ANALYSIS: Pain lies with international business at Qantas

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The landmark full-year loss after tax of A$244 million ($256 million) announced by Qantas on 23 August has made the headlines as it was the first reported by the airline since its 1995 privatisation.

However, the result should come as no surprise as it followed the profit warning issued back in June when the pain being suffered by Qantas's international operations came into sharp focus. And more encouraging was the fact that the Oneworld carrier's underlying pre-tax profit of A$95 million was at the top end of expectations and compares with A$552 million the previous year.

The underlying full-year EBIT loss of around A$450 million for Qantas's international business - in stark contrast to the profits in its domestic and Jetstar operations - illustrates the pressures on this part of the airline. Qantas has had its international operations under the microscope for a while. "The issues are the same as they've been for a long time - Qantas has a good performing domestic market business where Jetstar provides a buffer against Virgin Australia which they've got to continue to ensure performs well. And [chief executive] Alan Joyce's actions to address the problems with the international business are well known," says CTAIRA analyst Chris Tarry.

Qantas had already embarked on a five-year restructuring plan and in May split its airline business into two separate units, giving Qantas International its own chief executive and separate operational and commercial functions. The full year loss excludes some large negative numbers, significantly "transformation costs" associated with Qantas International of $376 million.

"Management can have a clear idea where it wants to take a business, but faces costs and challenges getting there," says Tarry. "Change is not costless and is not instant."

Pressure has come on several fronts. There are the global headwinds all airlines are facing which means IATA envisages collective airline profits halving this year to just $3 billion. The continued economic problems in key long-haul markets, particularly in Europe, put more pressure on Qantas's international operations.

Similarly the higher fuel price environment has increased the cost burden for airlines - the Brent Crude Oil barrel price was around $60 mark when Qantas originally placed its order for Boeing 787s - of which it cancelled 35 -9s today - in late 2005 but has traded at over $100 for much of the last two years.

Like many legacy carriers, which continue the long-standing battle to reduce their own costs, the heat has also been turned up by heightened competition. The expansion of the highly competitive Gulf carriers, both globally and in Australia - Emirates already serves four Australian cities, Etihad Airways three and Qatar Airways two - raises the stakes on international routes.

The competitive pressure has also been ramped up closer to home through the repositioning of Virgin Australia under former Qantas executive John Borghetti's leadership into a more direct challenger in the full-service market. And these two forces have come together through the strategic alliance between Virgin Australia and Abu Dhabi's Etihad.

"On the long-haul you've seen change competition - that whole market has changed as for anyone flying traffic down to southeast Asia or Australaisa, the Gulf carriers are extremely well placed because their geographic location means they have amazing catchment areas to fly from and to. But Jetstar's long-haul business out of Australia reaches those parts that Qantas' can't because of its cost structure," Tarry says.

This increasing competition, combined with the tough market, has prompted Qantas to consider a possible alliance future with one of the Gulf giants. Qantas last month confirmed talks are taking place with Emirates on a possible commercial tie-up - most likely a codeshare agreement through Dubai - though the Australian carrier has been coy on the detail.

That Emirates is seen as possible solution perhaps illustrates the size of the challenge facing the Australian carrier on its international business. Until recently Emirates appeared an unlikely ally - few of the big legacy carrier groups have embraced the Gulf giants, while it also raises questions around Qantas joint venture with British Airways on the "kangaroo route" between Australia and Europe.

In splitting out its international business in May, Qantas chief executive Alan Joyce said this segment was loss-making and did not deliver sustainable returns. "We are committed to turning it around through the five-year strategy we announced last year, based on flying to global gateways, deeper alliances, smart investment in produce and disciplined capacity management," he said. A few months on, talks with Emirates and the 787 cancellations illustrate the extent to which this is a path being followed.

"What will the final shape of Qantas group be? Jetstar, Qantas Domestic, and in five years' time what size and role will Qantas International have and where will it fly? I just don't know," says Tarry.