Investment revolution in the travel industry
- Six fundamental strategies of the airline industry.
- After analyzing Qantas, today I look into Air NZ.
- With huge growth potential, Air NZ is taking aggressive strategies.
- High leverage is the main concern about Air NZ.
One important feature of the airline industry is that airline companies can only control supply, but cannot control demand. In other words, airlines can control the number of flights and the flight distances, they cannot determine the number of passengers. Therefore, matching supply with demand is one of the key issues to be a successful airline company. If the supply is much higher than the demand, then a huge amount of unnecessary costs would be incurred. In contrast, if the supply is much lower than the demand, the profits cannot be maximized. This feature causes airline companies to take unique strategies. The successes in these strategies are crucial to the success of an airline company.
Strategy 1: Clustered alliances between domestic and foreign carries.
Introduced in 1967, code-sharing alliances increase each airline’s network spread and geographic reach with little extra cost. This kind of cooperation enables partner airlines to improve productivity, to price their services more aggressively, and therefore raise profitability. The following is a statistic of the three biggest airline alliances:
|Annual Passengers||475 million||569 million||610 million|
There are also relatively small alliances, such as Alaska, U-FLY, Vanilla, and Value alliances, but become the member of these three airlines are most influential. Qantas, which I analyzed in the last article belongs to Oneworld. Air New Zealand belongs to Star Alliance (joined in 1999), the biggest airline alliance so far. Star Alliance now has 28 members. The following graph shows the logo of all members of Star Alliance.
Source: Star alliance website
Strategy 2: Brand image and reputation
Like in the finance world, the big three agencies (Moody’s, Standard & Poor’s, and Fitch) rate credit for companies, there is also an institute rates airlines, who is known as Skytrax (originally known as Inflight Research Services), a United Kingdom–based consultancy. Skytrax also rates airports and awards the best airline and airport each year since 1999 for airports and 2001 for airlines. Three major Oceanian airlines: Air NZ, Qantas and Virgin Australia are all Four Star airline (see Skytrax rating). Therefore, Air NZ has a relatively good reputation. In addition, in the 2017 ranking, Air NZ is positioned at the 19th place (For more information, see the world’s best airline website). In the 2016 ranking, Air NZ is positioned at 17th place (Qantas is at 15th and 9th place in 2017 and 2016, respectively).
Strategy 3: Advertising campaigns
As we mentioned at the beginning, as airlines cannot control demand, it becomes critical for them to convince passengers to fly the same route on one line instead of another. Given there is a bottom line for the pricing, adverting is very important. Generally speaking, an airline show allocates 2% of revenue to advertising, and the figure should be higher if the airline launch a new service, enter into a new market, or more directly, gain more shares from competitors.
Strategy 4: Reservation system
As the significant improvement in technology and information system, especially online payment, in the recent years, an efficient reservation system is now a very powerful channel for airlines communicate with customers. This is true not only because internet make online booking more convenient, but also because airlines can maximize yield based on forecasted booking patterns. Most passengers do not book immediately as soon as they come to the website. They usually browse for a while before booking. This can provide airlines with valuable information to determine their pricing strategy.
Strategy 5: Frequent-flyer programs
This is a way for airlines to keep loyalty and therefore maintain the stability of the revenue. As we mentioned, airlines do not control demand. However, through these programs, they can at least influence the demand. This is important because the costs of these programs are much less than advertising campaigns, but it can prevent customers switch to competitors in the same route. More importantly, travelers normally not spend just on airlines, they also need hotels and restaurant and so on. Therefore, frequent-flyer programs can easily expand to other value creation chains.
Strategy 6: Agency/government relation
While airlines now can sell their tickets online, the travel agencies remain an important link to airlines as they can include airlines into travelers’ fly/drive/hotel/restaurant/leisure package. Also, they can help airlines to sell off-peak capacity and thus keep a high profit margin. Furthermore, government relation is important because cross-border travelling become more and more popular, in this case, stable and successful flights between countries must coordinate with custom offices of the countries involved.
