28-Feb-2013 7:15 PM

Air New Zealand reports NZD136 million 1HFY2013 profit, up 300%. A generally favourable outlook

Analysis

The fruits of several years of investment in new aircraft and product are finally bearing fruit for Air New Zealand, with the carrier reporting a NZD139 million (USD115.6 million) underlying first half profit for FY2013, up 300% on a year earlier. Statutory profit after tax of NZD100 million (USD83.1) was also up NZD62 million (USD51.5 million).

The key driver of the result, the highest in five years, is a NZD72 million (USD59.9 million) improvement in passenger revenue on a 3.2% increase in demand and a 2.7% increase in capacity.

The restructured long-haul network provided the biggest improvements, having returned to profitability for the first time since the global financial crisis and seeing significant growth in demand and yield.

Air NZ's new CEO, Christopher Luxon, who took over from Rob Fyfe on 01-Jan-2013 has declared the airline is now in a "growth phase" and will take delivery of two additional 777-300ER from Jul-2014, replacing the last two 747-400s. The carrier is now focused on sustainable growth in the Pacific Rim region and a number of initiatives will be rolled out over the next few months.

Normalised profits before tax for the second half of FY2013, based on the carrier's current forecast of demand and fuel prices "will comfortably exceed the corresponding period last year."

Air New Zealand looks well placed for consistent and sustainable growth

Chairman John Palmer attributed the result to "the substantial change programme the airline has been implementing has positioned the business for consistent growth and sustainable profitability over the coming years".

During the half, Air NZ withdrew its twice weekly Auckland-Beijing services and consolidated its Chinese operations to Shanghai which has since become a daily service from Auckland.

Mr Luxon's background in retail and marketing during his previous career at Unilever consumer goods group is also coming through with the carrier focusing on improved sales systems in key markets.

"A key driver in achieving this turnaround has been getting our network right and improving our sales execution," Mr Luxon said.

Normalised earnings before tax

Operating revenue was up 3.4% to NZD2.4 billion (USD2 billion) on capacity growth across the network. Group yield improved by 0.3% to NZD13.6c (USD11.3c) per RPK, driven by a 3.8% gain in long-haul yields.

Domestic yields, however, suffered at the hands of competition, reducing 2.2%. Unit costs fell 4.7% to give a CASK of NZD11.17c (USD9.3c).

Mr Luxon said the result was a step towards Air NZ achieving a "virtuous circle of profitable growth" where growing revenues and cost controls lead to better profitability, shareholder returns enabling further reinvestment in the business.

Air New Zealand financial summary (NZD): 1HFY2013 vs 1HFY2012

Unit costs fell 4.7% to give a CASK of NZD11.17c (USD)

Air New Zealand operating performance summary (NZD): 1HFY2013 vs 1HFY2012

Air New Zealand profit changes (NZD): 1HFY2013 vs 1HFY2012

Air NZ is ahead of schedule to achieve NZD250 million (USD207.9 million) in profit improvements by FY2015 having achieved NZD60 million (USD49.9 million) in overhead cost reductions.

Further improvements are expected to come from ancillary revenue growth of NZD40 million (USD33.3 million), NZD60 million (USD49.9 million) in long-haul network improvements, fleet efficiencies NZD35 million (USD29.1 million) and NZD55 million (USD45.7 million) from supply chain and other direct cost improvements.

The restructured long-haul network is back in the black

Long-haul services returned to profit for the first time in five years, reflecting the redeployment of Asian capacity to markets with stronger demand, particularly North America.

The economic effect of the 777-300ER fleet replacing the 747-400s, offering 20% operating cost savings, was beginning to flow through. Mr Luxon insisted the two additional 777s were not an insurance policy against further potential delay in the delivery of the 787-9s owing to the grounding of the existing 787-8 fleet over concerns relating to battery malfunctions.

He remained confident that the first 787-9, for which Air NZ is the launch customer, would arrive mid-2014 as scheduled.

International operating summary (NZD): 1HFT2013 vs 1HFY2012

Additional Boeing 777-300 arrive in 2014

Air NZ will take delivery of two 777-300ERs in Jun-2014 and Sep-2014. Both aircraft will be on operating leases.

The carrier is still evaluating deployment options for the aircraft which could include adding capacity to existing routes or opening new destinations in the Americas, Asia or Australasia.

Denver and Houston have both been previously highlighted by the airline as possible candidates that could be served with existing equipment.

The North American market is performing well with a 17% increase in Americans travelling to New Zealand in Jan-2013 and a 6% increase in New Zealanders outbound, albeit compared to a weak high season in 2012.

In addition to consolidating the China services to Shanghai, Air NZ also switched partners in Japan from JAL to ANA, gaining greater access to the Japanese domestic market.

A valuable Cathay Pacific codeshare will bolster China access

Air NZ will pull off the loss-making Hong Kong-London route on 04-Mar-2013 and has instead entered into a codeshare agreement with Cathay Pacific between Auckland and Hong Kong.

The freed-up Hong Kong-London capacity will be redeployed on North American routes from Apr-2013

The Cathay tie-up is an extension of Air NZ's strategy to increase its network reach through alliances, avoiding the need to commit substantial capital to additional aircraft. Under the deal, effective from Dec-2012, Air NZ and Cathay will codeshare on each other's Hong Kong-Auckland services.

