Qantas domestic cuts bring it back to reality

QF Group 738 and 767 at SYD.JPGQantas, including Jetstar, will trim domestic capacity and defer or cancel forthcoming narrow-body aircraft, including Boeing 737-800s.

Although the Qantas Group’s domestic network–mainline and Jetstar–is not as glamorous as its international network, it is profitable and, along with the frequent flyer programme, props up Qantas’s loss-making international network. It thus seems especially concerning when Qantas announces, as it did today, that it will curtail Qantas and Jetstar’s domestic growth from 8% to 5.5%, cancel or defer 12 aircraft between now and end FY2012, and reduce the number of leased aircraft next financial year.

But Qantas has been brought back to the reality of another domestic downturn and having an overly ambitious expansion plan. Although Virgin Australia in May 2010 downgraded its financial outlook on account of a weakening leisure market, Qantas this February pressed ahead with aircraft acquisitions, despite in the previous few months experiencing earthquakes in New Zealand, cyclones in Queensland, and floods elsewhere in Australia.

Qantas announced that the end of FY2013 Qantas mainline would lease five additional Boeing 737-800 aircraft and extend leases on a further two. Jetstar saw even more growth with new leases on 10 A320s and lease extensions on 11 A320s (plus a new A330-200 for its international division).

The disparity between Qantas and Virgin was further evidenced a month later when Virgin announced it would post an annual loss. In the same market, how could one airline be signing for aircraft while another expects a loss of A$30-80m? Virgin is incurring costs as part of its business transformation, but Qantas was too bullish on a resilient market while also banking on filling the void Virgin would create by going after a greater share of the corporate market.

Qantas’s reckoning appears to have been that Virgin’s cost would rise with its transformation, which would make its leisure seats more expensive and thus ripe for Jetstar to capture while Virgin’s premium product would also see costs increase, making Qantas’s business product more viable to Virgin passengers.

As Qantas chief executive Alan Joyce said when announcing the leases in February: “We see great opportunities for Jetstar, particularly in the domestic market as our competition changes their focus. It is an opportunity Jetstar is seizing.”

It has so far ended up being a non-opportunity. Virgin’s simplified fare structure has relatively maintained fares, although they could rise–creating the opportunity Qantas saw–as Virgin keeps spending and settles in to its new position once the new brand launch excitement dies down. Virgin’s business transformation, as detailed to a Macquarie investor conference, calls for the airline to re-position itself this and next financial year and then start to achieve better yields in the 2012-2013 financial years timeframe.

Trimming overly-ambitious growth is better than cutting moderate growth, which could explain Qantas emphasizing in a statement its “strong funding position”: cash balance over A$3b, and, Qantas says, being the highest-rated airline in the world with a BBB/Baa2 investment grade rating. Qantas all but says it will still be fine after trimming growth.

The downturn is not confined to Qantas and Virgin. Tiger Airways during its annual results conference last month announced it would maintain capacity in Australia this year as its Australian division incurred a loss. “That was primarily due to the weather events that we saw in Australia from December through February,” chief executive Tony Davis remarked at the time. But since then, Tiger’s decision to axe Australian routes show it too is seeing a downturn, and not just a one-off bad period from natural disasters.

To add context to the Qantas Group’s figure of now taking delivery of 34 aircraft in FY2012 instead of the 43 previously planned, in February Qantas expected to take delivery of six 737-800s by the end of FY2011 and a further 15 737-800s in FY2012, when Jetstar would also take delivery of 15 A320s.

Finally, Qantas trimming its domestic fleet is noteworthy given Joyce’s comments last week Qantas would consider cutting its international fleet, whatever merit the proposition has.

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