Air New Zealand hones in on long-haul restructure as first half profit falls

Mr Fyfe intends to leave ANZ in a sustainable position by the time of his departure at the end of this year, capping a tenure of six years that leaves a legacy of a rejuvenated and inventive carrier strongly engaged with its workforce, much to the awe and jealously of the industry.

ANZ's 71% profit fall comes as the airline plans to shed 441 jobs and warns of future cuts as it seeks a NZD195 million profit improvement by FY2015, including the previously announced NZD110 million improvement in the long-haul business. Its short-haul business remains strong and ANZ in Oct-2011 announced an order for 12 ATR72-600s to facilitate expansion in the very profitable regional New Zealand market.

See related article: Air New Zealand orders up to 12 ATR72-600s for rapid regional expansion

ANZ has affirmed Mr Fyfe will remain with the carrier through the end of the year despite local reports speculating otherwise. The carrier is still evaluating its response to the 23-Feb-2012 announcement by Virgin Australia that it will split its business units to allow further international investment. ANZ in Jan-2011 invested in partner Virgin Australia, largely seen as a pre-emptive move to block other carriers from investing. ANZ warns of overcapacity in international markets and has made a move to explore a new market, South America, via a one-off charter flight to Buenos Aires in Sep-2012.

15% increase in fuel sees profit fall

ANZ's normalised profit of NZD33 million for the six months to 31-Dec-2011, a 71% drop over the prior period, is largely a result of a 5% increase in cost, and primarily a 15% increase in fuel expenditure even though ANZ saw a 2.6% decrease in revenue passenger kilometres and introduced more efficient aircraft. Despite the drop in passengers, yield was up 4.4% and total revenue was up 2.5%. This was still below what ANZ would have liked, and lack of further growth a result of Japan still not recovering from its earthquake and tsunami. ANZ's Japanese capacity has remained down from last year.

ANZ mum on Virgin ownership changes, but had considered scenario

Mr Fyfe said ANZ was still evaluating opportunities and scenarios that could unfold as a result of Virgin Australia changing its ownership structure in which its international division will be a separate and unlisted entity from the domestic company, which will no longer be exposed to foreign ownership requirements.

While Mr Fyfe said he learned of the decision when it was announced to the market on 23-Feb-2012, in compliance with regulatory laws, ANZ had evaluated the possibility when deciding to make its initial investment.

Air New Zealand acquired a 14.99% stake in Virgin Australia in Jan-2011, and while it paid a premium to do so, said it viewed the stock as under-valued. At the time ANZ said the stake was a commitment to the carrier, its alliance partner across the Tasman, ANZ's largest region by available seats. ANZ increased its stake to 19.99% in Sep-2011, with both stakes largely seen as prohibiting another carrier - namely Etihad - from doing so. ANZ will have to pay more to maintain that position or accept other carriers moving in following Virgin Australia's corporate restructure.

Under Australian regulations, international carriers must be majority owned by local investors while domestic carriers can be entirely foreign owned, such as with Tiger Airways. The restructure will allow Virgin Australia to increase foreign ownership. CEO John Borghetti said the change was more a result of needing to apply a mechanism to comply with ownership requirements - it had briefly and unintentionally exceeded the foreign ownership threshold - and not a result of requests from other foreign carriers to invest. However, Virgin Australia partner Etihad has said in recent months it would like to acquire a stake in the carrier.

787-9 further delayed

ANZ is the launch customer for Boeing's 787-9 Dreamliner, which ANZ announced has been further delayed to mid-2014. Guidance from Boeing in Oct-2011 was for early 2014. The aircraft was originally due for delivery in late 2010. Boeing in mid-2011 entered into a public war of words with ANZ via the media, insisting the carrier's announcement of a 2014 delivery date was incorrect and that Boeing would deliver the aircraft in 2013. ANZ now expects a single 787-9 between Apr-2014 and Jul-2014, and a further two in the financial year ending 30-Jun-2015.

ANZ had been banking on the 787 to allow it to replace older aircraft and facilitate expansion. As a result, ANZ will keep its 767 fleet and two of its 747-400s until 787s come online. The carrier announced it has settled delay payments with Boeing and has also exercised - at likely very good prices - two 787-9 options, bringing its total firm orders to 10.

Long-haul network review to be announced in coming weeks

ANZ will announce further long-haul network changes in the coming weeks. Overall Mr Fyfe is confident of markets it serves - unlike competitor Qantas, which has announced plans to withdraw from Buenos Aires, Mumbai and long-haul flights from Auckland - with the exception of temporary concerns in Japan, due to the earthquake and tsunami affecting demand, and markets where new entrants have recently emerged.

"If you isolate Japan linked to the earthquake and you isolate the slight discontinuities from new entrants, we don't see any particular market that is overly problematic or overly positive. We see improvement opportunities over all markets and remain confident of all markets we fly," Mr Fyfe said.

This week it has put on sale a seasonal twice-weekly service between Auckland and Bali commencing 19-Jun-2012. The nine-hour Bali service, which like many of ANZ's routes will face no direct competition, will shave considerable time off existing routes via Australia that involve journeys typically at least 12 hours and often more.

