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Qantas: Has the airline arrested its nose dive?

Qantas Airways (ASX: QAN) has announced a large underlying loss of $252 million for the first half of 2014.

Despite the partnership with Emirates on international routes to Europe, Qantas’ International division saw an underlying EBIT loss almost triple from $91 million in the first half of 2013 to $262 million this half.

Jetstar has fallen to an EBIT loss of $16 million, from a profit of $128 million in the previous year.

Qantas Domestic saw its EBIT fall 74% from $218 million last year to just $57 million this half.

CEO Alan Joyce says the result is unacceptable, and comprehensive action would be taken in response. Amongst those measures, include accelerating its Transformation program to achieve $2 billion in cost reductions by 2017.

All up, the airline says it will implement around 250 initiatives.

That includes 5,000 full time employees losing their jobs at a cost of $500 million; Qantas will slash some underperforming routes including Perth to Singapore, reduce the number of aircraft types from 11 to 7, and has deferred some new aircraft orders.

The airline has also sold its Brisbane airport lease for $112 million, and says it is in ongoing discussions around its Sydney and Melbourne terminals.

The Qantas Sale Act

But perhaps the biggest issue yet to be resolved is the political tussle over the direction of the Flying Kangaroo. The current government is reported to be readying changes to the Qantas Sale Act, which is likely to allow more foreign ownership, and possibly the eventual ownership of Qantas by a foreign airline.

Prime Minister has called it “a “ball and chain”.

The Opposition leader Bill Shorten says that would result in thousands of jobs heading overseas as well as losing its national carrier status if it was taken over by a foreign owned airline.

The Act prohibits foreign ownership over 49%, foreign airlines holding more than a 35% stake, and any single foreign shareholder to 25%.

Warren Truss, Transport Minister says Qantas’ current situation is untenable, as it tries to compete with Virgin Australia (ASX: VAH), which has no such limits on foreign ownership.

As Mr Truss has told Fairfax Media,

“The government is ­philosophically attracted to levelling the playing field so that Qantas is able to cooperate fairly and equally with other airlines.”

However, any proposed changes to the Sale Act are unlikely to pass the Senate, as the Greens and Labor both oppose any changes. From July 1, the makeup of the Senate will change, but new members are mostly opposed to any changes.

Interestingly, six Labor MPs have attacked Qantas management, saying it was to blame for the situation the airline finds itself in.

Regional Express (ASX: REX) agrees, saying the airline is causing its own problems, and any government led bailout of the airline will leave regional airlines in a “most uncompetitive position”.

Virgin’s decision to split its domestic and international operations has seen the likes of Air New Zealand (ASX: AIZ), Etihad and Singapore Airlines take a combined 75% stake in Virgin.

All three are backed by their respective governments, and consequently there is a view that Virgin doesn’t need to make a profit and can lower prices to unsustainable levels, forcing Qantas to follow suit.

As a result, both airlines suffer from overcapacity, and both are unable to make a profit.

Qantas says the domestic profit pool has shrunk from more than $700 million in 2012 to less than $100 million in the last six months. Close to 9 million available seat kilometres have been added by both airlines over that time – which is clearly unsustainable.

Debt guarantee

The other option the government is considering is a debt guarantee in the short term. That could allow Qantas to receive a better interest rate on its mountain of debt through a higher credit rating. That would lower its costs, but is clearly not a long term solution.

Whichever way the government supports Qantas, there are fears that it will allow the airline to continue its line in the sand strategy of maintaining its 65% share of the domestic market at any cost.

Virgin pilots have criticised Qantas over the strategy, saying the airline had destroyed its own profit margin, and called it a ‘reckless policy’.

Foolish takeaway

No matter what Qantas or the government do, the airline still faces the same issues including intense international and domestic competition, high fuel and capex costs. Adding to that is Qantas’ ‘line in the sand’ approach to its domestic market share.

But with the airline sticking to that policy, it may take a change of management before the airline can turn around its financial results.

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