a new world order emerges. Qantas is not the only airline confronted by a massive readjustment of world markets. Each has different issues to face, but the common ingredients are the inevitability of change and the relentless need to be highly adaptable.