Wirraway
13th Dec 2004, 16:19
Mon "Australian Financial Review"
Smoother Flying Ahead For Airlines
Date December 13th, 2004
Alan Jury
Richard Branson's visit to launch the Virgin Atlantic service prompted Alan Jury to discuss Qantas and Virgin Blue's outlook with Challenger Financial Group's Nerida Hall and QIC's John Gethin-Jones.
The impact of rising fuel prices on airlines' profitability has been muted in 2004 because of hedging and fuel surcharges. How will Qantas and Virgin Blue manage the situation in 2005 and 2006?
Nerida Hall: Qantas currently hedges fuel prices to the West Texas Intermediate crude prices, but takes active positions on refining margins. Currently Qantas has approximately 70 per cent of its financial year 2005 fuel needs hedged to the WTI. Qantas will manage rising input prices by taking ongoing active positions on refining margins. Virgin Blue currently hedges fuel prices directly to the Singapore Jet price, and has approximately 10 per cent hedged for the second half of financial 2005. Virgin Blue will continue to manage rising input costs through hedging directly to the Singapore Jet price together with a measured "across the board fare review". This approach is more precise then an arbitrary increase in ticket prices.
John Gethin-Jones: We don't expect that Qantas or Virgin will handle their fuel purchases any differently in 2005 and 2006, essentially hedging purchases when price opportunities arise. The ability to impose a surcharge provides an effective safety net for them without any significant impact so far on passenger travel.
What do you regard as the major threats and opportunities presented by a stronger Australian dollar for Qantas and Virgin Blue? Do you regard them as net beneficiaries?
Nerida Hall: Virgin Blue would be a beneficiary of a stronger Australian dollar due to its predominantly domestic exposure, with the group's revenue being based in Australian dollars and expenses in US dollars. Qantas would also benefit due to its domestic exposure and large capital expenditure program. John Gethin-Jones: Up to 40 per cent of Qantas's and Virgin's cost bases are denominated in US dollars and there is no doubt they benefit from a lower US dollar, subject to the level of hedging in place. Qantas has the highest capital expenditure plans in the year ahead and the stronger Australian dollar will lower the overall capital cost for them.
For investors, what do you see as the principal points of differentiation between Qantas and Virgin Blue?
Nerida Hall: Virgin Blue's business model can best be described as "cost-minus" as opposed to the Qantas business model, which can be described as "cost-plus". Virgin Blue being a start-up operation has enabled management to start with a clean sheet of paper. This contrasts with Qantas, which is constantly dealing with legacy issues and ongoing competitive stakeholders.
Virgin Blue has also had the expertise of their major shareholder, Patrick Corporation, which understands shareholder value and the importance of a business model with a sustainable competitive advantage. John Gethin-Jones: The airline industry is a commodity business, particularly short-haul. Maintaining a cost advantage is therefore critical. Qantas is slowly moving in the right direction, but Virgin still has the advantage at this point.
What is your view of Qantas's recent changes to its loyalty program?
Nerida Hall: This change will result in some backlash among customers as frequent flyer points are more commonly used for international flights. A move to international accounting standards will also enable Qantas to review its entire loyalty program and structure.
John Gethin-Jones: Qantas has been slowly eating away at loyalty benefits for a number of years and will probably continue to do so. As a shareholder, we are supportive if the moves reduce the cost of the programs without alienating passenger loyalty.
Launching Jetstar allowed Qantas to nullify some of the cost advantages enjoyed by Virgin Blue. How do you envisage Jetstar affecting the results of Qantas and Virgin Blue?
Nerida Hall: The risk for Jetstar over time is the salary differential between Jetstar and the domestic mainline pilots and cabin crew. It may impede corporate culture. Virgin Blue has a unique and dynamic culture with a value-add and cost-focus attitude. John Gethin-Jones: Jetstar is yet to prove its commercial viability, although some analysts believe that the market is underestimating the success of Jetstar and anticipate we will be positively surprised at the next results release.
Because of the particular focus on the leisure market, where Virgin had gained significant market penetration, any gains by Jetstar will be at Virgin's expense.
Do you expect the current competitive pricing regime to be maintained, or can we expect to see a move towards duopoly-type pricing next year?
Nerida Hall: A move towards duopoly-type pricing seems more likely now that capacity plans and pricing decisions for both players are approaching rationality. Load factors are reaching 80 per cent and capacity plans for both operators look reasonable. Over the next 12 months yield stabilisation is expected. John Gethin-Jones: Pricing is a function of added capacity and market growth. Provided the economy holds up next year, yields will be firmer than they are today. There is clear evidence that the margin between Qantas and Virgin has compressed over recent history. The period of raw pricing aggression may now be behind us.
Virgin Atlantic has just launched a Kangaroo Route service. Do you think this will have a significant impact on results for Qantas? Do you think there is any feeder benefit for Virgin Blue?
Nerida Hall: The aviation industry is highly competitive and capital intensive. Additional capacity could have an impact on Qantas's international operations but it will depend on flight frequency and ticket pricing. The bigger risk for Qantas over the medium term is a relaxation in terms of "open-sky" policy. Qantas has a number of protected routes and if open-sky policy does result this will pose a much greater risk to the future of Qantas's earnings.
Virgin Atlantic has recently announced a code-sharing arrangement with Virgin Blue. This should result in an increase in traffic, however it is unlikely to be material. John Gethin-Jones: The impact will be negligible. Virgin Atlantic will have a very small share of what is already a reasonably competitive route. Some feeder benefits will come to Virgin Blue via the code-sharing arrangements but in the context of the current passenger levels the number of additional passengers is modest.
· Nerida Hall is a senior industrial analyst at Challenger Financial Services Group. John Gethin-Jones is general manager, global equities, for QIC.
==========================================
Smoother Flying Ahead For Airlines
Date December 13th, 2004
Alan Jury
Richard Branson's visit to launch the Virgin Atlantic service prompted Alan Jury to discuss Qantas and Virgin Blue's outlook with Challenger Financial Group's Nerida Hall and QIC's John Gethin-Jones.
The impact of rising fuel prices on airlines' profitability has been muted in 2004 because of hedging and fuel surcharges. How will Qantas and Virgin Blue manage the situation in 2005 and 2006?
Nerida Hall: Qantas currently hedges fuel prices to the West Texas Intermediate crude prices, but takes active positions on refining margins. Currently Qantas has approximately 70 per cent of its financial year 2005 fuel needs hedged to the WTI. Qantas will manage rising input prices by taking ongoing active positions on refining margins. Virgin Blue currently hedges fuel prices directly to the Singapore Jet price, and has approximately 10 per cent hedged for the second half of financial 2005. Virgin Blue will continue to manage rising input costs through hedging directly to the Singapore Jet price together with a measured "across the board fare review". This approach is more precise then an arbitrary increase in ticket prices.
John Gethin-Jones: We don't expect that Qantas or Virgin will handle their fuel purchases any differently in 2005 and 2006, essentially hedging purchases when price opportunities arise. The ability to impose a surcharge provides an effective safety net for them without any significant impact so far on passenger travel.
What do you regard as the major threats and opportunities presented by a stronger Australian dollar for Qantas and Virgin Blue? Do you regard them as net beneficiaries?
Nerida Hall: Virgin Blue would be a beneficiary of a stronger Australian dollar due to its predominantly domestic exposure, with the group's revenue being based in Australian dollars and expenses in US dollars. Qantas would also benefit due to its domestic exposure and large capital expenditure program. John Gethin-Jones: Up to 40 per cent of Qantas's and Virgin's cost bases are denominated in US dollars and there is no doubt they benefit from a lower US dollar, subject to the level of hedging in place. Qantas has the highest capital expenditure plans in the year ahead and the stronger Australian dollar will lower the overall capital cost for them.
For investors, what do you see as the principal points of differentiation between Qantas and Virgin Blue?
Nerida Hall: Virgin Blue's business model can best be described as "cost-minus" as opposed to the Qantas business model, which can be described as "cost-plus". Virgin Blue being a start-up operation has enabled management to start with a clean sheet of paper. This contrasts with Qantas, which is constantly dealing with legacy issues and ongoing competitive stakeholders.
Virgin Blue has also had the expertise of their major shareholder, Patrick Corporation, which understands shareholder value and the importance of a business model with a sustainable competitive advantage. John Gethin-Jones: The airline industry is a commodity business, particularly short-haul. Maintaining a cost advantage is therefore critical. Qantas is slowly moving in the right direction, but Virgin still has the advantage at this point.
What is your view of Qantas's recent changes to its loyalty program?
Nerida Hall: This change will result in some backlash among customers as frequent flyer points are more commonly used for international flights. A move to international accounting standards will also enable Qantas to review its entire loyalty program and structure.
John Gethin-Jones: Qantas has been slowly eating away at loyalty benefits for a number of years and will probably continue to do so. As a shareholder, we are supportive if the moves reduce the cost of the programs without alienating passenger loyalty.
Launching Jetstar allowed Qantas to nullify some of the cost advantages enjoyed by Virgin Blue. How do you envisage Jetstar affecting the results of Qantas and Virgin Blue?
Nerida Hall: The risk for Jetstar over time is the salary differential between Jetstar and the domestic mainline pilots and cabin crew. It may impede corporate culture. Virgin Blue has a unique and dynamic culture with a value-add and cost-focus attitude. John Gethin-Jones: Jetstar is yet to prove its commercial viability, although some analysts believe that the market is underestimating the success of Jetstar and anticipate we will be positively surprised at the next results release.
Because of the particular focus on the leisure market, where Virgin had gained significant market penetration, any gains by Jetstar will be at Virgin's expense.
Do you expect the current competitive pricing regime to be maintained, or can we expect to see a move towards duopoly-type pricing next year?
Nerida Hall: A move towards duopoly-type pricing seems more likely now that capacity plans and pricing decisions for both players are approaching rationality. Load factors are reaching 80 per cent and capacity plans for both operators look reasonable. Over the next 12 months yield stabilisation is expected. John Gethin-Jones: Pricing is a function of added capacity and market growth. Provided the economy holds up next year, yields will be firmer than they are today. There is clear evidence that the margin between Qantas and Virgin has compressed over recent history. The period of raw pricing aggression may now be behind us.
Virgin Atlantic has just launched a Kangaroo Route service. Do you think this will have a significant impact on results for Qantas? Do you think there is any feeder benefit for Virgin Blue?
Nerida Hall: The aviation industry is highly competitive and capital intensive. Additional capacity could have an impact on Qantas's international operations but it will depend on flight frequency and ticket pricing. The bigger risk for Qantas over the medium term is a relaxation in terms of "open-sky" policy. Qantas has a number of protected routes and if open-sky policy does result this will pose a much greater risk to the future of Qantas's earnings.
Virgin Atlantic has recently announced a code-sharing arrangement with Virgin Blue. This should result in an increase in traffic, however it is unlikely to be material. John Gethin-Jones: The impact will be negligible. Virgin Atlantic will have a very small share of what is already a reasonably competitive route. Some feeder benefits will come to Virgin Blue via the code-sharing arrangements but in the context of the current passenger levels the number of additional passengers is modest.
· Nerida Hall is a senior industrial analyst at Challenger Financial Services Group. John Gethin-Jones is general manager, global equities, for QIC.
==========================================