South Pacific Airline Outlook 2020s: New long haul opportunities

Summary:

• Ultra-long range route moves have major ramifications for Qantas and Air New Zealand.
• Softening demand puts downward pressure on capacity in Australasian markets.
• Air New Zealand and Virgin Australia launch multiyear cost cutting programmes.
• Virgin Australia focuses on financial health rather than growth or market share.
• Pacific Island airlines confront challenges, but new aircraft types offer opportunities.

Capacity growth appears to have peaked in Australia and NZ markets

Capacity trends in the major South Pacific markets reflect the airlines' growing caution regarding the industry outlook.

System-wide seat capacity in the Australian market is expected to be reduced by 1.7% year-on-year in 2019, according to data from CAPA and OAG. This would be a reversal from the gains of 2.9%, 3.5% and 3.8% in 2016-2018. The decline is most notable on international routes, where seat capacity is projected to drop 2.9% in 2019, versus a 5.8% increase in 2018.

This is partly due to a reduction in service into Australia from overseas airlines. Capacity gains have been more modest in the domestic market over the past two years, and domestic seats are likely to decline by 0.9% in 2019.

In the New Zealand market, system capacity is expected to be lower by 1.7% in 2019, following a gain of 4.2% in 2018. The domestic reduction will be 2.3%, and international 1.2%.

Ultra-long haul flights are very much in vogue

Despite these trends, airlines are likely to push ahead with ultra-long haul plans.

Qantas has said it will make a final decision on whether to proceed with Project Sunrise - and presumably select an aircraft to operate the flights - by the end of 2019. The prospect and symbolism of a nonstop Sydney-London (or Sydney-New York) route will garner a lot of headlines, but the associated fleet choice will have much wider ramifications for Qantas.

The competing proposals for Project Sunrise are based on the Airbus A350 and Boeing 777X families. The airline has stressed that whatever type is chosen will also serve other parts of its international network, and any order decision will provide a major signal about the future of the airline's widebody fleet.

Qantas is also likely to introduce more nonstop 787-9 flights to Europe from Perth, following the launch of Perth-London service in 2018. The airline has said that Perth-Paris is next on its list, although a dispute with Perth Airport over the use of 'domestic' terminals three and four for limited international operations is holding up these plans.

Qantas is already a major player on long range flights. The airline now has 11 routes of more than 6000nm, which is the third highest total behind only Emirates and United, according to Boeing. The expected announcement of more of these routes could push Qantas even higher up the list.

The continuing growth of the Boeing 787 and A350 fleets globally has had a dramatic impact on the Australasian market. Routes from Australia or New Zealand currently account for seven of the world's 15 longest 787 flights according to Boeing. When 787 routes announced but not yet launched are included, the Australasia total rises to 8-9 of the top 15.

Air New Zealand is using 787-9s for its own ultra-long haul plans. In Oct-2019 the airline announced its intention to begin flying nonstop from Auckland to New York Newark Liberty International Airport from Oct-2020. This will not only be the airline's longest route, but also be the fifth longest in the world by distance.

At the same time, Air New Zealand will cut the one-stop London service, which was operated as a continuation of its Auckland-Los Angeles route.

Looking further ahead, Air New Zealand has ordered eight 787-10s for delivery beginning in 2022, to replace its 777-200ERs. It can swap any of these orders to -9s, and the new aircraft will be powered by GE engines that are expected to provide more range than the engines in its current 787 fleet.

Air New Zealand's next widebody fleet decision will be the replacement of its 777-300ERs. It intends to start the decision process within a few years and begin the replacement in the mid- to late 2020s.

More fleet decisions are looming for Qantas. The Project Sunrise evaluation is absorbing a lot of Qantas's planning resources, but the airline has said that once this project is out of the way it will turn its attention to other aircraft replacement needs in 2020.

Qantas CEO Alan Joyce said the airline will consider ordering more 787-9s next year, from its pool of options and purchase rights. The airline also intends to launch a competition to replace its 75 Boeing 737s. The contenders will be the 737 MAX and A320neo families.

Looking further ahead, Mr Joyce believes Boeing's proposed new mid-market airplane (NMA) programme will be "the perfect aircraft" for certain domestic trunk routes, such as between Sydney and Melbourne. In its regional operation, Qantas will be assessing replacement options for its Fokker F100s and Boeing 717s.

Virgin Australia's priority is keeping a tight rein on cost and capacity

Financial health will be a major focus for Australasian airlines in 2020. While Qantas is still recording impressive profits, its results for its 2019 fiscal year were lower compared to the previous year.

Virgin Australia and Air New Zealand have both launched new cost cutting initiatives to improve their financial performance in the face of softening demand and the prospect of an airline industry slowdown.

Virgin Australia has indicated that a return to profitability will be its priority, after the results sank to a AUD71.2 million (USD48.8 million) underlying loss in FY2019. CEO Paul Scurrah took over in Mar-2019 and has made no secret of the fact that network growth will take a back seat to improving financial returns. Earnings have suffered in recent years as the airline restructured its operations and grew under the leadership of former CEO John Borghetti. Mr Scurrah's immediate focus will be the bottom line.

To achieve this aim, Mr Scurrah has reviewed all aspects of the business and made a series of moves to reduce costs. The airline is cutting 750 corporate and headquarters staff, which will save AUD75 million (USD51.4 million) per year. A supplier review is expected to yield another AUD50 million (USD34.2 million) per year.

Network changes announced in Nov-2019 will mean that Virgin pulls out of its Melbourne-Hong Kong and Sydney-Christchurch services. These will be balanced by new service from Brisbane to Tokyo Haneda Airport (taking up the single pair of new Haneda slots awarded in Nov-2019) and the resumption of Melbourne-Bali. Two Virgin domestic routes - both from Perth - will be cut, and there will be frequency reductions elsewhere in the international and domestic networks. Most of these changes will be in place by Mar-2020.