ANZ has also increased capacity to the profitable North American market in southern hemisphere summer 2012/2013. Over the current 2011/2012 summer schedule, next year will see up to five additional weekly services with a total capacity of upwards of 23 frequencies between Honolulu, Los Angeles, San Francisco and Vancouver.

Mr Fyfe indicated these capacity increases were partly a result of Qantas' decision last week to withdraw Auckland-Los Angeles services from May-2012 in order to the use the aircraft in the more profitable Australian domestic market. Remarking that the daily service likely brought in approximately NZD50 million (USD42 million) of revenue annually, Mr Fyfe said the gap in capacity "is a very significant opportunity for Air New Zealand to clearly pick up a significant portion of that revenue, and either fill seats on existing aircraft or, in fact, we'll add some additional services into the North American market to meet that demand".

Additionally, in Dec-2011 ANZ announced a codeshare agreement with fellow Star Alliance carrier All Nippon Airways that will take affect later this year, replacing a codeshare agreement with oneworld's Japan Airlines.

ANZ evaluating fare and product structure to combat long-haul LCCs

ANZ's review will be not just about destinations and capacity but also fare structure and product type, a reference to considerations of deploying ANZ's Seats to Suit fare structure on long-haul flights. ANZ in 2010 introduced the four-tiered bundle fare structure predominantly on Tasman services. The structure, which includes fares only for carry-on luggage, was designed to let ANZ grow revenue and passenger numbers in a market with a strong presence of LCCs, which could better could attract passengers in the leisure-oriented market. ANZ has repeatedly proclaimed the success of Seats to Suit given the revenue increases as well as ability to grow the trans-Tasman market more than any other carrier.

New Zealand over the past year has seen an influx of new carriers, including AirAsia X (serving Kuala Lumpur), China Southern (serving Guangzhou) and Jetstar (serving Singapore, but with additional long-haul destinations likely in the future). ANZ does not serve either of their three hubs - although there was muted pondering of a flight to Guangzhou - but the three carriers are also targeting onward connections where there would be competition with ANZ. AirAsia X was a particular challenger with services to London, although London will be suspended in Mar-2012. While Mr Fyfe sees large potential in the China-New Zealand market, China Southern is a particular threat given its extraordinarily low sixth freedom fares as well as access to mainland China.

See related article: Chinese airlines' sixth freedom roles could challenge Middle East, Asian, European hubs this decade

There is a competitive threat from all three carriers in that Mr Fyfe believes there is general overcapacity from New Zealand to Asia and Europe. AirAsia X's London withdrawal will ease that, but China Southern in Jun-2012 will commence Guangzhou-London services. Remarking of China Southern's expansion to a daily service between Guangzhou and Auckland, Mr Fyfe remarked, "I don't think the demand has yet to grow to support that level of service into that market." While Jetstar has not disclosed performance of its Singapore-Auckland route, it has said new long-haul routes to Singapore are still absorbing capacity. Overall for Jetstar International, which comprises all international A320 and A330 flights from Australia and New Zealand, in 1H2012 available seat kilometers rose 8.4% but revenue seat kilometres only increased 5.1%.

Additionally, AirAsia, China Southern and Jetstar are competing with ANZ for the same pool of New Zealand travellers and lower LCC fares may entice the market over ANZ services. The Seats to Suit model could ease that pressure.

While the Seats to Suit structure was initially introduced on three/four hour flights, it was later expanded to its seven/eight hour service between Auckland and Perth. ANZ's new Bali flight, at nine hours, will use the Seats to Suit model, indicating the fare structure can work on longer flights. The demand for additional frills like meals and checked luggage can be greater on long-haul flights, but the Seats to Suit model allows advertising of lower introductory fares. On the Bali flight there is currently a NZD30 (USD25) one-way difference between the basic fare and the fare with checked luggage. There is a further NZD50 (USD42) difference for the next tier, which includes frills like meals and advanced seat reservation, contributing to ANZ's goal of creating NZD40 (USD33 million) million of ancillary revenue profit by FY2014.

"We've had great success with our seats-to-suit product on the Tasman. We positioned ourselves to compete far more effectively against budget carriers while retaining a place in the business and premium market as well. We're exploring how or if that could be applied to the long-haul business," Mr Fyfe said when first announcing the long-haul restructure in Aug-2011.

A South American foray, but long-term prospects bleak

ANZ in Sep-2012 will conduct a single 777-300ER charter flight to Buenos Aires for rugby fans to see New Zealand's All Blacks team compete in a match. ANZ for some years has shown interest in the South American market, both to serve as a point-to-point destination but also as possibly a sixth freedom carrier linking the burgeoning markets of Asia and South America. However, ANZ more recently has shied away from that vision of making New Zealand a hub given increased competition from Gulf network carriers.

