Thursday, October 26, 2017

Less Is More for Qantas

In many industries, shareholders like to see executives boldly expanding into new markets. In aviation, not so much.

Qantas Airways announcement Thursday that it plans to lift capacity on international routes by about 5 percent in the six months through December relative to the same period last year sent its shares down as much as 7.2 percent in early trading, the worst such performance since annual results were released in August.

It's not hard to see why. Domestic aviation -- particularly for Qantas, which has a local market share north of 60 percent -- is a nice orderly business that the big incumbents can generally carve up among themselves. Venture out on the open skies, and you quickly find there are tougher conditions and a host of more aggressive competitors.

In terms of revenue per available seat kilometer -- a measure of the productivity of a single airplane seat -- the lie-flat beds and branded pajamas bestowed on full-service passengers on Qantas's international routes don't bring in much more than the cheap-and-cheerful sandwich cart seats on budget arm Jetstar.

Foreign Affairs

Qantas's full-service international flights are barely more productive in revenue terms than its budget carrier Jetstar.

With Australia's economy showing signs of improvement after a period of stagnation, that pattern played out clearly in the three months through September. Revenue on domestic routes rose 8 percent from a year earlier, Qantas said Thursday, while on international routes it edged up a mere 0.2 percent.

It would be nice if airlines could always tailor their supply to demand. But unfortunately they can't add and subtract seats one at a time, only in the 150-to-450 seat blocks that constitute a plane-full.

With Virgin Australia and Cathay Pacific Airways adding seats on flights between Australia and Hong Kong, and Qantas starting to receive the first Boeing Co. 787 Dreamliners to operate its ultra-long-haul route from Perth to London, it's inevitable that sometimes capacity grows in advance of demand.

Leave Them Wanting More

Qantas's valuation tends to rise when it cuts back on capacity growth, and vice versa.

As Gadfly has argued previously, the temptations and risks of the wider world remain an enduring dilemma for Qantas. Fear of missing out on the outbound Chinese tourism boom risks dragging the carrier away from its more profitable core business.

In recent years, Qantas has showed admirable discipline in limiting its China-bound aircraft to Hong Kong and the Shanghai hub of its partner China Eastern Airlines Corp. With daily flights now being added to Beijing and the addition of cavernous A380 cabins on the Hong Kong route, that restraint looks to be slipping.

Qantas has seen one of the airline industry's great turnarounds since its nadir between 2011 and 2014, and its shares on Monday touched their highest level since the company's 1995 listing. But most of the benefits of this recovery have already been realized, with non-fuel costs moving sideways in recent years.

Cruising Altitude 

Qantas has worked to cut costs over the years -- but the low-hanging fruit has already been picked.

At 4.5 times blended forward 12-month Ebitda estimates, the flying kangaroo's enterprise value is close to the top of its historic valuation range. That seems a risky place from which to embark on an expensive new foreign adventure.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To be sure, Jetstar is arguably an international airline itself: About 60 percent of reported capacity is on its international routes and the Singapore-based Jetstar Asia brand.

(David Fickling Bloomberg)

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