Australia / Analyst Insights
Domestic airlines are lifting off again as capacity falls
by Sylvia Lay
Jul 13 2016

Qantas Airways Limited and Virgin Australia Holdings Limited, Australia’s largest two domestic carriers, were locked in an aggressive price-based competition over most of the past five years, vying for greater market share in the domestic airlines industry. This price war slowed in mid-2015 due to losses in 2013-14 (and in 2014-15 for Virgin), which caused both airlines to focus on realigning capacity with demand. Reduced capacity has led to higher airfares, boosting revenue growth for both companies.

Revenue per available seat kilometre (RASK), a financial measure used to calculate an airline’s profitability and efficiency, fell in April 2016 due to weak demand in domestic travel and resulted in both airlines cutting capacity. The subsequent capacity reductions are expected to result in both airlines continuing to raise domestic airfares over the next five years.

Following the end of the airfare war, Qantas has reduced flight numbers and capacity. Subdued demand for domestic travel, which was associated with weak confidence in the economy, also contributed to reductions. Qantas’ share price decreased due to reduced capacity. The decision to further cut capacity came due to a poor performance during the Easter school holidays in April 2016, which prompted the airline to revise plans for seat capacity in May and June. Qantas’ domestic patronage fell by 8.0% in April 2016 and flights for May 2016 have fallen by 15.0% compared with 2015. This is in stark contrast with two years ago, when Qantas was ramping up capacity to compete with Virgin.  Despite Qantas’ low RASK in April, trends have improved in May and June since cutting capacity. Industry-specific revenue for Qantas is expected to increase in 2015-16.

Changing market conditions have similarly affected Virgin, which cut its seat capacity by 5.1% across domestic and international flights in June 2016. Virgin has removed a number of aircraft used for regional flights from its fleet, cutting the number of flights in regional Queensland, New South Wales, the Australian Capital Territory, Victoria and Tasmania (though some of this was related to the mining boom ending). Consequently, Virgin’s domestic capacity is expected to fall by 3.0% in June. This includes cuts to its wholly owned subsidiary Tigerair Australia. Industry-specific revenue for Virgin is expected to increase in 2015-16. Other low-cost carriers have followed suit and decreased seat capacity. Qantas’ low-cost carrier Jetstar has cut its seat capacity by 0.5% in April 2016.

As domestic airlines have reduced their seating capacity, this has allowed them to charge higher average airfares. Higher airfares will likely be the norm over the next five years, as the ongoing uncertainty associated with the domestic economy will encourage the major domestic carriers to focus on consolidation rather than aggressive capacity expansion.

 

Relevant companies:

Qantas Airways Limited

Virgin Australia Holdings Limited