The global airline industry’s recovery path from the pandemic has been as turbulent as its infection. The demand for air travel is clearly robust, but Qantas has found the logistical challenge very difficult as it has coincided with rapidly rising fuel costs. Domestic travel is already ahead of pre-COVID levels and international demand is steadily accumulating as QAN adds back capacity and destinations.
Domestic capacity is being cut to offset higher fuel prices. Jet fuel prices have increased by 108% in the last year to US$164/bbl (Singapore jet fuel) and this has caused QAN to pare back its domestic capacity. For FY23f, cuts from July through to March 2023 will reduce the total planned flying capacity to 106% of pre-COVID levels in 2Q23f and 110% in 3Q23f.
At the 1H22 result in February, QAN said it expected its FY22f fuel cost to be ‘materially lower than pre-COVID’ (1H19 fuel cost $1,963 million) but higher than FY21 ($835 million). Sensibly, QAN had hedged ~90% of its 2H22 fuel cost on the assumption of oil at US$92/bbl and the AUD at 72c, but the situation has turned out to be less favourable for QAN.
Reducing the actual volume of fuel consumed (by reducing capacity) is the reaction. QAN had initially thought fare price rises would be enough to cater for rising fuel costs, but even with some hair-curling anecdotal evidence of very high fares to some destinations, this theory has not played out.
QAN has not specified which domestic routes are to be curtailed, but we know that multiple new routes (41 Qantas domestic, 7 Jetstar in 1H22) have been added in recent months as part of a market share grab. The second leg to this strategy is the recent full takeover offer for Alliance Aviation (AQZ) in which QAN has a 20% stake. This is subject to the approval of the ACCC.
There are no changes to QAN’s international capacity plans. The company is expecting to reach 70% of pre-COVID capacity by 1Q23f from 50% currently. QAN is bringing back all 10 of its remaining A380s which it had written down in value by $1.43 billion in 2020.
Labour issues have become problematic as pandemic layoffs prove hard to replace. QAN reinstated large numbers of its idled staff prior to Christmas last year, only to be thwarted by the Omicron outbreak. QAN kept these staff active despite an instant collapse in demand for air travel due to reimposed restrictions. QAN did not adjust its capacity at the time and this decision was estimated to cost it around $800 million in 2H22f.
Staff shortages at peak travel times (including call centres) has been a big headache. School holidays have just begun for several eastern states and QAN has added more than 1,000 new people to help during the rush.
As part of the longer term strategy to manage staff levels, QAN has offered up to 19,000 EBA-covered employees a $5,000 payment which depends on accepting a new EBA. So far, about 4,000 employees under various EBAs have accepted the offer. This is in addition to a 2% annual pay increase being negotiated across the Group.
Non-executive employees had already been given 1,000 QAN shares back in February (currently worth ~$4,500). These shares will vest shortly in August if key conditions are met.
Pre-COVID total personnel expenses of $4.3 billion (FY19) represented 25% of total revenue. This was slightly higher than fuel costs at the time.
At the 1H22 result, QAN said it had over 2,500 roles to fill over the next 12 months and had received more than 20,000 applications.
Investment view
The flight path to recovery was unlikely to be smooth and uninterrupted. But the global aviation market is recovering, with domestic markets already beyond pre-COVID levels and international demand impatient enough to be paying exorbitant fares in some cases.
The 78th annual meeting of IATA in Doha recently showed that the global industry is well on the way back to profitability after incurring losses of US$138 billion in 2020 and US$42 billion in 2021. IATA said efficiency gains and improving yields are helping although higher fuel and labour costs are not. Jet fuel spreads over crude oil prices are well above normal levels causing further pain.
Financially, QAN is making further improvements as net debt is expected to reach $4 billion by the end of FY22f.
Conditions are not yet ideal for QAN, but there is definite improvement happening.
Risks to investment view
The return to international travel may be hindered by recurring restrictions and conditions imposed by individual countries. Fuel and employee costs are the two largest group expenses and changes in each could be material for earnings.
Recommendation
We have retained our Buy recommendation.
