Nightmare for Qantas shareholders set to continue

Not much has to go wrong for Qantas' profit to turn to a loss. It is this reality, as well as the sub-par shareholder returns, that have motivated the Qantas board and management to play hardball with the unions.

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Regardless of the decision of Fair Work Australia to terminate the industrial action, Qantas (ASX: QAN) has its work cut out for it.

I'll leave the arguments about the rights and wrongs of the actions of Qantas and its unions to others. What is past debate is that the airline is in a diabolically difficult industry.

While aeroplanes are hideously expensive to buy and airlines require complex infrastructure (both machines and the people and processes to run them), these aren't sufficient barriers to entry – there are more available airline seats than there are consumers who are willing to pay the going prices to use them.

Profits hard to come by

Accordingly, there are very few consistently profitable airline operators. Qantas is one of them, having managed to turn a profit in each of the past 10 years. Proving just how tough the market has become recently, the past three years have been the worst three in that decade – and by a fair margin.

The recent profits, measured against the shareholders' funds invested in the business, would hardly have beaten inflation, and would have been far short of the return those funds could have earned in a simple term deposit.

Virgin Australia, which competes with Qantas in Australia and on some international routes, lost money in two of the past three years, and its profit in the third was marginal.

Global prices, local costs

Clearly, Qantas is competing in one of the most globalised industries in business. Some costs are identical for each airline (including landing charges and fuel costs), while others, such as labour, depend heavily on the wage levels in the countries in which the staff are employed. The vast majority of Qantas' staff are employed in Australia, where wages are significantly higher than many of the countries in which its major competitors are based.

High costs aren't necessarily a negative – they can be a key source of advantage in a market where a company can use those wages, and the staff employed, to deliver a superior product or service for which consumers are prepared to pay higher prices.

If you've seen one…

The problem for airlines is that the service has effectively become commoditised. A flight to Los Angeles, Bangkok or London takes the same amount of time, is just as uncomfortable, and has similar food and entertainment options regardless of which airline you fly with.

Yes, safety is a factor, but safety records are largely similar among the top tier of international airlines. While it's true that Qantas is yet to suffer a fatality, consumers on the whole seem to be prepared to accept that modern international aviation safety is a function of regulation rather than something that is in the keeping of the airlines themselves.

'Buy Australian' wanes

If you're thinking that the descriptions above don't apply to you – that you're prepared to fly Qantas because it's Australian, because it's safer or because you think it's a better airline than the others, Alan Joyce will be glad to hear it. The bad news for Qantas is that you're one of the small minority.

Sue Morphet would have some sympathy for Joyce. The CEO of Pacific Brands (ASX: PBG), maker of Bonds, Kind Gee and Sheridan, knows full well the gap between consumer intentions and their actions.

Australian consumers by and large express a desire to buy Australian made products. Unfortunately for Pacific Brands and Qantas, the hip-pocket nerve is stronger than our nationalistic intentions. Just as Pacific Brands had to move much of its production offshore to be able to compete with low-cost imports, so it is with Qantas.

Unless consumers are willing to pay more to fly with the local carrier, they must either reduce their costs to be able to compete on price or find a way to make the higher price worthwhile for consumers to pay.  Unfortunately for the Flying Kangaroo, consumers have voted with their wallets – and management clearly felt they had no choice but to draw a line in the sand.

Foolish take-away

Not much has to go wrong for Qantas' profit to turn to a loss. It is this reality, as well as the sub-par shareholder returns, that have motivated the Qantas board and management to play hardball with the unions. You can argue with the strategy, and history will show whether Alan Joyce has pulled the right rein, but it's very hard to argue that Qantas' business is – to use the jargon – a burning platform, and something has to give.

It'll be hard for Qantas shareholders to do well until the airline is able to match its competitors' cost bases. Investors in other companies should heed this example and make sure their companies either offer a service for which its' customers are prepared to pay more, or have a cost advantage – and preferably both. If not, their investments may well be sitting ducks when the competition – from at home or abroad – arrives.

Are you looking for more quality stock ideas? Click here to request a new free report titled The Motley Fool's Top Stock For 2012.

Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in Pacific Brands. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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