How many tricks does Qantas have left in its hat?

Elizabeth Knight reports in the Sydney Morning Herald that in less than three weeks, Qantas’s chief executive, Geoff Dixon, will stand before shareholders at the company’s annual meeting and hand over his keys to Alan Joyce. Amid the backslapping and hand shaking someone is going to have to deliver what will likely be some more sober news about the prospects for the airline’s profitability.

Anecdotally, the Qantas picture does not look particularly rosy. Stories of people cancelling their international holidays are everywhere. Equally, the corporate market is showing signs of cutting travel budgets as the early stages of an economic slowdown emerge.

There were rumours around this week that a senior Qantas executive, John Borghetti, had told staff that bookings were down sharply and from that an expectation has grown among some that there will be a further large capacity cut coming – some say as large as 10 per cent.

The capacity cuts may not yet be this extreme, but there will undoubtedly be more than have been announced.

Over his long reign as chief executive, Dixon has been a masterful magician at pulling the earnings rabbit out of the hat and telling investors about the difficulty of the trick.

Dixon has had plenty of challenges along the way, most of which he has faced well. The latest has been the surging fuel price – in the face of which the company still managed a robust $1.3 billionprofit before tax this year.

Indeed, Dixon’s mastery of costs is legendary.

But the challenge facing the airline industry is monumental. Of course, many business are facing difficult operating environments but the effect on airlines of an economic slowdown is bigger than most.

There are several reasons for this. The first is that air travel is perhaps the ultimate discretionary item, particularly international travel. Other extravagances such as a fur coat, expensive jewellery or a Mercedes fall into this category but the market for these is very small.

Air travel is a big-ticket item that is bought by the wider public, so when it comes to belt tightening the overseas holiday is a common place to start.

The other problem for airlines is that in the short term they have high fixed costs. Wages and capacity can be cut over time but there is no immediate flexibility.

Compared with Virgin Blue – which will also be doing it tough – Qantas is more vulnerable because as the corporate and consumer income declines, overseas travel is hit hardest.

Virgin Blue is primarily domestic and has less reliance on business travel.

The trouble for airlines is that once the public’s income falls it is very hard to entice people to travel by cutting fares.

Economists call this inelasticity – it means that managing the revenue line is particularly difficult.

In recent conversations with airline executives, it was suggested that passenger numbers had been holding up, but that people were downgrading.

In other words, first class was moving to business, business was moving to full economy, and there had been migration to budget airlines. This is a problem because the big profits are made from premium fares.

But no one was making any positive noises about bookings. It will clearly be a soft Christmas holiday season for all airlines, and Qantas will be no exception.

Making predictions on next year’s full-year profits for an airline would be particularly difficult. But there will be an expectation at the annual meeting of at least some guidance.

At this stage the analysts’ forecasts range from $400 million pre-tax to more than $1 billion.

A JPMorgan analyst, Matthew Crowe, released a report on Qantas and Virgin Blue earlier this week. He has an estimate of $510 million but notes that if he is on the money he expects to see 30 per cent downgrades to consensus estimates.

Qantas, when tapped on the shoulder by the Australian Stock Exchange a few months back, suggested $750 million was in the ball park. It will be fascinating to see whether this is amended in a few weeks.

Qantas would rather focus on the opportunities presented by the world economic slump for consolidation in the industry. It is talking to other carriers, thought to be in our region – and, after years of trying, maybe it might find a dance partner.

A Report by The Mole from The Sydney Morning Herald.