Analysts divided on impact on Air NZ's earnings of Jetstar's regional routes challenge

UBS analyst Marcus Curley said Air New Zealand's underlying earnings could be cut between $13 million and $20 million in the 2016 financial year.

Analysts are divided on the likely financial impact to Air New Zealand [NZX: AIR] of Jetstar's decision to start flying domestic regional routes from December.

Jetstar, the low-cost offshoot of Australian-owned Qantas Airways, said yesterday it planned to expand from flying the main trunk routes into at least four regional destinations which are still to be determined. It's likely to cherry-pick the most-profitable deals with local airport companies.

In a research report, UBS analyst Marcus Curley said Air New Zealand's underlying earnings could be cut between $13 million and $20 million in the 2016 financial year. However, he said that reflected an expected lift in the airline's overall earnings before interest and tax of $126 million to $692 million in the same financial year due to the impact of lower fuel costs and relatively modest new competition on its domestic and international routes, outside of China.

In another research note, Deutsche Bank said working out the earnings impact on Air New Zealand was difficult because it doesn't disclose the profitability of its domestic network, it's still not known how much fares will fall, and how much the expected lower prices will stimulate demand.

It said the 2007 arrival of PacificBlue on regional routes stimulated passenger growth by 30% year on year and studies have shown that every 10% drop in prices lifts demand by 15-20%. Qantas chief executive Alan Joyce said yesterday that Jetstar's arrival on domestic routes had typically cut fares by 40% and he expected a similar outcome on regional routes in New Zealand.

Deutsche Bank forecasts a range of $30-50 million of potential revenue loss for the national airline or between 4-7% of ebit. That's based on Jetstar entering with fares 15% lower on average, which results in market fares down 10% with demand stimulated by 15%.

Curley said based on regional routes accounting for around half of Air New Zealand's domestic profitability or ebit of $130 million in the 2015 financial year and Jetstar representing 9% of capacity on regional routes, the impact could be $13 million. But Air New Zealand matching Jetstar's expected lower prices of around 30% would lower revenue by $20 million. Air New Zealand has said it will not be undercut on prices on the regional routes and was "ready for the battle".

Mr Curley said the New Zealand airline should be able to command a premium, reflecting its superior frequency of flights and aircraft quality with its larger new ATR72 aircraft competing against Jetstar's 10-year-old Q300s. He believed Jetstar's planes would be sourced from ones surplus to Qantas's regional service following reduced demand after the mining downturn.

Deutsche Bank forecast Air New Zealand's domestic yields overall would fall by 2.5% and load factors drop 200 basis points in the 2016 financial year due to increased competition such as Jetstar but it has left unchanged its forecast of $450 million net profit for the group.

UBS is forecasting net profit of $472 million for the next financial year and has maintained a buy recommendation on the stock.

Air New Zealand's share price slumped 10% yesterday due to Jetstar's further foray into its home territory but has since recovered some of that in today's trading, rising 9c to $2.48.


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