Australia's domestic airlines are defying gravity. While the vast majority of companies selling everything from electronics and clothing to baked beans are locked in ferocious price cutting war, the airlines are quietly lifting their fares.

After years of cutting fares to stimulate demand, the airlines have started to employ a new formula. It's simple enough - cut the number of seats and you can charge more for them. This doesn't work so well internationally because there is plenty of competition, but it does domestically.

Both Virgin and Qantas are being careful and clinical about which routes and what types of customers can wear fare increases and where they will cut capacity, but the trend is clear enough.

A report released to clients by Citi analyst Anthony Moulder provides a pretty clear view of how meaningful these changes are.

"With a combination of stronger demand and low capacity growth, we expect fares will continue to increase domestically, increasing the profitability of both carriers and ultimately lifting domestic earnings about over $1.1 billion annually."

The benefits for Qantas in particular have been very clear. It will produce its second-largest profit on record this year and analysts are now predicting it will deliver its biggest-ever profit next year.

Virgin will report a loss this year but the current (fourth) quarter is forecast to improve on the same period last year.

Domestic airlines have two distinct advantages over most other industries - they have a duopoly in the Australian market and they are not victims of the digital disruption that has decimated so many other industries like retailing, media and even banks.

They are a protected species because the economics of starting a new domestic airline don't stack up. Several have tried and all have failed.

For a while Qantas and Virgin tried to engage in the fare-cutting war but both were wounded.

All Qantas and Virgin needed to do was act rationally - avoid fare and capacity price wars - and regain pricing power.

Until recently, investment markets have been unconvinced that any airline could report reliable earnings.

(Remember, Ansett managed to go belly up even when it operated in an effective duopoly.)

A few years back, Qantas was looking to the government for a financial bailout after reporting a loss of $2.8 billion in 2014.

And even though Qantas engineered one of the most extraordinary Lazarus-like financial comebacks, there have been plenty of investors that simply can't stomach the traditional rollercoaster earnings ride that has marked the aviation industry.

Therefore, despite the strong earnings performance Qantas has achieved over the past couple of years, it has been valued by the stock market a discount to other listed non-airline companies.

But it increasingly seems that Qantas, at least, is winning over the sceptics. Already this year, Qantas' share price has gone up more than 60 per cent.

Citi is predicting there is more in the tank for the share price. It released a report on Friday arguing that Qantas' share price could be the subject of a re-rating if it were valued on the same multiple of earnings as other companies and its international airline peers. It says the share price discount is less justified now because the earnings are more sustainable than ever.

And Citi increased its target price for Qantas from $4.71 to $7.09 with an expectation other investment banks will also revise up their Qantas forecasts.

It was enough to push up Qantas' share price on Friday morning by 2.1 per cent to $5.26.

The other side of the ledger, particularly for Qantas, is the costs it has taken out of the business.

"Three years ago, we said we would deliver on $2 billion in transformation, and we've now given ourselves our targets for the next three years and management's focused on delivering on that," Qantas boss Alan Joyce told Businessday this week.

Joyce backed the continued rise in the share price, which he said "would look after itself" if its self-imposed cost savings targets of $400 million annually are met.

Taking costs out of their businesses allows the airlines to improve their yields even when taking a cut in airfares.

Virgin's cost-cutting and reorganisation program is not as large nor as well advanced as Qantas'.

Another factor tantalising Qantas investors is the prospect of further capital management.

Several analysts have forecast share buybacks to continue, and Citi is expecting an increase in dividends beyond the stated minimum of 7 cents per share per half.

Whether the optimists' views prove prescient now depends on how well Qantas can improve the performance of its international division - and increase its Asia focus.

But more importantly for both carriers, shareholders must be able to trust that the current peace which has broken out between the two domestic carriers remains intact.