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China alliance key to Qantas turnaround

Qantas (ASX: QAN) will tap into the booming Chinese tourism and business travel market in a new code-share agreement with Guangzhou-based China Southern.

Guangzhou is China’s third largest city and acts as a gateway to the southern region’s growing business and manufacturing centres. Analysts have been broadly supportive of the deal and note that it plugs an obvious hole in Qantas’s growth strategy.

The deal with China Southern is similar to another codeshare deal brokered earlier this year between Qantas and Shanghai-based China Eastern. The existing codeshare agreement includes the Jetstar Hong Kong joint venture between the two companies. The new agreement however, is just for Qantas flights and will allow Qantas customers to book on China Southern flights from Sydney, Melbourne, Brisbane and Perth into Guangzhou.

In return, China Southern customers will code share on Qantas flights on 10 different routes in Australia and New Zealand. The deal is a good fit for both Qantas and China Southern. China Southern has plans to increase its Australian capacity to 55 services per week within two years, and Qantas is aggressively growing its presence in Asia through codeshares and the Jetstar joint venture. Qantas CEO Alan Joyce noted that around one-sixth of revenue now comes from Asia, with the plan obviously to increase that number.

The announcement comes at an interesting time for Qantas. It’s been in the media for a number of reasons in recent months, including disappointing traffic numbers, complaints about a recent Virgin Australia (ASX: VAH) capital raising, and lobbying the government for either guaranteed loans or an increase in foreign investment. The government appears unlikely to provide debt guarantees, however an increase in the foreign investment provision appears realistic in the shorter term.

Foolish takeaway

Qantas is being pressured from all sides. Its margins are being squeezed by rivals’ increasing capacity and lowering airfares, while restrictions placed on the company restrict foreign investment. CEO Alan Joyce is doing his best to turn around the company by lowering costs, but with some analysts expecting a loss of between $50 and $500 million for the year to June 2014 the worst may be yet to come.

Luckily Qantas has a $1 billion cash hoard and the lion’s share of the domestic market. If it can maintain its share through the current competitive environment the share price should remain relatively stable.

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Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned.

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