The Australian airline is saddled with high costs, and it’s missing out on the one growth market on its map

Pikes Wines, a vineyard in the Clare Valley of South Australia, has seen its business in Asia soar, with sales to China accounting for 20 percent of exports, up from zero five years ago. That’s one reason Pikes sales chief Peter Bentley takes about 80 domestic and international flights each year for work. But Qantas Airways (QAN:AU) long known for connecting Australia to the rest of the world offers only seven flights a week to China. (Air China and China Southern Airlines (ZNH) together have more than 50.) “They don’t have enough choices, says Bentley.We are on the doorstep of Asia and that is where we have the growth, and yet we seem to have these outdated ties to Mother England.

When the flying kangaroo was first painted on Qantas planes in 1947, more than half of Australians were born in the U.K. Today, only a quarter are of English descent. But the failure to adapt to that change and rising long-haul competition from Middle Eastern carriers has seen Qantas’s share of Australian arrivals slump to less than 20 percent from more than 35 percent a decade ago. The number of passengers flying to London was little changed over the past decade, while those headed for Beijing or Shanghai almost tripled.

Qantas Chief Executive Officer Alan Joyce is intent on remaking his high-cost carrier, which has a 65 percent domestic market share in Australia, into one that can better compete on faster-growing routes to Beijing and Shanghai. So Qantas is reducing unprofitable flights to Europe, shifting maintenance to cheaper facilities in Southeast Asia, and trying to start an airline based in Malaysia or Singapore that could handle intra-Asia traffic.Asia will continue to play a larger part in the global economy,Joyce says.There is nowhere like it. It has massive untapped potential.Investors aren’t certain he’ll succeed. Qantas shares plunged 36 percent in the past 12 months amid worries about Chinese rivals, a loss of business to lower-cost Middle East airlines such as Emirates, and Qantas’s more than A$600 million ($641 million) rise in fuel costs last year.

Moody’s Investors Service (MCO) downgraded the airline to its lowest investment grade on Jan. 31, citing competition and fuel prices’ drag on earnings. “They either have to come up with a business plan with costs close to their competitors’ or they just slowly contract, says Andrew Sisson, managing director of Franklin Resources’ Balanced Equity Management, Qantas’s biggest shareholder, with an 11 percent stake.If you can fly people to Kuala Lumpur or Singapore, you’ve at least got a natural market to draw on, but they won’t fly on you if you’re not price-competitive.

Setting up an airline in an Asian hub would let Joyce hire pilots and crew locally at a lower cost and offer a greater choice of connecting flights to compete with Singapore Airlines and Cathay Pacific Airways. Personnel expenses eat up 27 percent of sales at Qantas, as opposed to about 15 percent at Singapore Air and Hong Kong-based Cathay Pacific. Qantas’s international routes log about $200 million in losses annually. “He has to get it right,” says Neil Hansford, chairman of Sydney-based Strategic Aviation Solutions, which advises airlines across the Asia-Pacific region. “The Asian carriers aren’t going to sit still. They will fight for every passenger Joyce tries to get.

Australian lawmakers and unions consider the possible launching of an offshore carrier a ploy to shift jobs abroad and subvert the 20-year-old legislation that privatized the airline. Legislators have proposed revisions to the law that would compel Qantas and its Jetstar budget unit to do most of their maintenance work in Australia and to cap the growth of Asian affiliates. Those proposals “would strangle our capacity to run our business,Joyce told an Australian Senate panel on Feb. 6.A wave of strikes last year led Joyce to ground the Qantas fleet in October for about two days, forcing the country’s labor regulator to intervene. Two of three unions are now in binding arbitration that will prevent them from striking and taking other labor actions for the lifetime of new contracts. Qantas engineers signed a deal in December allowing new jets to be maintained in Asia.

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