Distance is also a problem. While ANZ could reach Buenos Aires or Santiago non-stop from Auckland with its existing fleet, ANZ sees the key South American point to serve as Sao Paulo, which neither its existing fleet nor 787-9s will be able to serve non-stop from Auckland (or at least without weight penalties that would make the route non-viable). Although the 787-9 has lost some performance due to weight increases, the original specifications put forward by Boeing would still have been a tight fit to serve Sao Paulo non-stop. ANZ has largely ruled out the 777-200LR, which could reach Sao Pulo non-stop but would require significant business traffic - unlikely to be attained in a leisure-heavy market - to make the route work on the -200LR, which ANZ has termed a "flying fuel tank" ill-suited to the current high fuel price environment. Although options exist to make a re-fuelling stop en route to Sao Paulo with existing equipment or 787-9s, ANZ does not consider this ideal.

These factors however are overshadowed by what will likely be the lack of a South American partner to critically carry onwards traffic and provide feed. Although Brazil's TAM is a member with ANZ in Star Alliance, TAM is expected to join merger partner LAN in the oneworld alliance later this year.

See related article: oneworld favoured with more at stake than Star in LAN-TAM alliance decision

LAN flies to Auckland and Sydney from Santiago while Qantas in Mar-2012 will launch Sydney-Santiago services, ruling out any cooperation between ANZ and LAN/TAM should TAM join oneworld as expected. The other current big Star group in Latin America, Avianca-TACA, does not have notable hubs in points ANZ would consider serving. (Avianca-TACA has a growing presence in Lima, which could offer the connections ANZ seeks, but ANZ has not formally raised the possibility of Lima being a target destination.)

The big remaining carrier in South America is Aerolineas Argentinas, although ANZ partnering with the carrier is very unlikely as the carrier has significant internal housekeeping to attend to and is due to become a member of SkyTeam. Further, regulatory affairs are uncertain. Qantas in 2008 re-launched services to Buenos Aires under assurance it would be able to codeshare with LAN Argentina, although granted a competitor to national carrier Aerolineas Argentinas. The Qantas-LAN Argentina codeshare was never permitted, even after the matter escalated to a political level. As a result, Qantas switched its South American service to Santiago, whose GDP growth has eclipsed Argentina's. ANZ would want a South American hub with strong business demand.

Virgin Atlantic eager for closer cooperation on London services

London has predominately been a loss-making market in the past year, Mr Fyfe has told CAPA. Qantas in Aug-2011 announced it would end two of its four London services to reduce losses. ANZ serves London via Los Angeles and via Hong Kong, with both waypoints loss-making depending on the time of the year. London-Hong Kong has already been reduced to five weekly services, but Mr Fyfe has branded as inaccurate local reports saying ANZ could entirely withdraw from London.

Like with Qantas, ANZ needs a presence for its overall market position and is unlikely to surrender valuable Heathrow slots. There is also possibility the market could rebound and ANZ over the past year has benefitted from a strengthening US market in which airlines are consistently increasing fares and prudently managing capacity.

One likely outcome is further cooperation with Virgin Atlantic. ANZ codeshares with Virgin Atlantic between San Francisco and London as well as trans-Tasman flights. Former Virgin Atlantic director of sales and marketing Paul Dickinson remarked in Feb-2011 that, pending various government approvals, Virgin Atlantic would like to further cooperate with ANZ by linking their mutual Asian destinations - Hong Kong, Shanghai and Tokyo - as hubs for New Zealand-London transfer traffic.

"We meet in so many places around the Pacific where we can hand over passengers," Mr Dickinson said. "To work in partnership where we can feed people to Air New Zealand's flights and they can feed people to our flights makes perfect sense." However current regulations limit their levels of cooperation. "We're only restricted by some of the government bilateral agreements. Where can we do it we are doing it immediately."

Virgin Atlantic has also expressed a wish for a second daily London-Hong Kong service but primarily lacks slots to do so. If ANZ was looking to consolidate or strengthen its position between Hong Kong and London, Virgin Atlantic would make a viable partner. The proposition is helped by the carriers have similar products, including a premium economy cabin and approximately the same business class seat. Virgin Atlantic, reeling from its unsuccessful bid to acquire bmi, may be eager to acquire or lease any slots from ANZ, although ANZ will likely want to maintain them while UK competition regulators may allocate Virgin some of bmi's slots in a concessionary move.

Mr Fyfe to stay through the year as ANZ commences search for new CEO

ANZ chairman John Palmer refuted local reports Mr Fyfe would leave earlier than at the end of 2012, as advised in Jan-2012 when Mr Fyfe announced he would finish his contract at ANZ and not renew. In addition to his commitment at ANZ, Mr Fyfe holds through the end of the year positions at Star Alliance and the International Air Transport Association. Mr Fyfe has not disclosed his plans after leaving ANZ but could be considering a number of industries; prior to ANZ Mr Fyfe held banking and media industry positions.

ANZ is underway into its selection for a new CEO, estimating the process to take approximately six months. ANZ is conducting a global search but has noted Mr Fyfe has cultivated strong internal candidates. The new CEO will inherit a carrier Mr Fyfe significantly turned around and owes much of the credit for. Unlike its regional competitor, staff engagement is high and the loss-making international market requires less structural change due in part to less competition. The carrier's outlook domestically is especially strong, and Mr Fyfe expects all divisions to be strong or on their way by the time he departs ANZ. His successor will inherit an airline in one of the strongest positions for any handover in recent times, leaving ANZ poised for more greatness.