Australia | Nov 21 2019
Qantas asserts that its dominant position in the domestic market and dual brand advantage will support ambitious targets for margin expansion.
-Disciplined capacity growth from all domestic operators critical to achieving targets
-Transformation benefits of $400m expected to be ongoing
-International targets may be very optimistic, Credit Suisse suggests
By Eva Brocklehurst
Margins were the highlight of the Qantas Airways ((QAN)) investor briefing as new ambitious targets were set. Targets for earnings (EBIT) margins of 18% and 22% by FY24 have been set for Qantas domestic and Jetstar domestic, respectively.
Management believes the company's dominant position in the domestic market and its dual-brand advantage will support margin expansion. While the targets appear optimistic, UBS assesses they are based on realistic assumptions for 2.5% unit revenue growth per annum and unit costs growth of 1% per annum.
The broker acknowledges disciplined capacity growth from all domestic operators remains critical to achieving targets, noting this is occurring, with Virgin Australia ((VAH)) removing -2% of near-term capacity over the past week. Citi also assumes the domestic market remains rational as many of the short-term catalysts play out for Qantas stock.
Credit Suisse observes these targets are 5-6 percentage points higher than historical peaks and based on rational capacity, revenue per available seat kilometre (RASK) growing at 2.5% per annum and available seat kilometres (ASK), ex fuel costs, growing by 1.0%.
Further momentum in the share price is likely to be driven by earnings revisions and multiple expansion and the targets represent significant upside to Morgan Stanley's long-term forecasts. Macquarie, too, assesses profitability improvements over the next five years in the domestic airline businesses could be significant, albeit subject to economic conditions.
Management previously guided to a minimum of $400m in transformation benefits in FY20, largely based on cost reductions, and now expects this to be ongoing via technology, operating efficiencies and supplier management.
A loyalty target for earnings of $500-600m by FY22, through membership growth and higher membership engagement, has been reiterated. This implies annual growth of 7-10% from FY17. Morgan Stanley believes the value in the Qantas loyalty business is hard to ignore, noting the new business additions and momentum.
UBS agrees but finds the target ambitious compared with FY19 earnings of $375m. The 5% growth anticipated from core partnerships is expected to be topped up by a doubling of the contribution from new business, such as insurance, by FY22. This implies annual growth of 7-10% from FY17. The broker points out visibility on the contribution from new business, such as insurance, is low.
Qantas is still committed to a decision on Project Sunrise by the end of 2019. The project remains subject to consideration of the minimal capital requirements for the fleet, the appropriate configuration and expected load factors. Moreover, new enterprise bargaining agreements must be put in place for pilots and crew members.
The company's financial framework assumes capital expenditure of $2bn is required to maintain its current fleet and, brokers note, this does not incorporate expenditure for long-range flights associated with Project Sunrise.
Morgan Stanley has always considered this capital expenditure guidance an 'average', with scope for some lumpy items year-on-year. Still, maintenance of the figuring should be viewed favourably, in light of some investor concerns regarding higher expenditure and lower free cash.
Macquarie asserts that, if Project Sunrise proceeds, it would likely remove the capital management option as balance-sheet capacity is reallocated. However, UBS does not believe the replacement of the domestic fleet should affect capital management assumptions as there is some flexibility regarding timing.
Qantas has also reiterated targets for returns on invested capital (ROIC) of over 10% for Qantas international and over 15% for Jetstar international. Credit Suisse calculates these targets equate to a Qantas group earnings margin of 15%.
This compares with the average group margin over the past 25 years of 6.5%. Qantas has hit double digits in this regard only twice, in FY16 and FY18. Hence, the broker suggests the airline may only achieve these targets in an "lucky year" and they are not sustainable.
As a side issue, Credit Suisse suspects the company's success in cost cutting and the strong financial performance over recent years could precipitate increased demands from employees. Hence, cost inflation could surprise to the upside.
FNArena's database has four Buy ratings and one Hold (Credit Suisse). The consensus target is $7.30, suggesting 2.2% upside to the last share price. Targets range from $6.60 (Credit Suisse) to $8.00 (Macquarie).
Disclaimer: the writer has shares in the stock.
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