Air New Zealand’s full-year result clearly demonstrates that the national carrier has fully recovered from its near-collapse while under the control of Brierley Investments.
The company reported net earnings of $214 million for the 12 months ended June 30, compared with $96 million for the June 2006 year. Net earnings before unusual items of $238 million were the highest since 1996.

The carrier has made a strong recovery under the astute leadership of Ralph Norris and Rob Fyfe, but it still has some way to go before it achieves the operating margins and sharemarket valuations of Australian rivals Qantas and Virgin Blue.

Air New Zealand’s revival began in January and February 2002 when the Crown provided $892 million of equity funding and Norris was appointed chief executive.
The share issue reduced Brierley Investments’ shareholding from 30.3 to 5.5 per cent and Singapore Airlines from 25.0 to 4.5 per cent.

The group made huge progress under Norris’ stewardship, particularly in balance-sheet terms. When Norris started, Air New Zealand had a post-Crown bailout equity ratio of only 22.6 per cent, cash of $604 million and borrowings of $1115 million. When he left in August 2005 to become chief executive of Commonwealth Bank of Australia it had an equity ratio of 37.7 per cent, cash of $1071 million and borrowings of only $679 million.

One of Norris’ other significant achievements was to convert customers from phone to online booking. As a result sales and marketing costs have fallen from $449 million in 2002 to $322 million in the latest full year.

Fyfe, who was appointed chief executive in October 2005, has placed a great deal of emphasis on growing passenger numbers and revenue.

Group revenue was static at $3.6 billion between 2002 and 2005 but it rose to $3.8 billion in 2006 and $4.3 billion in the June 2007 year.

Passenger growth has been impressive, particularly on the domestic routes. In the June 2002 year Air New Zealand carried 8.3 million passengers, with 59.2 per cent on domestic routes, while in the latest year it carried 12.5 million passengers with 62 per cent on the domestic network.

More and more New Zealanders are travelling as Air New Zealand is offering a wide range of fares and a user-friendly internet booking facility.

But as the accompanying table shows, the airline’s ebitda margin (earnings before interest, tax, depreciation and amortisation) was only 13.1 per cent in 2007 compared with 15.9 per cent for Qantas and an impressive 19.5 per cent for Virgin Blue. Air New Zealand’s margins have improved since 2002 but they have been consistently below the other two listed Australasian airlines.

The simple explanation is fuel costs. Aircraft burn far more fuel on long-haul international flights than they do on domestic routes. As a consequence airlines with large domestic markets perform relatively well when oil prices are high but long-haul operators are in a better position when fuel prices are low.

In the June 2007 year 62 per cent of Air New Zealand’s passengers and 76.4 per cent of Qantas’ passengers flew on domestic routes. Virgin is coy but its domestic loading is estimated to be well over 90 per cent.

The greater importance of long-haul to Air New Zealand is reflected in its fuel costs. In the latest year they represented 26 per cent of the airline’s total revenue of $4.3 billion compared with 22 per cent for Qantas and 23 per cent for Virgin Blue. Air New Zealand has the lower operating margin but in the mid-1990s, when oil was under US$20 a barrel, the company achieved far higher margins than Qantas.

One of the major challenges facing Air New Zealand, Qantas and Virgin Blue is the entry of Tiger Airways into the Australian domestic market and the start-up of Pacific Blue in New Zealand. Tiger is 49 per cent owned by Singapore Airlines and Pacific Blue is 100 per cent owned by Virgin Blue.

Most stockbroker analysts believe Tiger will not affect Qantas’ domestic operations and a clear majority continue to have a buy recommendation on Australia’s national carrier.

But New Zealand investors have taken a negative view of Pacific Blue’s arrival, even though its operation will be relatively small, at least at first.

Air New Zealand has 60 aircraft operating on its domestic routes, compared with only two that Pacific Blue is proposing to operate. As Qantas has cut its aircraft from five to four there will be a net addition of only one new aircraft to the New Zealand domestic market with Pacific Blue.

Qantas, which may never have made a profit in New Zealand and will be under more pressure from Pacific Blue than Air New Zealand, has four options. It can either continue to run its existing operation, replace these operations with Jetstar (its discount operation), run a small aircraft operation with more emphasis on the leisure market and regional airports or quit New Zealand altogether.

Qantas’ response to Pacific Blue will have a bearing on overall market conditions but the new entrant should not have a major impact on Air New Zealand.
All three listed Australasian companies have given positive guidance for the June 2008 year.

Air New Zealand revealed its “forward bookings through to the high season are strong” and it expects to exceed its 2007 pre-tax and pre-unusual earnings of $268 million next year.

Qantas said “the first six weeks of 2007/08 have been very strong for all our flying businesses and forward bookings are equally buoyant through to the end of the calendar year”. It expects a 30 per cent rise in pre-tax earnings for the June 2008 year.

Virgin Blue believes its strong performance this year will continue next year.
Air New Zealand’s long-term objective is to grow its revenue base, improve aircraft efficiency, protect its domestic market share and contain costs. The order of four Boeing 777-300ER aircraft, due in 2011 and 2012, will help as they use 20 per cent less fuel than the ones they replace and will be much cheaper to maintain.

Air New Zealand’s share price does not reflect its strong performance in recent years and encouraging outlook. Investors tend to be cautious about airline companies because of the low barriers to entry and the large number of bankruptcies in recent years.

This caution was reflected this week when Contact Energy chief executive David Baldwin reported net earnings of $240 million for the year compared with Air New Zealand’s $238 million before unusual items.

The earnings of the two companies are almost identical but Contact Energy has a sharemarket value of $5.3 billion compared with Air New Zealand’s $2.1 billion.

Air New Zealand: Strong recovery but margins are lagging

  Air New Zealand Qantas Virgin Blue
  NZ$million A$million A$million
Revenue 4,297 15,166 2,169
Expenses (3.735) (12,756) 1,745
EBITDA  562 2,410  424
Depreciation/amortisation (279) (1,363) (100)
EBIT 283 1,047 324
Net interest (15)  (15) (16)
Pre-tax profit 268 1,032 308
Unusual items (24)
Tax  (30) (312) (93)
Net Earnings 214 720  216
EBITDA margin 13.1% 15.9% 19.5%
Share price $2.01 A$5.49 A$2.09
Market value NZ$2.1b  A$10.9b  A$2.2b
P/E Multiple      
– 2007 actual  9.8 15.1 10.2
– 2008 forecast 9.6 11.0 9.3