Joe Aston’s Chairman’s Lounge is a good read and well researched. As you’d expect from him it is a bit like a gossip magazine in parts but does give good insights into how the airline operates and is positioned.

AFR - QAN ASX: Why Qantas had to give frequent flyers more spending options (afr.com)

There is a simple reason why Qantas is making it easier to use frequent flyer points – all those points are burning a hole in customers’ pockets.

Frequent flyers are racking up about 200 billion points a year. They love the program – the points, the chance to get free flights or upgrades, the status credits – all of it, it is an undisputed winner. Macquarie’s analysts went as far as to call it possibly the leading frequent flyer program globally.

Qantas CEO Vanessa Hudson announced the changes on Monday.  Oscar Colman

That points issuance is growing like a weed – it was up 13 per cent in the six months to December and 48 per cent last financial year (admittedly a bit of a post-pandemic rebound year), and Qantas makes money selling these points to third-party buyers such as the banks.

The problem is frequent flyers cannot spend the points quickly enough, or do not want to spend them on what’s on offer. And if there is no spending, what is a point really worth?

We can see from Qantas’ filings that it issues more points than frequent flyers redeem every year.

At its peak, frequent flyers were earning about 40 per cent more points than they would redeem in any one year. The gap was 17 per cent in the six months just gone.

Even in COVID-19 when planes were not in the sky, frequent flyers racked up a lot more points than they spent, which shows how important the banks and other third-parties points buyers are to the loyalty proposition.

The result is a swelling frequent flyer program with more customers and more points, a rusted-on customer base that seem to be perpetually in points accumulation mode, and now some of those customers are fed up.

They watch their frequent flyer balance closely – people in the airline industry will tell you that frequent flyers track their points balances closer than their superannuation balance – and want to cash in.

How do you fix it? Try to get them spending.

Now we know these customers like flying and special treatment – that’s why they are in the frequent flyer program or signed up for a Qantas-branded credit card in the first place. They want to use their points for flights and upgrades, not always on the Qantas shop’s wine, coffee machines or golf balls that they buy elsewhere.

So that’s why Qantas is creating a new tier of products that make it easier to book flights using points.

These flights, dubbed Classic Rewards Plus, are more expensive from a points perspective – but there are so many points out there (and growing every year) and so many frequent flyer members that want to spend them, that it can make sense for both Qantas and its frequent flyers.

Is it a genius move? Not really. Rather it is the frequent flyer shake-up that Qantas had to have given unrest in its customer ranks and the way its frequent flyer program has evolved and grown in the past two decades. Qantas needs to show customers it is serious about those points having value – that they are more than just a number on a statement or part of a social status game – and can be spent on something they want: flights.

$120m cost to Qantas

By doing that, it shores up Qantas’ proposition to banks and other companies that use frequent flyer points to sell their own products. These buyers need to keep buying if Qantas’ loyalty arm is to record $1 billion in annual earnings by the end of the decade, as planned.

Macquarie’s analysts say the restructure rectifies the problem. “Combined with tier FF members getting different levels of access to the seats, the risk was increasing that perceived value of the points was declining for many members, as they struggled to redeem them,” the analysts told clients on Tuesday morning.

“Whilst alternatives for redemption on classic are available, they are low-value options, no better than the competitive program offers. We contend points plus pay became a negative to the program as it highlights a sharp difference between the Classic program.”

As always, it will take a bit of time for frequent flyers to assess the new system, and we bet there will be some initial shock and complaints; that is Qantas getting back what it created – a system of entitlement, privilege and “loyalty”.

There are frequent flyer members who loyally used their Qantas credit card and flew Qantas at every opportunity for the past few decades, to be in the position where they use their points today. They want Qantas to show some loyalty back.

Classic rewards plus flights will be sold under a new variable pricing system and will kick in once the base-level classic rewards seats are sold out.

Macquarie’s analysts tested it out and found a one-way economy trip from Sydney to Tokyo valued points at 1¢ each vs the old classic system at 3¢, for example.

The changes are expected to cost Qantas $120 million in FY25, their first full-year, which is part of the airline’s announced $230 million “investment in the customer”.

Will Qantas recoup some of that from the third party points buyers?

Jarden’s analysts are doubtful. “We think it is unlikely that its partners have agreed to pay more for points inventories, leaving the earnings growth outlook reliant on a combination of membership growth and realised margin (breakage assumptions, fare mix benefits, ancillary network usages) from points redemptions,” they told clients.

