Qantas Circles Cash Pile, More To Come?

This story features QANTAS AIRWAYS LIMITED. For more info SHARE ANALYSIS: QAN

Cash is flowing at Qantas and the company rounded off a robust FY17 result with a reinstated buy-back. Is there more to come?

-High cash flow expected as long as fuel prices remain low and domestic industry stable
-International over-capacity continues across the region and compression of yields is probable
-Are further domestic airfare increases required to justify valuation?
 

By Eva Brocklehurst

Cash is flowing at Qantas Airways ((QAN)), with returns of $500m from FY17, comprising a 7c per share dividend and an on-market buy-back. Citi observes, over the last 12 months, the stock has re-rated and no longer has one of the lowest forward enterprise value/operating earnings multiples in its global airline coverage.

Stability across 70% of Qantas earnings is higher than regional competitors and the broker suggests a continuation of dividends, high returns on invested capital and margins make the stock a more attractive alternative. Macquarie agrees and considers the stock cheap on several metrics relative to historical levels and global peers.

Ord Minnett does not share this optimism and, following a review of the result and surge in the share price over 2017, downgrades to Sell from Hold. The broker points out that the shares were up 81% for the year to date at the last close of $6.02 versus a unimpressive rise of 1.4% in the benchmark S&P/ASX 200.

Ord Minnett was happy to rate the stock a Buy a year ago, when it was trading at $3.07, and a Hold a month ago at $4.24 but, at $6.02, no. To support such a valuation the broker believes further domestic airfare increases are required in the order of 10%. The current operating environment is still challenging and the broker suspects weak demand and over-capacity prevail. Hence, expectations for airfare increases appear optimistic.

Domestic

Nevertheless, others suggest the current domestic operating environment is becoming more constructive. Market capacity continues to be rationalised and, combined with a stabilising of the resources industry, should mean domestic demand improves over the coming months.

A reduction in capacity to match weaker passenger demand enabled Qantas to raise its fares and report a 2.6% rise in yield. So long as fuel prices remain low and the duopoly in the domestic airline industry is stable, brokers expect high levels of cash flow.

Credit Suisse attributes strong growth in domestic business to improved sentiment, as weakness in mid-2016 from the federal election was cycled, along with disciplined management of capacity. Qantas outperformed Virgin Australia ((VAH)), suggesting it had captured additional corporate market share.

The highlight for UBS was a 5% increase in domestic revenue in the second half, benefiting from a 2% decline in capacity and increased market share. The strong share price performance in the year-to-date means the stock is trading in line with global peers.

UBS considers this justified, given superior quality from a business which currently derives two thirds of income from its domestic and frequent-fliers. The broker expects another record for domestic earnings in FY18. UBS also notes airlines are inherently volatile and high risk, which means that higher earnings quality should be rewarded by the market through higher multiples.

International

Internationally, over-capacity across the region continues and further yield compression is probable into FY18. The company has provided no guidance, given poor visibility and uncertain trading conditions.

This was the low aspect to the result. International registered a -36.1% decline in earnings, fuelled by growth in available seat kilometres of 4.4% and a -4.0% fall in passenger yields. Ord Minnett is particularly concerned about the second half, where earnings declined -50.8% on the prior corresponding half.

Buy-back

Given the foreign ownership of Qantas is around 46.73%, and cannot be more than 49%, Citi believes the company is opportunistic regarding a $373m buy-back. However, the majority of that amount is still expected to be completed. UBS expects the company to distribute $1bn in FY18 and in FY19, while still remaining in its target gearing range. The buy-back is expected to provide around 6% per annum in accretion to earnings per share.

The company has announced it is exploring the possibility of servicing new direct routes, such as New York City, by 2022. A decision will be based on the ability of manufacturers to achieve the ultra-long haul aircraft and more clarity is expected over the next 12 months.

Macquarie believes Qantas will first assess the performance of its long-haul London route to gauge the prospect. The key to additional routes will be the ability to earn premium yields, given the requirement for non-revenue generating pay load and probability of fewer seats.

FNArena's database shows four Buy ratings and one Sell (Ord Minnett). The consensus target is $6.46, suggesting 13.1% upside to the last share price. This compares with $5.54 ahead of the results. Targets range from $4.55 (Ord Minnett) to $7.30 (Macquarie).

Disclaimer: The writer has shares in the company.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms