Brian Gaynor: Air NZ quick to act as number of flyers falls

Airline chief executives face constant challenges and new Qantas chief executive Alan Joyce felt the full weight of his position this week when he slashed the company's June 2009 year profit forecast by a further 80 per cent.

The headline in the Australian Financial Review read "Qantas profit in freefall" followed by two subheadings: "Business travel slump hits earnings" and "1750 staff axed, planes grounded".

Air New Zealand chief executive Rob Fyfe faces the same difficult trading conditions but his company appears to be holding up better than Qantas and Virgin Blue, the two other Australasian listed carriers, in terms of profitability.

One of the most important factors affecting airlines is passenger numbers, which are best measured by revenue passenger kilometres or RPKs.

RPKs multiply the number of passengers by the kilometres flown and this enables us to compare companies that have a predominantly short-haul operation compared with those that have more long-range international routes.

As the accompanying table shows, Air New Zealand and Qantas have experienced sharp declines in RPKs over the past few months.

New Zealand's national airline had a 9.1 per cent reduction in RPKs for the four months ended February 28 compared with the same period in 2007-08. Its four main routes performed as follows:

The United Kingdom route through North America, which is the largest in terms of RPKs, experienced a 13.3 per cent decline in the four-month period.

The UK route through Asia and Japan was down 7.9 per cent.

The Tasman and Pacific routes experienced a 6.7 per cent drop in RPKs.

Domestic RPKs were off 4.5 per cent in the same November to February period.

February was the worst month as far as all routes were concerned. Air New Zealand's total RPKs for the month were down 11.4 per cent compared with February 2008.

The good news as far as Air New Zealand is concerned is that it responded quickly to the downturn by cutting capacity.

Although group RPKs for the first eight months of the June 2008 year were down 6 per cent, the passenger load factor was off only slightly, from 80.2 per cent to 79.2 per cent.

This is because of major capacity reductions on the UK routes, through both North America and Asia/Japan.

However, the Tasman/Pacific routes remain a major problem with the load factor falling from 79.4 per cent in the July 2007 to February 2008 period to 74.5 per cent for the first eight months of the current financial year.

These figures clearly indicate there has never been a better time to buy cheap tickets to Sydney, Melbourne or Brisbane as Air New Zealand, and other airlines, drop fares to try to boost load factors on these routes.

Air New Zealand doesn't report monthly cargo figures but this is also a problem for the Australasian carriers. Air New Zealand has experienced reduced demand in this area and from March 31 withdrew its twice-weekly 747 freight service from Auckland to a number of markets including Australia, China, Germany and USA.

This service contributed about a third of the group's cargo revenue.

Qantas delivered its bad news on Tuesday when it revealed that its June 2009 year pre-tax profit guidance had been reduced to the $100 million to $200 million range. This compared with its previous guidance of $500 million and $1.4 billion achieved in the June 2008 year.

Chief executive Joyce said Qantas Airlines' international and freight services were bearing the brunt of the decline in economic conditions. He said the company was experiencing an unprecedented drop in demand for premium travel but Jetstar and the Qantas Frequent Flyer business were continuing to perform well.

These comments are consistent with the company's RPK data. In the four months ended February 28 group RPKs fell by 5.7 per cent and the main individual operations performed as follows:

Qantas international experienced a 9.1 per cent decline in RPKs during the four-month period.

Qantas domestic was down 5.3 per cent.

Jetstar international and domestic had a 6.2 per cent gain in RPKs in the November to February period. Jetstar international has performed particularly well, indicating that demand for low-cost international travel remains strong.

Joyce said Qantas had made a number of decisions to improve efficiencies and reduce costs. These include a 5 per cent capacity reduction and the grounding of 10 extra aircraft. It was also deferring a significant number of new aircraft deliveries and reducing staff numbers by 1550.

Qantas has 34,000 employees, which is 3.1 times the 11,000 employed by Air New Zealand at the end of its June 2008 year. As Qantas also carries 3.1 times more passengers than Air New Zealand, these employee numbers are in line with the respective size of each company's operations.

Virgin Blue's RPK statistics are a complete contrast, mainly because of route expansions by Pacific Blue, the carrier's international airline, and the inauguration of V Australia, its new airline flying between Australia and the west coast of the United States.

Nevertheless its domestic RPKs rose by 6.6 per cent in the first eight months of its June 2009 financial year and the company's international RPKs surged by 60.2 per cent. The only problem is that Virgin Blue's international capacity has grown at a faster pace than RPKs and the company's international load factor dropped from 81.8 per cent in the July 2007 to February 2008 period to only 72.8 per cent in the first eight months of the current financial year.

By comparison, Qantas international's load factor declined from 83.9 per cent to 81.1 per cent over the same period while Air New Zealand's long-haul load factor rose from 81.9 per cent to 82.9 per cent.

This indicates that Air New Zealand is managing its long-haul capacity more realistically than Qantas and Virgin Blue, because it anticipated the reduction in demand at an early stage.

The Australasian carriers face the same problems as do all airlines; they have high operating leverage and must either cut capacity or fares when demand falls. This is a bonanza for travellers but adversely affects the profitability of these carriers. As a result the profit outlook for all three companies for the June 2009 year is bleak:

Air New Zealand's net profit is forecast to fall from $218 million in the June 2008 year to $73 million this year.

Qantas' net earnings after tax are expected to plunge from A$969 million to just A$82 million over the same period.

Virgin Blue is expected to go from an after-tax profit of A$141 million last year to a loss of A$5 million this year.

The three listed Australasian airlines need to experience three positive developments before there is a sustained upturn in profitability. These are; an increase in passenger demand, a reduction in the cut-throat competition on many international routes and continuing low aviation fuel prices.

Analysts are predicting a slow but steady improvement in profitability in the 2010 and 2011 years but none of them are expecting Air New Zealand or Qantas to achieve their June 2008 year profit levels within this time frame.

But investors should not be put off by these predictions, as most broker analysts have been hopelessly wrong in their airline predictions.

The best advice for investors is to continue to monitor this sector because when an economic recovery eventually occurs these companies, particularly Air New Zealand, could be among the strongest sharemarket performers.

* Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.