QUBSF - Does Qantas Airways Present An Appealing Investment Opportunity In The Post-Pandemic Era?

2023-08-22 05:55:27 ET

Summary

• Qantas Airways is a potential asset for investors looking for opportunities in the aviation sector's recovery from the COVID-19 pandemic.
• Qantas enjoys a dominant position in the stable Australian domestic aviation market and is expected to maintain its market share.
• The airline's passenger revenue is rebounding, driven by strong domestic and international demand, and its loyalty program is contributing to profitability.

Investment Thesis

As the aviation sector navigates its way through the aftermath of the COVID-19 pandemic, investors are actively searching for potential assets poised to thrive in the wake of this global recovery. One notable contender that warrants attention is Qantas Airways (QUBSF). The intention of this article is to examine the potential viability of investing in Qantas within a long-term investment portfolio.

Company Overview

Qantas Airways, Australia's renowned flagship carrier, stands as an iconic symbol of aviation excellence and resilience. With a rich history spanning over a century, Qantas has solidified its position as a leading airline.

Qantas' performance for the current year to date has been notably remarkable, exhibiting a return of 5.56%, in contrast to the broader ASX 200 index return of 2.91%. This translates to an alpha of 2.65%.

Business model

Qantas Airways enjoys a dominant position in the Australian domestic aviation market, which is one of the world's most stable economies. The country's strong GDP growth, increasing disposable income and a thriving tourism industry bode well for Qantas’ prospects. The company's extensive network, comprising both Qantas and its low-cost subsidiary Jetstar, connects major cities.

The aviation sector is well acquainted with the influence of unforeseeable elements such as fuel costs, geopolitical occurrences, and worldwide health emergencies that can affect operational efficiency and financial gains. Despite contending with challenges mentioned above, Qantas has showcased unwavering resilience.

Market Share

Qantas Airways is expected to maintain its dominant position in both Australia's domestic and international markets, despite the possibility of relinquishing some of its pandemic-induced advantages to emerging and revitalized competitors. The airline is cautiously ramping up its capacity after addressing issues that had negatively impacted its reputation due to service mishaps in 2022.

Domestic Presence

Qantas is positioned to uphold its position as the frontrunner in Australia's domestic aviation sector, despite encountering challenges in preserving the market share it gained amid the pandemic. Bolstered by Jetstar, its passenger share surged to 77% in July 2020, benefiting from Virgin's contraction, a notable increase from the 55% it held two decades ago. This share was subsequently influenced by the cessation of Ansett in 2001, followed by adjustments due to the expansion of Virgin Australia. The CEO of Qantas perceives that the company's inherent market share has now stabilized at 70%.

Qantas is confronted with competition from a revitalized Virgin, projected to regain profitability this year, as well as Rex's ongoing expansion into jet operations and the entrance of Bonza in the budget segment. Qantas' domestic passenger market share currently stands at 36%, in contrast to the 34% it held in 2019. In parallel, the share held by the Virgin group has decreased from 30% to 28%.

International Presence

The following bar chart provides an overview of the market share distribution for each airline spanning from the pre-pandemic period up to Q1 2023. It's evident that Qantas doesn't face the risk of losing its international market share. Combining the contributions of both Qantas and Jetstar, they collectively held 5% more of the international passenger market compared to three years prior, achieving a total of 28%. Emirates and Qatar maintained a stable share at 10% combined, but Qatar's share increased by 2%, reaching 5%, whereas Emirates experienced a corresponding decrease. Cathay Pacific's market share remained constant at 4% in 2019, aligning with the figures from 1Q. On the other hand, Singapore Airlines saw growth in its market share, advancing from 7% in 2022 to 9% in 2023, marking a gain of 2% . Conversely, Virgin Australia's market share decreased from 6% in 2022 to 3% in 2023, indicating a noticeable decline of 3%.

The table below showcases the shifts in market share percentages for each airline from 2019 to Q1 2023.

Customer stratification via Loyalty Program

Qantas manages a highly prosperous 15 million member airline loyalty initiative known as Qantas Frequent Flyer, which has achieved remarkable global success. The Qantas Frequent Flyer program deserves recognition for its impact on the airline's revenue generation and the ability to maintain customer engagement.

Qantas has targeted at least 70% growth in loyalty EBIT in the next two years and in the first six months alone, the program contributed an impressive EBIT of $220 million. Furthermore, the program exceeded pre-COVID-19 levels in both points earned and redeemed. Over the past year, the program witnessed the expansion of its loyalty coalition, attracting approximately one million new members. At present, the program boasts a diverse collective of over 700 partners, encompassing both the Qantas Frequent Flyer and Qantas Business Rewards segments.

The division generates a margin from the sale of points to partners like credit card companies and for redemption through third-party award providers. Even amidst the pandemic, member credit card spending exhibited resilience. With Qantas gradually reinstating its capacity, increased member engagement is expected to positively impact the loyalty program. Currently, the risks to the loyalty program's standing are minimal, although Virgin has improved its retail collaborations.

Qantas Passenger Recovery

Passenger Revenue Contributes Over 80%

In the first half of 2023, passenger revenue achieved 84% of the overall total, marking the first instance since the onset of the pandemic. Over the same period, cargo revenue accounted for over 30% and played a significant role for the group.

In the year 2023, passenger operations was positioned as the primary catalyst for revenue growth, as evidenced by a near doubling of ticket sales. This surge in ticket sales accounted for 80% of the gains witnessed in the first half of 2023. These upward trends played a role in driving the passenger revenue for the first half to exceed 84% of the total, not seen since 2020. This upswing was supported by strong yields and an anticipated recovery to 70% of pre-pandemic international capacity within 2023. Furthermore, the expansion in domestic flight capacity is anticipated to continue, reaching excess of 90% of the levels recorded in 2019.

With the ongoing reopening of Asia and the gradual recovery of the Chinese market, there is potential for Qantas' international capacity rebound to exceed the presently targeted 85% of 2019 levels.

Qantas' and Emirates collaboration

The renewed partnership agreement between Qantas and Emirates has provided Qantas with the opportunity to tap into an expansive range of destinations beyond its traditional routes, thereby facilitating growth and improved connectivity. For Emirates passengers, this collaboration offers access to more than 55 Australian destinations that are not part of Emirates' existing network. Simultaneously, Qantas passengers can leverage Emirates' flights to access Dubai and connect with over 50 global cities that are not directly accessible through Qantas routes. This alliance is expected to enhance passenger traffic and flow for both airlines .

Financials

Balance Sheet

Qantas is projected to sustain a profit performance in the second half of 2023 due to the consistent strength of domestic traffic patterns, the ongoing recovery of the international market, and heightened pricing across its various operations. Anticipated figures for the latter half of the year suggest a record net income exceeding A$600 million. However, looking ahead to 2024 and beyond, earnings might stabilize as pricing aligns with historical norms in conjunction with the normalization of capacity.

Nonetheless, Qantas indicates that margins are now permanently improved across all business segments. The restoration of earnings and cash flow is contributing to the mending of the balance sheet, with net debt falling below the company's targeted range. This financial progress enables the initiation of buyback programs, even amidst an increase in capital expenditures.

The focus on Qantas' financial position persists since losses of A$7 billion due to the pandemic have considerably diminished shareholder equity, leaving just A$11 million by December . The anticipation of recovering positive cash flow and achieving an unprecedented net profit in 2023 should aid in bringing down net debt below the specified range. However, if share buybacks and dividends from earlier periods are pursued, this could extend the duration required to rejuvenate the equity strength.

Shareholder Returns

Qantas has a history of delivering attractive returns to its shareholders. In the initial half of the year 2022/23, the net capital expenditure summed up to $738 million. Simultaneously, the group engaged in an on-market share buy-back, thereby returning $400 million to its shareholders. This initiative led to a notable decrease of 3.7% in the total shares available. Taking into account the projected trajectory for the business and its financial recuperation, the board made a decision to declare a further on-market buy-back, reaching a value of up to $500 million.

Return on Assets (ROA) signifies the management's accomplishment in generating returns from operational endeavors and exemplifies the company's adeptness at converting sales revenue into profits. Presently, the ROA stands at 3.14.

ROE measures the yield on capital contributed by shareholders. While the current ROA seems substantial at over 5,000%, it is noteworthy that this metric is skewed by the company's substantial debt levels. Thus, considering Return on Invested Capital [ROIC] could offer a more meaningful perspective on returns, the 12-month period ending on June, 2022, the ROIC was reported at -31.6%.

Net Debt Below Target

Qantas' financial recuperation might span several years as it navigates the aftermath of pandemic disruptions. As of December 2022, the net debt stood lower than both the pre-Covid level of A$4.7 billion and the lower limit of its A$3.7 billion target range. Forecasts indicate a further reduction to A$2.7 billion by the third quarter of 2023.

As of the same date, shareholder equity stood at a modest A$11 million after absorbing A$7 billion in pandemic-related losses over a span of three years. Contrastingly, the airline's equity buffer was more robust at A$3.9 billion four years ago.

Record Profits and Share Repurchases

Rebuilding Qantas' book-equity is expected to take longer unless the company issues new shares. Dividends were consistently distributed before the pandemic, but the dividend payment for year 2020 was cancelled due to the pandemic. In contrast to Singapore Airlines and Cathay Pacific, Qantas did not receive any government help (Singapore Airlines received $10 billion, and Cathay Pacific received $5 billion).

In terms of net profit, Qantas is on track to achieve an exceptional record profit of potentially $1.7 billion this year (GAAP adjusted), riding the wave of escalating travel demand. The impressive profit margins owe their strength to robust demand for both domestic and international flights, elevated ticket prices, and a range of prudent cost-saving measures. Taking into account the projected net profits and dividends consensus for the upcoming three years, Qantas is estimated to have reconstructed its book equity to approximately A$1.7 billion by the end of 2025.