Virgin Australia - excluding Tigerair Australia - has a 29.9% domestic market share, according to data from CAPA and OAG for the week of 04-Nov-2019. The airline's planned capacity reduction of at least 2% could change this, but the company will not be concerned with a market share slip if earnings rebound.

Fleet replacement has been temporarily shelved, with Virgin's first Boeing 737 MAX deliveries deferred by 20 months to Jul-2021. This will reduce short term capital spending, and replacement is not urgent since Virgin's narrowbody fleet is still relatively young, with an average age of nine years. Three Fokker F100s will be cut from the regional fleet by Mar-2020.

Tigerair to refocus on vacation routes

Changes are also coming to Virgin's LCC subsidiary Tigerair. Mr Scurrah has said that he wants to refocus Tigerair on vacation routes and differentiate its role more clearly. Three Tigerair domestic routes will be cut early in the year and the fleet will be reduced, with the retirement of two A320s by the middle of the year. Tigerair's transition from A320s to Boeing 737s will continue.

While these are all significant moves, more could be coming. Virgin has not ruled out further fleet and network cuts if they become necessary, and Mr Scurrah has proved he is not afraid to pull the trigger should financial conditions deteriorate.

Air New Zealand adjusts to a new market environment

Air New Zealand has enjoyed a remarkably long run of profitability, but experienced a net profit drop to NZD270 million (USD172 million) for its fiscal year through 30-Jun-2019 - a fall from NZD390 million (USD248 million) in the prior year. Although this is still a healthy result, the airline believes the decline is evidence of a fundamental shift in market demand. This has prompted cost cutting moves on multiple fronts.

Initial steps for Air New Zealand, announced in March, involve the deferral of some aircraft deliveries to spread the capital investment burden. Air New Zealand has lengthened its planned delivery window for the 777-200ER replacements and deferred some of its A321neo and A320neo deliveries.

Air New Zealand has also scaled back its capacity targets. It now plans to grow by 4%-5% in FY2020, compared to its previous goal of 5%-7% annual growth over the next three years. The international network will still expand in an effort to boost inbound tourism, although there will be a 2%-3% reduction in domestic capacity.

Separately, the airline has unveiled a two year cost cutting programme aimed at identifying NZD60 million (USD38 million) in annual savings. This will come from a 5% reduction in overhead costs, including some limited labour cost savings, and a "targeted review" of operational costs.

These actions may seem extreme for a company that is still solidly profitable. However, if management is correct in its demand projections, then acting before a further decline will prove a prescient move.

Air New Zealand's new CEO Greg Foran

Like Virgin Australia, Air New Zealand will be tackling its next challenges with a new CEO.

Greg Foran will take over the reins in early 2020. While he is a relative newcomer to the airline industry, Mr Foran has a compelling leadership resume as CEO of the US division of the retail giant Walmart.

On the domestic front, Air New Zealand's main competitor Jetstar is dropping its turboprop regional services from Dec-2019 while retaining its jet flights on trunk routes. There have been indications that Air New Zealand may increase its cooperation with some independent regional airlines that generally operate routes not flown by the larger airline.

A major development in New Zealand's international market in 2020 will be the launch of two new routes by American Airlines. The airline is introducing Dallas-Auckland and Los Angeles-Christchurch in Oct-2020. These flights, operated in conjunction with American's partner Qantas, will provide more competition in Air New Zealand's key long haul market, as well as boosting capacity between the US and New Zealand.

New aircraft types prove ideal for Pacific Island airlines

The major themes for the airlines of the Pacific Island nations are fleet renewal and infrastructure development.

After many years of little change, several of the smaller South Pacific airlines have placed orders for new generation aircraft types that in many cases will open new market opportunities. Some new variants offer the ideal combination of size and range for these airlines.

Air Vanuatu has ordered four Airbus A220s, which are due to start arriving in Jun-2020. The aircraft is potentially a game changer for the long thin South Pacific routes, offering long haul jet capability with only 100 seats and similar seat economics to those of new widebody aircraft.

Air Kiribati is also due to receive two jet aircraft - Embraer E190-E2s in Dec-2019 and Apr-2020, a significant step as the airline is currently a turboprop operator.

Aircalin has begun the replacement of its Airbus jet fleet with A320neos and A330neos, allowing it to refresh its cabin product.

Air Niugini has four Boeing 737 MAX aircraft due for delivery late in 2020, and it is also considering other orders.

Air Tahiti Nui has just completed its fleet renewal, having received four 787-9s to replace its A340s.

Fiji Airways received its first A350 in November with a second due in December, although its narrowbody refresh has been disrupted by the worldwide grounding of the 737 MAXs. The airline ordered five MAXs to replace its 737NGs, but only two had been delivered before the groundings took effect.

Samoa's ill-advised move in Sep-2017 to terminate a JV with Virgin Australia and re-establish independent Samoa Airways ran into severe headwinds following the 2019 grounding of its planned aircraft, a MAX 9. To replace it, the airline expensively leased a 737-800NG from Malindo Air at short notice, shortly followed by the resignation of the Samoa Airways Chairman in Apr-2019 and its CEO in May-2019. In Aug-2019 Samoa's Minister for Transport announced plans to recapitalise the airline, while also talking of acquiring a further aircraft and adding long haul service to the US mainland.

Most Pacific Island airlines are government-owned, and the common goal for fleet investments is to entice more visitors to boost the vital tourism sector.

However, in many cases aviation and tourism infrastructure deficiencies also have to be addressed. Airports and air traffic control equipment need updating, and a lack of hotel rooms curtails inbound visitor numbers.