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Treasure Chest: Qantas Still Ascending

Treasure Chest | Jul 04 2017

Why does a stock that’s run so hard in a year still attract seven from eight Buy ratings from major brokers?

– Stable duopoly in Australia
– Stronger margins
– Discount to international peers


By Greg Peel

Qantas Airways ((QAN)) has come a long way since the infamous grounding of 2011. When the stock hit its nadir of close to $1.00 in early 2014, questions were being raised as to whether the airline could survive and whether it could be sold, which would require a change to federal legislation.

The stock is now trading at $5.75. That’s a 418% rally in three and a half years and a 115% rally since the previous low set on a pullback one year ago. Supporting the rally has been the big fall in oil prices over the period, and a move within the airline industry to cease mutually destructive competition and rationalise capacity. On such an exponential surge, one would expect brokers would be calling the move overextended.

Of the eight major brokers on the FNArena database covering Qantas, none has a Sell (or equivalent) rating. One has Hold. The rest retain Buy ratings.

Underpinning ongoing positive views is the fact, noted by brokers, that despite the Lazarus performance Qantas is still trading at a discount to global peers. Early last month Citi suggested there will likely be “material upgrades” to consensus earnings forecasts from FY18 onwards.

If the Australian airline industry has learned one thing over the past decades, it is that the domestic market cannot handle a third airline. So many have tried and failed.

After a period of rationalisation, Qantas’ domestic service now operates in a stable duopoly with Virgin, Credit Suisse suggests. Qantas’ loyalty program arguably enjoys better-than-duopoly status. Together these make up around 70% of stock valuation.

While popular with Dustin Hoffman, Qantas’ international service only accounts for 15% of value. This balance means Qantas enjoys more stable earnings than its international peers, Credit Suisse notes.

Over the past 20 or so years, Qantas has only suffered two years of pre-tax losses. US and European airlines have suffered many years of losses. Domestically, Qantas is able to enjoy a ticket price yield of around 15% above Virgin, at a unit cost that is only around 5% above Virgin, Credit Suisse points out. The broker believes Virgin’s focus from here will be on attempting to improve its profitability rather than trying to gain market share.

This means duopoly conditions should remain stable for some time, Credit Suisse suggests. A stabilised domestic duopoly deserves a premium in the broker’s view.

Credit Suisse already had a Buy (Outperform) rating on Qantas but last week lifted its target price to $6.75 from $5.00 to apply said premium to valuation.

This is still not the high marker among FNArena database targets. Citi has set $7.09. The consensus target of eight brokers is $5.54, suggesting downside, but then neither Deutsche Bank ($4.10) nor Morgan Stanley ($4.30) have updated since the February result season.

The only real sceptic is Ord Minnett, who as late as May retained a Hold rating with a $4.15 target.

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