Qantas - what should investors do now?

One of the key issues for investors is to determine whether the recent woes at Qantas are temporary or permanent.  If they are permanent, that spells danger, but if the issues are temporary it could provide opportunity.

Matt Williams, the head of equities at Airlie Funds Management says that the Qantas Domestic business and the Loyalty businesses are the most profitable in the Qantas group and the most highly rated by investors.  Qantas Domestic accounted for over 40% of operating profit and the Loyalty business generated $1bn of free cash flow in the 2023 financial year.  He says that this is unlikely to change and while the ‘fallout’ remains unknown, consumers will still fly and spend on their credit card.

Qantas earnings chart

Williams adds that earnings are very sensitive to changes in demand and demand has been very strong coming out of COVID.  Qantas Domestic capacity is almost back at pre COVID levels, while Qantas International capacity is 66% of pre COVID levels, which provides some opportunity for growth.  He is of the view that Qantas earnings are more likely than not to be closer to peak earnings in the short/medium term, particularly given the fall in Qantas average fares (both domestic and international) of 11% in the last 6 months of the 2023 financial year.  Jetstar domestic recorded a 17% fall in average fares.

Nick Markiewicz, portfolio manager from Lanyon Asset Management says that Alan Joyce is leaving the business with record profitability, but with low public support, fragile Government relations, and a near record capital expenditure bill.  From these facts one could make a powerful argument that short term profit objectives have been pursued ahead of the longer term interests of customers.  

Markiewicz believes that while the profit pendulum may have swung too far in one direction more recently, this needs to be considered against some of the reasonable long term decisions by management.  These include the establishment and growth of Jetstar, resetting union relations, the restructuring of Qantas (particularly the International arm) back to profitability in 2014 and the navigation of COVID.

Williams believes the problems at Qantas are fixable but they will take time and money.  Markiewicz is of the view that the history of corporate scandals suggests that the current furore around Qantas is likely to be short lived, particularly given the change in leadership.

So if the problems are fixable, does the current share price represent opportunity?  Markiewicz says the share price is at the same level as it was in mid 2017, despite net income doubling over this period.  As a result the Qantas price earnings (PE) ratio has fallen from around 10 times to 5 times earnings, which is amongst the lowest in Qantas history.  This also compares favourably to global peers, where the median PE ratio is 6.6 times, making Qantas one of the cheapest airlines in the world.

The share price appears to be factoring in risks such as changes in Government attitude toward Qantas, potential for increased competition and the need to upgrade the fleet in coming years.

Williams flags that history is littered with companies that have tried and failed to compete with Qantas (Tiger, Compass, Ansett, and Virgin 1.0), so its risky and he considers it a lower probability.

Markiewicz highlights the group’s fleet age has increased from 7.7 years in 2014, to nearly 14 years in 2022, putting it just below the global average. Management intend to purchase 65 aircraft over the next three years. This will see annual capital expenditures rise above $3bn for each of the next three years. This will directly impact profits, which will in turn, make future earnings far more sensitive to changes in revenue.

The more noticeable impact will be to free cashflow, which will likely fall to negligible levels as these aircraft are received. This raises risks for shareholders, as it increases the importance of the operating business sustaining record profits to fund these purchases, and means management may have to draw on the balance sheet (i.e increase debt) if they want to pay a dividend or continue buying back stock.

However new aircraft will add to the airlines customer proposition as well as significantly reduce fuel burn and other operating costs.

Investors should invest into companies that have rising customer satisfaction and strong balance sheets.  Generally profits follow customer satisfaction.  For Qantas this is a work in progress.



Each month Mark Draper (GEM Capital) writes for the Australian Financial Review - this article appeared in the 20th September 2023 edition.