Cathay will also lease Air NZ's daily Heathrow slot which it will begin to operate in Jun-2013.

The Cathay partnership is a rare and valuable coup for Air NZ. Cathay has been notoriously reticent in partnering with other carriers - although Qantas' recent deal with Emirates is causing some rethinking of that reluctance. Air NZ hopes the relationship will gain it further access to the Chinese market, where the carrier has so far struggled to make headway, while also contending with increasing competition from China Southern. China's largest airline, China Southern is rapidly building its links to New Zealand and Australia from its Guangzhou hub on mainland China, just inland from Hong Kong.

See related articles:

Air New Zealand-Virgin Australia alliance builds Tasman demand

Despite the importance of the Australian market (about two thirds of New Zealand's international seats are across the Tasman), Air NZ's alliance with Virgin Australia received little more than passing mention: "proving very successful, giving us a combined market leading position on the Trans-Tasman routes....Our ownership interest of 19.99%...reinforces this relationship." But Air NZ has yet to generate the bridgehead it has long sought into the domestic Australian market.

The partnership has driven 4.4% demand growth on the route, while capacity has also been increased 6.4%. The increase was mainly due to the replacement in Sep-2012 of a 234-seat 767-300 on the daily Auckland-Perth service with a 304-seat 777-200ER which boosted capacity on the route by more than 20%.

Hawaiian Airlines breaks Air NZ's Auckland-Honolulu monopoly

Air NZ will also lose its monopoly on the Auckland-Honolulu route in Mar-2013 when Hawaiian Airlines launches a three times weekly service using a two-class 294-seat A330-200 aircraft. The move more than doubles capacity on the Honolulu-Auckland route from 690 one-way seats a week to nearly 1,600 seats.

Air NZ has responded to the threat by adding a weekly frequency to match Hawaiian.

Hawaiian believes there is significant growth potential on the route, pointing to the 30% reduction in passenger numbers on the route after the introduction of the 747-400 allowed Air NZ to operate direct Auckland-Los Angeles services, dropping Honolulu as a refuelling stop over.

Air NZ also plans to continue with seasonal services to Bali and Sunshine Coast.

Tasman and Pacific Islands operating summary (NZD): 1HFY2013 vs 1HFY2012

Domestic yields are under pressure as Jetstar applies pressure

Domestic yields declined 4.3% to NZD27.8c (USD23.1c) as fares fell and the economy struggles to gain pace.

Demand grew slightly ahead of capacity, leading to a marginal improvement in load factors.

The accelerated delivery schedules for the remaining A320s and introduction of seven ATR72-600 will reduce unit costs and allow Air NZ to compete against LCC Jetstar. Seven domestic A320 have been delivered, with another eight to come by the end of FY2015. Two out of seven ATRs have also arrived, with the remainder due by the end of FY2016.

Domestic operating summary: 1HFY2013 vs 1HFY2012

Jetstar is making small domestic market share gains, but Air NZ is likely to be able to keep its advances at bay as additional A320s join the fleet over the next two years.

Jetstar competes on the main trunk routes between Auckland, Wellington, Christchurch, Dunedin and tourist town Queenstown.

The LCC has about a 17% share of the total domestic market, but on most routes where it competes with Air NZ, Jetstar currently has about a 30% share, up from about 25% a year ago, according to Innovata. Air NZ's strength remains in its dominance of regional routes where its fleet of ATRs and Beech1900s allow it penetrate routes where Jetstar cannot go with its all-A320 fleet.

Air NZ's average nine year old fleet age will rise ahead of arrival of new aircraft

The average fleet age of nine years will increase slightly over the next year, before improving as another seven A320 arrive over the next two years to replace domestic 737-300s as well as the balance of an order of seven ATR72-600 which will provide incremental growth on the domestic routes.

Air New Zealand fleet delivery schedule

Air New Zealand is well placed to capitalise on its long term strategy, but some longstanding challenges remain

Air NZ has begun to deliver on the significant investment and is now back in "growth mode" as it looks to expand its Pacific Rim business. The carrier has had the balance sheet strength - and the courage - to invest in aircraft and product at the most effective stages in the economic cycle.

The carrier will now implement its "Go Beyond Plan" plan which calls for building on its strong platform over the next five years, although precisely what form that will take remains to be seen.

As the new domestic fleet comes in, along with the long awaited 787-9, allowing Air NZ to expand its business, unit costs should reduce further allowing the carrier to realise the returns on an investment and strategy that has been several years in the making.

An intelligent underdog strategy, development of a strong brand and a commitment to cost containment has worked well for Air New Zealand on its long-haul routes. Since the carrier's effective renationalisation 12 years ago, it has gradually evolved a long-haul strategy which is a combination of selective partnerships, withdrawal from under-performing routes and under-the-radar operations in its own right. The test of longer term resilience will come as international expansion occurs.

And, although the partnership with Virgin Australia attracted only passing mention in the report, Air New Zealand will continue to seek a more expansive position behind its Australian gateways if it is to hold a growing Jetstar at bay in the long run.