ADVANCING, AUSTRALIA FARES
ROD ORAM31 August 2008
Air New Zealand deserves large credit for its year-end results this past week. Given the traumas of the global aviation industry, a drop in profit of only 32 percent is testament to its new-built resilience in the face of unprecedented economic and market stress.
However, the challenges only get harder from here. If fuel prices remain above $US140 a barrel this year, it won't make a profit; if intensifying competition on the Tasman slashes yields, profits will shrivel; and if tourism trends continue to deteriorate, the airline and the sector will be diverted from revitalising their long-term wealth generation strategy.
The trouble is, the airline and the tourism sector are becoming increasingly dependent on short-stay visitors from Australia. They believe they need them to keep their beds, attractions and planes full in the face of shrinking demand from more lucrative, long-staying, long-distance travellers such as North Americans, Europeans and Japanese.
Understandably, though, short-term survival is Air New Zealand's primary focus, even though arguably some of its actions are undermining its and the tourism sector's long-term goals.
Still, the airline's recent achievements are impressive. Taking as a base point the $259 million of normalised earnings in the 2006-07 year, it added in the 2007-08 year a further $302m profit from new routes and more capacity, $139m from higher fare yields and $83m more from freight and contract services, particularly aircraft overhaul.
All those demonstrate its powers to develop new business, particularly in the difficult and costly area of opening up new routes. Its ability to do so is one of the main keys to its long-term strength. In this it has one big advantage over its competitors. Thanks to the nature of its network, it's highly skilled at running profitably long overseas routes on only thin volumes of passengers.
But the strong profit growth was sharply undermined by big cost increases: $88m more for labour, reflecting higher wages and some more staff, $300m more for fuel even after hedging, $50m for maintenance, $109m for aircraft operations, passenger services and sales and marketing, and $37m for other cost increases.
As a result, profits fell from $259m to $197m. Crucially, though, the new business proved to be a lifesaver. The extra routes and capacity were nicely profitable, even with the huge burden of fuel increases.
It would have been very easy for Air New Zealand to have played safe last year and shelved its expansion. Thankfully, it kept its nerve and executed well. If it had carried those fuel costs without the new businesses, it would have reported a very poor result.
Fuel will continue to dominate this year's results. Analysts expect little if any easing in costs, yet hedging is only part of the answer. Wisely, the airline hedges only 57% of its fuel bill. If it covered more but costs fell, it would become less competitive against other airlines. Of course, hedging more would give it more protection if costs rose. But the gain in competitiveness would be disproportionately less than the loss of advantage if costs fell.
The airline continues to eke out fuel efficiencies where it can. For example, its September 12 flight from Auckland to San Francisco will have special permission from New Zealand and US air traffic control to fly the optimal take-off, routing and landing to see how much fuel can be saved.
Nine months ago it began a bio-fuels initiative with the hope of using them for 1 million barrels, 10% of its needs, in 2013. It is exploring non-edible plant and algal sources for the fuel in conjunction with the likes of Boeing and Rolls-Royce, the engine maker.
If the biofuels can be produced economically in large volume, they will be a useful hedge against rising crude oil prices. Moreover, the airline will save on carbon dioxide emissions and the charges on them planned by the European Union.
Demand is the other big dynamic Air New Zealand wrestles with. It expects trans-Tasman capacity to increase some 11% over the next six to nine months, thanks to new entrants and the introduction by several existing carriers of the enormous Airbus A380.
Air New Zealand coped well with previous periods of intense competition on the routes. One of the keys this time will be the opening up of more point-to-point, thin volume routes which its competitors can't easily match.
Auckland-Adelaide is an excellent existing example. Qantas had a brief stab at matching Air New Zealand's daily schedule but quickly gave up, handing a monopoly service to our national carrier. With South Australia proving an increasingly popular destination for New Zealand travellers and source of tourists heading here, the route makes good money.
But it is also a microcosm of a much bigger issue for the airline and tourism. Visitor trends are shifting dramatically and, in some ways, badly. The sector's latest medium-term forecasts, released August 1, graphically illustrate the problem. Overall, a total of 2.97 million international visitors are expected to arrive in 2013, up 20.8% from 2007. But that was revised down from 3.17 million, a 29% increase, forecast last year.
The downgrade is doubly damaging: it is a hefty reduction in overall growth; and it is driven by a shift in markets. Comparing this year's forecast with last, the rate of growth of the UK, US and Chinese markets was cut. And volumes from Japan and South Korea will actually fall outright while Germany will stagnate.
And it is Australians who rescue the sector. Last year, 950,000 of them arrived, 978,000 are forecast for this year and 1.2 million in 2013, (up from 1.16 million in 2013 in last year's forecast).
It is great to have the neighbours over. But they stay an average of only around 10 days across the whole season versus the 25.4 days average for all tourists in 2004, the industry's high point. And they spend per day a lot less than the likes of the British and Germans.
Length of stay and average spend are the sector's two key performance measures, particularly if it is serious about being a high value rather than high volume industry. Yet, those stats have been sinking for the past four years. Most growth now is coming from trips of five or less days, almost entirely by Australians and Chinese.
Chinese tourists are starting to complain that such whirlwind packaged tours are a sub-optimal experience.
Moreover, Australians are essentially domestic tourists here because we are so familiar to them. They don't spend as much or demand such variety of experience and very high standards as, say, Germans, British, Japanese and Americans who consider this a rather exotic place to come.
In essence, our tourism sector is shifting rapidly from an international business to a domestic one, as it will be if we ever have a trans-Tasman currency and open border. Thirty years ago, Australians accounted for just over 50% of our tourists. They dropped to 28% in the late 1990s when the sector was focusing its efforts intensely on international markets. Today, they are back up to 40%.
Next year, more than 1 million Australians are likely to visit. That's 1 in 20 of their entire population. While family ties will keep many coming, that volume seems highly vulnerable to higher fuel costs, air fares or environmental sensitivities about flying.
The answer, though, is not fewer Australians. Rather it is more long-staying, high value tourists who will still keep coming when times get tough. But to attract them we need a serious rethink of the tourism experience we offer. For example, adding culture, health and learning to the adrenalin and scenery we offer now. And then marketing all those attributes even more effectively than we do now.
Air New Zealand has some ideas about that. But it needs to be very careful that its pre-occupation with short-term survival doesn't undermine its, and the tourism sector's, investment in the long term, more profitable and more resilient future.
© 2008 Fairfax New Zealand Limited.
Sunday Star Times
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