For those who are still following Qantas, you might have seen in your emails recently that Qantas are starting to ramp up promotion on sale fares, both domestic and overseas.

Admittedly, its all for low season, and having done recent searches for overseas flights at peak times, they are still pricing peak fares at well above their competitors (50% higher to Europe in the Southern Autumn/Spring).

Profitability (or rather inverse losses), is likely to return to normal over the next two years, so if you are still on board, I think it's time to sell.

I'm still bullish on Qantas medium term.

Reasoning:

1) Domestic travel is now largely unhindered, with WA rejoining the federation in the next few days, and domestic was where the profits were earned.

2) Qantas have no real competition for the profitable business dollar. Virgin are a shadow of their former selves, Rex and Bonza are not preferred where time is money (believe me, I have been burned too many times by a stingy employer), and whilst remote working has taken off, remote working cannot replace everything.

3) International will take a while to come back online, but when it does, knowing that you'll be able to rely on an airline to get home will carry a nice hefty premium that many will be happy to pay. I know I would.

4) Project Sunrise (direct long haul from east coast to UK/Europe and east Coast of USA) is going ahead, which minimises transit stops, which are likely to be highly desirable in COVID era travel, which will also come with a nice premium.

5) Qantas know that they need to keep those with golden and platinum handcuuffs tied to the airline (I'm one who is trapped). As of today, Qantas had announced yet another status extension, but have started to wean us off the idea of status extensions by structuring requalification to reward those who are actually flying. Smart move on their part - status extensions are low cost and keep your highest value customers from deciding to try a competitor.

Ultimately, I think Qantas are in the box seat with pricing power, and the low margin leisure traveller dollar won't be where their profits in the next few years lie. Investing in an airline being profitable? Strange times indeed.

Following up on my previous straws, the time to exit this trade will be when optimism about international travel from Australia in the near term is high.

Mr Strawman is fond of the saying that the market is a voting machine, and in this instance, the Qantas share price will definitely go the way of expectations.

I'll look to exit the position on SM at around $6-$6.50. My guess will be around November when there is plenty of noise from AJ about flying internationally again, even though domestic is where the money is made.

Shame I didn't trade it with real shares due to opportunity cost, but the thesis remains.

Further to my previous straw, it's becoming apparent that the market sentiment on Qantas is clearly overshooting the mark. The pre-COVID price was all about anticipated growth in Qantas International, not the boring backwater engine room of domestic. 

For FY19, EBIT for International was 25% of EBIT, with domestic + Jetstar + loyalty making up the rest. FY19 was lower margin due to high fuel costs. The latter three divisions were going gangbusters before the most recent lock downs, and will no doubt pick up once demand starts again for domestic with vaccine passports (government supported or at the insistence of Qantas).

When borders open up again, with the requirement to quarantine either at home or in special accomodation will temper demand, low cost leisure (i.e. Jetstar International) and low margin budget economy fares will be non-existent. So the money will be spent by higher margin business travellers who will no doubt be lured into spending with Qantas by double and likely triple status credit offers for fully flex business fares, rather than going with the competition.

Would any serious business traveller trust Emirates, Qatar, Etihad, Singapore, United or American, to get you home in the current environment? I wouldn't.

I think it's worth somewhere between $5.50-$6.50 on current metrics. Definitely not high reward, but it's still an easy trade with little downside risk.

Qantas International was never hugely profitable, and relied upon rusted on frequent flyers held by platinum handcuffs (of which I am one) to keep it afloat.

Qantas domestic, however was hugely profitable pre-COVID, and at least before the Sydney lockdown, with domestic flying capacity at 90% for Qantas and 110% for Jetstar, the result was always going to be better than the market was pricing in. 

With a pre-COVID valuation of approx 10x EPS for FY19, all the bad financial news out, Government now talking about financial assistance, a decent financial buffer, and the domestic competition on the floor, the market is currently pricing Qantas down on sentiment.

It's definitely not long term, but it's an easy trade with little downside, and plenty of upside once domestic borders open up without much restriction, and international demand stays low for some time to come.

05-May-2020:  Qantas Group Market Update

Weren't QAN a screaming buy below $2.50 in March!!  By the time I'd convinced myself they were a buy, they were already back over $3 and heading north again.  They closed at $2.14 back on March 19th.  They are back over $3.60 today and still heading north.  Fortunately, I didn't miss out entirely, as I was distracted at the time buying other bargains such as BPT at below $1 and NWH at around $1.10.