Qantas has shocked the market with a 90% profit downgrade, causing shares to plunge to their lowest point since privatisation.
Tony Webber, formerly the Qantas chief economist and now Associate Professor with the University of Sydney Business School, gives his take on the airline’s poor fortunes.
What is your take on the announcement and share price bloodbath that followed?
I think the share price says it all really. It’s a very, very, heavy loss for the international business and what’s probably more alarming is that they have put a profit guidance of between $50 million and $100 million on financial year ending 2012 when there is only 20 odd days left in the financial year.
So that tells you that they are having a really tough time determining their earnings, or their future earnings. So if it is hard to determine what their future earnings are going to be in 20 odd days, you can just imagine how hard they are finding it in determining their earnings for a 12 month or a 24-month period, or over the life of a big asset, like an aircraft.
Is this a case of Qantas International pulling down the Qantas group?
Qantas International hasn’t been making money for a long time and the domestic and regional businesses, Qantas mainline and Qantas Link, have been propping up International for a very long time. The only time an international business has made any money was a couple of years back, just before the GFC, and that had some fairly extreme, favourable conditions to make that happen. I think you can say with confidence that domestic and the regional business is really necessary to support the international business.
The sharemarket reaction and the profit expectation, which was announced today, is just saying that there’s one part of their business that is dysfunctional and has not been working for a long time. It is going to be really hard to fix it.
In terms of splitting the domestic and international financial results, they are obviously adopting a strategy of letting the markets be aware of international results. The only reason I can think of them doing this is to demonstrate more formally to the government and to some trade unions that their international performance is very, very weak. The reason for doing that for some of the unions is because those unions don’t believe that is the case.
Does this give last month’s restructure a different complexion now?
I think it probably says to Simon Hickey, who is the new boss of Qantas International, that you have got your work cut out for you. I know Simon quite well - he joined on exactly the same day as I did about 7 years ago - and he knows how tough a job it is going to be and he would have some ideas on how to turn it around.
A lot of the commentators are saying exactly that, it is going to be really really tough. Could we actually see the end of Qantas International? Is there a possibility that they might try to sell it, get rid of it as a loss-making operation?
I don’t think they can go without an international business just because there is so much connectivity between international and domestic. They have got lots of passengers flying domestically who have come from overseas or there are Australians travelling overseas and use the domestic link to connect up with an international service.
There are strong network effects between domestic and international, which means those strong inter-relationships will be completely lost if you chop off the international arm of business. I don’t think no one in their right mind would buy Qantas International, unless you want a loss-making entity that consistently performing below targets. Unless you want that in your business, then go for it.
Over a long horizon, you would be better off selling all of the aircraft that relate to international business and depositing the proceeds into a long-term deposit account. It is for this reason, amongst many, that governments own airlines - because the airlines cannot simply reward owners with the rate of return that is required relative to the risk associated with buying a stake in the airline.
So what about plans for an Asian airline? Is this off the agenda?
I think it probably pushes it forward. They need to make a radical change, and part of that involves concentrating on an international partner of some kind or a new national carrier. I don’t think they are looking at borrowing more capital or raising more capital, because that brings risk with it. They have always talked about any new venture being capital light, so that means they are really looking for a partner. I don’t know who their partner would be; the only carrier I can think of is Cathay Pacific because Singapore does not want to do it, Malaysia has said they don’t want to do it. Etihad is tied up with Virgin and Singapore is tied up with Virgin, so they are running out of potential partners.
What do you think the next move is for Qantas now?
I honestly don’t know. I know what they should do to solve the problem. They have had the opportunity to use the solutions I have proposed for some time and they have chosen not to use them. I think to understand the solution, you’ve got to understand the problems. I think there are a few problems, but the two that stand out are: they are growing their capacity too quickly and the market is growing its capacity too quickly, and the oil price is elevated.
The international aviation market in Australia is growing at about 5% per annum. At current oil prices, market capacity should be growing at about half that pace if it is to be consistent with maximising profit.
Now Qantas has only got direct control over its own capacity, so they can cut back on their capacity growth. The only way it can affect the capacity growth of all the market is if they go to the government and say, “Hey, can you stop giving these guys that are growing too quickly extra rights because they are bad for the economy at current exchange rates”. Because the way it works, foreign carriers are able to grow their capacity into the Australian market if they go and apply to the federal government for more rights to carry that capacity into Australia. The Australian government suggests: I’ll give you more rights. I’ll give you more frequencies or I will let you use bigger aircraft. I think Qantas has a case to demonstrate that at the moment, with the Australian dollar so high, granting those guys extra capacity is not good for the Australian people.
Wouldn’t they argue about the competition aspect?
Adding more capacity is good for airfares, it is not good for tourism. It is not good for tourism because it takes more Aussies out, rather than bringing tourists in. When you take Aussies out, you actually take them away from tourism domestically. It has a double whammy affect. Domestic tourism has been in decline by about 1% a year for the past 12 years, so it is on its knees. This is part of the reason why retail trade is weak as well.