Culling The Flying Kangaroos

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This story features QANTAS AIRWAYS LIMITED.
For more info SHARE ANALYSIS: QAN
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

A year ago the global airline industry was very excited by the pending, albeit delayed, arrival of new twenty-first century airliners from both Boeing and Airbus. One year later an the global airline industry has been decimated. The price of oil has doubled.

Regional airlines across the globe are now failing, merging, or hanging by a gossamer thread. It’s a double-whammy effect, for the higher oil price means consumers are less likely to make discretionary flights as they watch their own finances, while the airlines are copping much higher costs which are difficult to pass on. In the perennially troubled US air industry, even the big names are talking merger yet again, or even Chapter 11.

Downunder the airline which has long enjoyed government-sanctioned dominance, the airline whose board had decided was worth selling one day and worth buying the next (but is still there) – Qantas ((QAN)) – has not escaped the oil price fallout. Despite having made creeping fuel surcharge increases and despite having half its oil costs hedged this year, Qantas has nonetheless run up a $2bn fuel bill which needs to be quickly addressed.

When the 59% oil price hedge rolls off in FY09, Qantas has the option to roll over. However, is it really wise to roll over when oil is at US$130/bbl? Oil could suddenly drop back to US$100/bbl and all the benefit of the FY08 hedge could be given back in FY09.

But then oil could just as easily keep rising, to US$150/bbl or beyond, in which case hedging will have seemed very prudent.

It’s a dilemma. Qantas will still probably need to raise its fuel price surcharges by another 5% shortly. With inflation hurting Australian passengers it is unlikely higher ticket prices will not also impact on passenger numbers. Inflation also reduces the opportunity to pick up a new wave of out-bound travellers looking to blow valuable Aussie dollars. And the flipside of the higher currency is that in-bound numbers will crash. Australia is about the furthest popular tourist destination away from those likely to otherwise exploit it.

So surcharge increases are not the panacea. With the oil price being a lottery Qantas has had no option but to batten down the hatches and jettison unnecessary ballast, looking to ride out the storm. Hence it will cut staff, cut routes, cut planes and even cancel a new plane. The question is: Is this good or bad for the share price?

On first glance, you’d have to say it was good. Cutting staff is always a positive, as long as planes don’t suddenly start falling out of the sky as a result. Freezing executive bonuses clearly helps. But if Qantas is flying less planes, does that mean less earnings anyway?

Not necessarily. Qantas plans to cut capacity by 5%. The first step is to decommission or temporarily ground old clunkers of aircraft that guzzle avgas and probably now belong in a museum. Then the airline can cut back on those routes that have never attracted full loads and are likely unprofitable anyway. Next is to remove some of the scheduled flights on over-serviced routes such as Sydney-Gold Coast.

Qantas could do all this and actually fly the same number of passengers who were going to fly anyway. This way costs would be reduced without revenue being overly affected. In the case of the Gold Coast for example, this mostly tourist run is likely to see diminishing passenger demand anyway.

The only real shock as far as analysts were concerned was the cancellation of a new plane for Jetstar. This is simply in contrast to Qantas’ previous stated objective to build for the future. It just goes to show how desperate the airline has become. However, apart from that analysts largely see the cutbacks as a positive in the short term.

So do we buy the shares?

The bottom line is the Qantas share price is purely and simply leveraged to the oil price. While the austerity measures are laudable, the Qantas share price will rise on falling oil and fall on rising oil. If you know where the oil price is going, then you could clean up.

But can you please tell us?

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