View Full Version : Airlines' tortoise and hare race (Robert Gottliebsen)

9th Dec 2003, 13:38
Tues "The Australian"

Airlines' tortoise and hare race
December 09, 2003
Robert Gottliebsen

The share market believes Virgin Blue will give Qantas a bath. And Asian markets believe Singapore Airlines will also out-manoeuvre the Australian airline giant despite facing similar problems.

Qantas chief executive Geoff Dixon and chairwoman Margaret Jackson therefore have an enormous task to convince the markets that they can match it with Koh Boon Hwee and Chew Choon Seng in Singapore and Virgin's combination of Richard Branson, Chris Corrigan and Brett Godfrey.

Although Qantas profits are expected to rise from 20 to 29c a share for the year ended June 30, 2004, the market thinks that's about all the Qantas management is capable of achieving.

Accordingly its price earnings ratio is less than 12. Singapore Airlines is priced above 18 times expected 2005 earnings reflecting faith in the company's management.

Virgin in Australia is priced close to 16 times forecast 2003-04 earnings.

The market thinks the combination of a traditional airline and a discount airline will not work.

One will cannibalise the other and Virgin will prove better than Qantas at the straight discount operation.

In addition, the Qantas costs of being based in Sydney are too high and the company's workplace agreements are not up to global standards. Qantas has swung its discount operation into Melbourne, hoping to better Virgin's Brisbane-based costs.

It is also rationalising its aircraft fleet. The difference between the work agreements of Qantas and Virgin may be exaggerated. In its early days Virgin had a huge advantage but according to the Institute of Public Affairs capacity-to-manage index, Qantas comes in at minus 11, which is clearly too high. However, the Virgin agreement is not that much better at minus nine.

Clearly the difference between the two airlines' costs reflects Virgin's concentration on one type of aircraft and its ability to manage its staff and overcome deficiencies in its workplace agreement.

Qantas is engaged in a substantial cost reduction exercise. The danger is that it will cut its costs too far, which will hit the Qantas full-service operation and mean that discount airlines become the dominant force in the market.

Virgin's greatest selling point to the business community has been the fact that the vast majority of its aircraft leave on time and few flights are cancelled. Qantas may have figures that show it can match the Virgin performance but, rightly or wrongly, in the marketplace, its image has been tarnished by flight cancellations.

The great advantage that Dixon and Jackson have is that while the market expects a big rise this year, after that the performance bar is low. If the Qantas plans work then the shares have considerable upside.

Conversely the expected $150 million Virgin profit for the year ended March 31, 2004, might be up substantially on the previous year, but is merely the starting point.

The company is structured to maximise profit growth. For example, 33 of the company's 40 aircraft were leased through long-term operating leases and the company has also arranged long-term debt facilities to finance the acquisition of 10 Boeing 737 next-generation aircraft.

If the market stabilises and Qantas begins to claw back market share then the highly leveraged Virgin Blue will simply not be able to produce the profits to justify the current price earnings ratio.

One of the tragedies of the float structure is that the equity rewards to the senior executives are pitched at low levels rather than where they should be - at the float price. The risk for Virgin shareholders is that this will be a tortoise-and-hare race.

At the moment the hare is way out in front. But it is just possible that the Qantas tortoise has been given a wake-up call and instead of worrying about cartels with Air New Zealand will get on with the job of adapting Qantas to what has become a dramatic change in the marketplace.

Robert Gottliebsen writes for The Australian and hosts Business Daily on ABC Asia Pacific TV.