22/06/2016

A quantum leap for once-struggling Qantas

A quantum leap for once-struggling Qantas

Qantas’s incoming Boeing 787s will not disrupt its restructuring plan

The Australian airline is two years into its three-year Transformation Plan which aims to permanently increase the airline’s productivity and competitiveness. Early indications are that the carrier appears to be on track for a sustained recovery.

Qantas has eight Boeing 787-9s which are scheduled to begin delivering in late 2017 through 2018.  The Ishka view is that the new aircraft, which will mostly be used to replace the airline’s ageing 747-400s, will not threaten Qantas’ profitable codeshare agreement with Emirates but will allow the airline to benefit from the high rise in Chinese traffic to Australia. 

On the road to recovery

Qantas’s Transformation Plan was introduced following heavy losses in 2013 – the first since Qantas was fully privatised in 1995 – and a revenue drop of AUD 550 million ($421 million). So far the carrier is $1.4 billion into the programme that intends to deliver $2 billion in gross benefits by the end of 2017. And last year Qantas made a convincing recovery, regaining their investment grade status and posting $975 million in pre-tax profit.

Further, the plan saw debt reduction of more than AUS 1 billion ($765.5 million), 4,000 job losses and a group expenditure reduction (excluding fuel) of 10%.  

Codeshare agreements with Emirates, China Southern and American Airlines have helped ease competition while the airline gets its finances in order.

The restructuring plan appears to be sustainable. The early indicators are pointing in the right direction. EBITAR is up, Revenue Seat Kilometre (RPK) is up by 2% and capacity growth has remained flat, ending the overcapacity that had previously damaged revenues.

Like many other airlines with a favourable fuel hedging position, the airline has benefited tremendously from lower fuel prices; also, the positive impact of reduced depreciation expenses resulting from the non-cash write down of Qantas International Fleet in 2013/2014 and the repeal of the Australian carbon tax.

Half of the group’s fleet – valued at over AUD 3.5 billion ($2.7 billion) – is now unencumbered, adding to a strong total liquidity position. And as part of the Transformation Plan the fleet has also been simplified from 11 types to seven and has an average age of 7.7 years – three below the targeted 8 to 10-year range.

Full year financial data is not yet available for 2016, but the first half results show continued improvement. The group continues to expand margins through both revenue growth and cost discipline. Revenue increased by 5% to AUD 8.5 billion, ($6.7 billion) while total unit costs were down by 7% compared with the first half of last year.

The full year results are expected to show a cautious 5% increase in capacity well in line with the long-term average for Australia. And transformation benefits including fuel efficiency, cost and revenue are projected to be AUD 450 million ($376 million) for the year.

Ultra-long haul ambitions

Qantas has eight Boeing 787-9 due to be phased in during 2017 and 2018.  They will replace five of the airline’s ageing 747-400s but will undoubtedly be deployed on new routes.  The longer range of the 787 presents new opportunities. Qantas’ CEO, Alan Joyce, has recently mooted direct flights between Melbourne and Dallas, Brisbane and Dallas, Sydney and Chicago and even Perth to London as a possibility, however Ishka doubts whether this route could be done directly without being payload restricted during parts of the year.

 The airline is expected to exercise more of its (45) options for the 787, although the timing of this remains unclear.

Ishka believes that the incoming aircraft will not affect the codeshare agreement Qantas has with Emirates. The arrangement has been successful to date with AUS 2 billion ($1.5 million) in bookings, amounting to a four-fold increase since 2013. Joyce himself has touted the success of the joint partnership model and it also frees up aircraft for use in the high-growth Asian market.

Chinese Market

Leisure demand from China is experiencing a growth spurt, and increased by 22% in 2015. Joyce expects this to quadruple in the next decade. Qantas is well placed to exploit this both as a full-service carrier and through its low-cost subsidiary, Jetstar. The different subsidiaries of the Qantas Group allows a greater flexibility to manage incoming aircraft orders.

If there is sufficient demand Qantas could deploy its 787s to serve the Chinese market.  Around a million Chinese tourists visit Australia each year and they typically take two or three domestic flights with each visit.   

Qantas currently has a codeshare agreement with China Southern Airlines and joint venture partnership with China Eastern on routes between China and Australia.  However, there has been ongoing speculation that Chinese investors may want to buy in to Qantas after two Chinese conglomerates, HNA Group and Nashan, took equity stakes in domestic rival Virgin Australia.  Around 5% of the carrier is available for foreign investors, and this might be enough to tempt a competitor airline to invest in a seat at the board.

Scenarios
What if Qantas decides to reject the Emirates codeshare?
Qantas entered into the agreement with Emirates in 2013, conceding that it was struggling to compete with the carrier amid soaring fuel costs. Although the partnership has been profitable for Qantas, it has been more advantageous to Emirates who had no trouble in the Australian market before this and have increased their market share, as hub flights now come via Dubai rather than Singapore.  With robust finances and 787-9s on order, Qantas is in a far better position to compete with direct flights to Europe. The airline is also eyeing the next generation of long-haul aircraft – the A350-900ULR and Boeing 777-8 – both of which are under development and currently due to enter service in 2018 and 2021 respectively.  If the agreement did collapse before it is due to expire in 2023, there would be a strong case for ordering these aircraft.
What if the fuel price goes up?
Qantas have strong hedges in place so should be able to manage well.  The carrier was seriously affected by high fuel prices in 2013-14. Costs reached a company record of AUS 4.5 billion ($ 3.67 million) – up 5.6% on the previous year. However, with new fuel hedges in place the benefit of a fall in prices over the course of 2015 has been protected for the full year 2016, with 73% participation to lower prices.  In fact, Moody’s says that Qantas has a strong enough balance sheet to withstand a more than doubling in the price of jet fuel without losing its hard-won investment grade credit rating.

The Ishka View

Qantas’ bottom line has recovered well, vindicating the transformation plan, and presents solid opportunities for investors.  It has a young fleet, expansion plans, and is well positioned to exploit the growth in Asian – and especially Chinese – demand.

It is too early to say whether Qantas’ ultra-long haul plans will be successful; others airlines have grappled with this segment in the past and withdrawn such services, though on their present course Ishka anticipates a sustained recovery for the airline.

Comments:

Sign in to post a comment. If you don't have an account register here.