Liquidity Analysis

The current ratio functions as a measure of liquidity, assessing a company's ability to fulfil its short-term financial commitments. The current ratio currently sits at 0.53. However, it's important to note that Qantas still holds a substantial amount of cash and receivables within its asset portfolio. Furthermore, one of the non-current liabilities includes revenue received in advance. In terms of historical context, Qantas has experienced a peak current ratio of 0.82 and a lowest point of 0.41.

Earnings Outlook

Qantas has evidently returned to profitability in the first half (see net debt and income graph above). This resurgence in profitability is anticipated to be driven by notable year-over-year surges in passenger-service revenue, which had reached 38% of pre-pandemic levels during 2022. The buoyant demand for flights is boosting yields even as Qantas expands its capacity. The company has outlined its projection for domestic and international capacity to reach 95% and 65% of pre-pandemic levels, respectively. This upswing in passenger yields might enable Qantas to outpace the escalation of staff and fuel costs in terms of revenue gains.

Qantas aims to elevate its full-time workforce to 84% of the pre-Covid-19 levels by the second half of the year. The profit pressure stemming from the global decline in freight demand might be less pronounced for Qantas due to its comparatively limited exposure to cargo operations. Additionally, the decrease in jet-fuel prices, which were down 13% as of February 21 compared to 2022, coupled with the strengthening of the Australian dollar, could act as mitigating factors against the rise in variable costs like labour, thus supporting overall profitability. All of which has helped the estimated net incomes for 2023 and 2024 be 1.7 billion (see the net debt and net profit graph above)

Long-term drivers

Elevated Capital Expenditure to Continue

Qantas is expected to exceed the projected A$2.7 billion capital expenditure for 2023, extending this trend until 2026 as the airline integrates aircraft from both Project Winton and Project Sunrise. Delays in original equipment manufacturing have influenced the 2024 capital expenditure, surpassing A$3.2 billion. This includes the acquisition of six Airbus A321LRs valued at over A$90 million each, along with five A220-300s and three A321Fs. Notably, this amount excludes the inclusion of eight E190s and seven A320/A319ceos through leasing agreements.

The heightened level of capital expenditure is predicted to persist into 2025-26 due to Qantas' phased introduction of the initial 12 A321XLRs out of the total 20 ordered under Winton, as well as the initial three of the 12 A350-1000s from Sunrise. Qantas foresees a surge in spending, particularly linked to Sunrise, reaching A$1.2 billion by 2026.

Analyst Recommendations

The majority of analysts' recommendations lean toward a buy rating for this stock, with the latest endorsement coming from Goldman Sachs, which holds an optimistic view of the company and perceives its shares to be underestimated. The analysts from Goldman highlight that "the present stock price does not accurately represent the improved earning potential of the group."

Goldman Sachs has expressed strong confidence in the company, assigning it a conviction buy rating along with a price target of $8.50 for its shares, up 35% from its closing price of $6.27. Although this might be a bit too optimistic I do believe a return of 15% is achievable.

Valuations

Qantas Forward Price-to-Earnings Ratios

Qantas is currently being traded at forward price/earnings ratios of 6.55x for 2023 and 6.08x for 2024. This stands in contrast to its 20-year average of 11.1x. The valuation multiples experienced a decline during the period of May-June 2022, attributed to operational challenges linked to resuming travel that affected both the company's reputation and share price. The forward P/E for 2023, which had previously reached a high of 15.5x , decreased during this time. Furthermore, the decrease in the price-to-earnings ratio can be linked to modifications in earnings per share subsequent to a profit warning issued in November. This adjustment has played a role in fostering an upward trend.

While Qantas has historically seen its P/E ratios trade at a discount compared to its faster-growing Asian counterparts, its current forward P/E levels are notably low even when measured against its historical ranges.

The following table presents a comparison of various investment metrics, enabling readers to assess Qantas in relation to its competitors. It's worth noting that data from several Chinese airlines has been omitted due to data limitations. All the data is sourced from the respective companies' annual reports for reference.

Conclusion

Qantas is navigating a complex path to recovery, aiming to maintain its market leadership both domestically and internationally. Despite facing challenges, the airline's strategic efforts are directed toward generating record profits and revitalizing its balance sheet. The ongoing impact of the pandemic on Qantas' financials is evident, with the company working to reduce net debt and restore shareholder equity.

The passenger operations are emerging as a strong growth driver, with Qantas witnessing a substantial rebound in passenger revenue. This recovery is expected to continue, driven by both domestic and international demand, ultimately contributing to the company's financial resurgence. Additionally, the Qantas Loyalty program remains a vital contributor to overall profitability.

Despite the hurdles, Qantas is projecting a promising future, with measures to maintain its position in the market. Its forward price-to-earnings ratios suggest potential undervaluation relative to historical averages, presenting an intriguing investment proposition.

In summary, Qantas' journey towards financial recovery is marked by a cautious yet strategic approach, aiming to bolster profits, strengthen its balance sheet, and maintain its market dominance.

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