Air New Zealand (Air NZ) was founded in 1940 operating trans-Tasman flights between New Zealand and Australia. The company became wholly owned by the New Zealand government in 1965. Air NZ was privatized in 1989, when a consortium of Brierley Investments and overseas airlines acquired the capital. In the same year, Air NZ sold 84 million shares to the public at $2.40. Air NZ returned to majority government ownership in 2001 after near bankruptcy. New Zealand government rescue package was $885 million for 75% ownership. With this rescue package, New Zealand Government was responsible to repay $300 million loan by issuing 1.28 billion convertible preference shares at 24c per share to The Crown and 2.16 billion ordinary shares at 27c per share. In November 2013, the government sold down its holding to 53%, and now the government ownership is around 51.91%.
Air NZ mainly focuses on three strategic areas: Domestic, Oceania, and International. The route of each region as follows:
For each region, the 2017 annual performance as follows,
The latest performance (1H2018) of each region as follows,
From the above charts, it can be seen that Air NZ also faces competitive pressure in the Asia market, which is the same challenge with Qantas. However, Air NZ has a strong competitive advantage in the Domestic and Oceanian markets, in particular in Tasman and Pacific islands. This is reflected in the 2017 annual results:
and 2018 interim results
In the domestic market, we believe Air NZ will keep its dominant position, as is main competitor Jetstar has not expanded and are not expected to expand in the future. In contrast, Air NZ will continue to expand (See “Jetstar’s domestic market share in New Zealand slips as Air New Zealand expands faster”). As a result, Air NZ will strengthen its position in the Domestic market, as the following chart shows (where the blue line stands for Air NZ and the orange line stands for Jetstar),
Source: CAPA – Centre for Aviation & OAG
In the Oceanian market, we expect that Air NZ would grow even faster,
There are two reasons. First, with Emirates’ departure, there are seven carriers serving the Tasman from Auckland and three fifth freedom routes (operated by airlines that stop in Australia and fly on) with daily flights. However, among these airlines, Air NZ, Virgin Australia and Qantas have the biggest chance to win the market shares (see “New airline battle lines across the Tasman: Filling a superjumbo gap”), as shown in the following pictures:
In fact, Air NZ has already taken a move for the market share (see “Air New Zealand announces new Trans-Tasman routes” and “Air NZ and Virgin Australia to end trans-Tasman alliance”).
Second, in the pacific island flight market, New Zealand has a potion that cannot be replaced by others. As stated in the Tourism 2025 in action “New Zealand is an island – 99% of international visitors arrive by air – and so connectivity is crucial.”. With the very strong regional market competitive advantage, I believe Air NZ has relatively large growth potential.
In the latest financial report, Air New Zealand announced earnings before taxation for the first six months of the 2018 financial year of $323 million, compared to $349 million in the prior period, down by 7.4%. Net profit after taxation was $232 million, down by 9.4%. However, operating revenue increases by 5.6%, resulting in a growth in cash flow from operations by $103 million or 27 percent to $479 million.
With lower provisional taxes paid due to the transitional impact of legislative tax changes for engine maintenance and strong cash position, I consider the reduced net profit is caused by the increase use of debt. Indeed, in its annual report, it states that “Gearing was 52.4%, increasing 0.6 percentage points from June 2017, driven by continued investment in fleet.” (Gearing is the ratio of net debt to the total capital). Thus, high leverage is one of the major risks of Air NZ, though it is still in the investment grade as the following picture shows,
From the above analyses, it can be seen that Air NZ strong competitive advantage and regional growth potential. I believe there are still huge potentials for the company to keep growing. However, the major risk of the firm, apart from the increase in the fuel price, is a relatively high leverage ratio.
The history of the company tells us that in the last time of the privatization of Air NZ in 1989, the leverage ratio of the company significantly increased to the edge of bankruptcy, which results in a rescue package from the government by selling shares to the Crown with cheap prices. This time seems to be quite similar, since the New Zealand government reduced its holdings from 75% to 53% in 2013 (and now close to the edge of privatization with the government holding just above 51%), the gearing of the firm has continuously increased. Therefore, in my opinion, one of the important tasks for the Air NZ now is to control its leverage, though it is the fact that currently there are many golden opportunities for Air NZ to grab, prioritizing these opportunities may be more important.