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On August 16 2011, the CEO of Australia’s iconic airline Qantas announced a major restructuring of the business model that both surprised and angered many Australians.  In essence, the five year plan calls for a shift away from the homeland and towards Asia. 

The truth is Qantas is not the only Australian company suffering in the two-speed economy to make this kind of a move.  Why are they doing this and should more Australian companies follow suit?  The history of our economy over the last several decades provides an answer.

Once upon a time investors observed that when the United States sneezed, Australia caught a cold.  Given the fact we are now more dependent on China than we ever were on the US, if China gets the sniffles, will we get pneumonia?

When the Chinese began their drive towards modernising their economy, creating a widely spread infrastructure was part of their master plan, fueled by export growth from cheap products.  Australia has benefited handsomely with China’s insatiable appetite for our resources.

The boom economy with which we have been blessed has had some downside.  The flood of cash into Australia has driven up the value of our dollar, driving up the cost of our exported goods.  

Non-mining industries that sell around the globe have suffered.  A recent case in point is the highly successful spin-off company from the Fosters Group – Treasury Wine Estates. In their recent financial release they reported a foreign exchange rate loss of approximately $30 million dollars.  The company claimed this was largely due to sales in the US and the EMEA (Europe, Middle East, and Africa.)

Treasury Wine Estates plans to do what an increasing number of Australian non-mining companies are doing – expand into China.  While China plans to continue infrastructure stgelopment and exports, the major emphasis in their next five year plan will be to grow their domestic demand.

Despite our strong ties to China, many Australian non-mining companies still count the United States and the Euro -Zone as their principal customers.  Given the anticipated rise in Chinese consumer demand for more goods and services, the time may be ripe for more Australian companies struggling at home to move into China.

If the Chinese success in promoting an export driven economy is a guide of what they can do, the transition to an economic model equally driven by consumer demand and continued urbanisation should dramatically increase opportunities for Australian companies.  What’s more, China’s inland cities are increasingly being added to the economic mix which has been primarily concentrated in the large cities and coastal regions.

Finally, there is now the emergence of what the government calls, Australia-China 2.0, a major trade initiative being trumpeted across Australia.  The purpose of this trade mission is to ensure that Australian businesses will be well-equipped to meet the demand for Australian exports these cities will generate.  The initial visit to China took place from 4th August 2011 to 9th August.  Australian Minister of Foreign Affairs, Kevin Rudd, had encouraged Australian companies in the following fields to join the trade mission:

•    Architecture, design, green technology, urban planning, water and air quality and waste management, clean energy, infrastructure and logistics
•    Education
•    Financial and professional services

Returning to Qantas, the initial anger at the job cuts announced grew when their recent financial results release showed a larger than expected increase in profit – it doubled.  However, their recent history leaves much to be desired.

Here is a five year chart of Qantas’ performance on several measures – sales, cash flow, earnings, and dividends, on a per share basis:

 

Per Share Statistics6/20076/20086/20096/20106/2011
Sales ($)7.678.1676.086.58
Cash Flow (Cents)119110.354.357.774.7
Dividends (Cents)1535600
Earnings (Cents)39.838.56.97.611.6

You can see Qantas was badly hurt by the Great Financial Crisis, as were most airlines throughout the world.  To complete the picture, let us look at a five year share price movement chart, comparing QAN against the ASX 200:

#FOTO:1267:400#

To most investors, these numbers coupled with the volatility of the price of oil make a sufficient case that Qantas needed change.  In theory, expanding in Asia could be a solution.  

Here are the four key elements of their plan:

•    Opening gateways to the world
•    Growing with Asia
•    Being best for global travelers
•    Building a strong viable business

The gateway strategy relies on partnerships with other major airline members in the oneworld alliance.  The heart of the plan lies in Asia, where Qantas plans to introduce two new airlines.

The first will be a low cost airline – Jetstar Japan – which will begin domestic operations by the end of 2012, with international operations to commence a year later.  Qantas is working together with the equally iconic Japanese brands – Mitsubishi and Japan Airlines.

Unfortunately, the details of the core potential strength of this restructuring plan have yet to be announced.  The only information Qantas released was the intent to begin a new premier airline in Asia, location to be determined.  The Qantas release emphasised this premium airline would “build on Qantas expertise but with a new name, new aircraft, and a new look and feel.”

The plan calls for retiring older aircraft, which Qantas cites as the reason for the loss of around 1,000 jobs.  It calls for significant capital outlays on new Airbus equipment.  They anticipate the need for 106 to 110 new Airbus 320 aircraft to support the existing Qantas group growth as well as for the Jetstar Japan operation and the to be named later Asian premium airline.

There is significant opposition to the plan, both from the unions and from Australians who fear the eventual loss of one of Australia’s globally recognised brand names.  

What should be of more concern to potential investors is the massive potential increase to Qantas’ existing long term debt of approximately 5.5 billion dollars.

What should be of concern to Australians in general is the potential impact of Asian expansions like these on the employment picture here in Australia.  When the United States manufacturing sector packed its factory bags and moved to China, the jobs went with.  Will that happen here?

More articles from this week’s newsletter 

18 Share Tips – 19 September 2011

5 Sold-Off Small Caps Going Cheap

Qantas Targets China

Filling Up Super At The Last Minute

China Buys US For A Bargain

Budgeting For A Downturn

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