ANALYSIS: Virgin and Qantas set to continue domestic capacity battle

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Although Australia's domestic airline market has returned to a duopoly scenario, Virgin and Qantas have signalled that they will continue to battle each other using capacity.

Intense competition between the two carriers have led to their respective domestic earnings falling sharply during the year ending 30 June. Qantas Domestic recorded a 21% fall in earnings before interest and taxation (EBIT) to A$365 million ($326 million). Virgin's domestic business was in the red to the tune of A$44.4 million. Qantas's Jetstar unit also recorded a 32% fall in EBIT, partially because of the weaker domestic conditions. However, the fall was also attributed to start-up costs at its Hong Kong and Japan operations.

Qantas chief Alan Joyce told reporters at a briefing that over the year there was aggregate 8% growth in capacity on the domestic market as Qantas and Virgin both added more seats into the market.

"Eight percent was a lot of capacity added last year - we think it was two years' growth," says Joyce.

He adds that Qantas is planning to only add 1.5-2% capacity to the domestic market over the next year as the market "does need some time to grow back into that capacity".

Curiously, despite the beating it took to its bottom line last year, Virgin chief executive John Borghetti is more bullish and says that the carrier will add 3-4% more capacity this year.

Some of that growth will come from further expansion on regional routes. The airline has said that it intends to start flying between Cairns and Weipa in 2014 once the route becomes deregulated. It will also announce one more route soon.

Borghetti believes that the market will be able to absorb the additional capacity.

"If you look at aviation in Australia, typically the domestic market growth has been 5%, [so] 3-5% is not an unusual growth," he says.

Analysis of Flightglobal's Capstats database seems to back up that assertion. Between 2010 and 2013, annual ASK growth in the market averaged 6% as Virgin moved into the corporate market, Qantas sought to maintain its market share, and as Jetstar and Tiger duked it out in the budget segment.

Borghetti adds that in the last four months, Virgin has seen "positive yield growth and the loads are building".

Virgin's projected capacity growth does not, however, include expected growth at Tigerair Australia, of which Virgin now owns 60%. Borghetti specifically refused to discuss the budget carrier's plans for the year, but noted that it was experiencing higher loads and seeing stronger forward bookings.

There is little doubt that Tigerair Australia will add more capacity over the year. Flightglobal's Ascend Online Fleets database shows that it is scheduled to take delivery of three Airbus A320s by the end of June 2014, taking its fleet to 14 aircraft.

Joyce has signalled that Qantas "maintains flexibility" in its fleet, and will likely add capacity to maintain market share at the 65% "line in the sand" that it regards as profit-maximising.

Qantas could do that by retaining some of the aircraft that it has earmarked for retirement, such as three Boeing 737-400s and three 767s. That would be in addition to the eight aircraft that its regional arm QantasLink will receive over the year - three Bombardier Dash 8 Q400s and five Boeing 717s.

More likely, however, it will add capacity via Jetstar. Leases on six A320s operated by the wider Jetstar group will expire by the end of the financial year, but they could potentially be extended to keep up capacity to meet the threat of a larger Tigerair Australia.

For both Virgin and Qantas, there is no doubt that the carriers have the resources to withstand another bruising year of competition. At the end of the fiscal year, Qantas had a cash balance of A$2.83 billion, while Virgin had A$581 million.

In the case of Virgin, it will soon also have access to a A$90 million unsecured term loan facility from shareholders Air New Zealand, Etihad Airways and Singapore Airlines. It appears that those three airlines also stand ready to lend further support if needed, and all have publicly backed Borghetti's strategy.

While 2014 may be the year that Australia's market returns to a duopoly, both players have shown that there are no plans to ease the competitive tension between them.