DAL - Qantas Airways: Disappointing ROIC Why The Airline Industry Is So Challenging

Summary

• Despite the global shock caused by the pandemic, Qantas' returns have been choppy but good.
• Over the past decade, the total return on shares is ~283%, trouncing the S&P at "just" 143%.
• Looking at Qantas' margins versus American peers: Southwest, Alaska Airlines, and Delta, we can see Qantas narrowly edges a victory with an EBITDA margin of 10.69%.

Introduction

Qantas Airways ( QABSY ) is the largest airline in Australia and one of the oldest airlines in the world, having been founded in 1920. And, by the way, just so you know. Surviving that long in the airline industry is a major feat given the numerous high-profile failures... looking at you Pan Am !

Interestingly, Qantas operates a fleet consisting of both Boeing ( BA ) and Airbus ( EADSY ) aircraft, including both domestic and international passenger and air cargo flights moving millions of passengers and goods each year.

But despite the global shock caused by the pandemic, Qantas' returns have been good.

In fact, over the past decade, the total return on shares is ~283%, trouncing the S&P's return of "just" 143%.

As we launch into 2023, hopefully putting COVID-19 behind us once and for all, I figure now is a good time to look at Qantas' business, see how they have recovered post the COVID-19 shutdown and look at where things may go from here.

Industry Overview

Let's start with an overview of the industry...

The airline industry is a highly competitive market, characterized by the constant introduction of new aircraft technologies and the need to meet constantly changing customer demands. Low-cost innovators, such as Southwest ( LUV ) and Ryanair ( RYAAY ) have forced legacy players to adapt and change, often hurting margins, more on this point later.

The industry is also subject to fluctuations in fuel prices, economic conditions, and government regulations all of which can hamper their businesses. As we all know, the COVID-19 pandemic significantly impacted the industry, leading to a sharp decline in demand for air travel and putting further pressure on many airlines to cut costs and restructure their operations.

The rise of low-cost carriers as well as COVID served as a one-two punch to legacy airline operators such as Qantas.

Barriers to Entry

While competition is fierce in the industry, there are also a few barriers to entry, most notably the large cost of buying and maintaining aircraft which can cost hundreds of millions of dollars per plane.

Further restricting competition, airports and air traffic control systems are heavily regulated and are subject to capacity constraints. These constraints can limit the growth of airlines and make it challenging for them to expand their operations. Air travel infrastructure is essential to the airline industry, and limitations in infrastructure can make it challenging for airlines to meet growing demand.

The combination of high capital costs and infrastructure constraints makes the airline industry a challenging place for new entrants to compete and establish a profitable business.

History of Expansion and Growth

Qantas has a long history of growth and expansion, domestically and internationally. Over the years, the company has expanded its fleet and increased its route network, becoming one of the largest and most successful airlines in the world. In recent years, Qantas has continued to grow and expand its operations, including the expansion of its low-cost subsidiary Jetstar and the growth of its international operations through its partnership with Emirates.

To support that growth, Qantas announced they will order dozens of planes from Airbus to expand its long-haul services. The airline's Project Sunrise plans to start nonstop flights from Sydney to London and New York in late 2025.

The flights aim to build on the success of existing direct long-haul services, which have increased in demand since the Covid-19 pandemic. The order for Airbus aircraft includes 12 A350-1000s configured for "ultra-long" haul. The airline didn't disclose the cost of the Airbus order but stated that a significant discount should be assumed. The order should be seen as a clear vote of confidence in the future of Qantas, according to the CEO, Alan Joyce.

Financials

Now that we have a grip on Qantas and the airline industry, let's take a look at their financials to see how they match up against their peers and to see if any trends have emerged over time.

Margins

Looking first at Qantas' margins versus American peers: Southwest, Alaska Airlines ( ALK ), American ( AAL ), and Delta ( DAL ), we can see Qantas narrowly edges a victory with an EBITDA margin of 10.69%.

As you can see in the chart above, margins are still below where they were pre-covid, it's my view that this is, at least in part, driven by the lack of business travelers. Business travelers usually fly in higher classes, such as first or business class, which come at higher ticket prices compared to the standard class. Furthermore, business travelers often book last-minute or flexible tickets, which also command higher prices.

Since business travelers may be gone for good, at least according to some analysts, investors may want to consider that these lower margins could be here to stay for the time being.

EPS History

While a 10% EBITDA margin is not great in the world of business, it's also not horrible. I cannot say the same about the EPS performance of these companies. Decades go by with marginal growth in earnings per share and cyclical crashes in demand quickly, and harshly, affect EPS.

Return on Invested Capital

The story only gets darker from here, Qantas' return on invested capital is just depressing to me. Looking at their average returns on capital over the past decade, we can see they are typically only able to generate low single-digit returns. This raises the question: When you can get a 4.5% return from the 2-year treasury, I am not sure why I would ever allow any of these companies to invest my capital for me.

To Wrap It Up

In conclusion, the future of Qantas and the airline industry as a whole remains uncertain. Despite its long history of growth and expansion, Qantas' margins are lower than they were pre-COVID, and they may not recover anytime soon given the loss of business travelers. This is a major concern, as business travelers usually fly in higher classes, and book last-minute or flexible tickets, all of which come at higher prices compared to standard-class tickets.

Furthermore, Qantas' financials paint a bleak picture with low earnings per share growth and a return on invested capital that leaves much to be desired. The airline industry is a challenging and competitive market, characterized by the constant introduction of new aircraft technologies, changes in fuel prices, economic conditions, and regulations, making it difficult for airlines to generate significant returns for investors.

Because of all those factors I rate Qantas stock a Sell, I view the recent run-up in shares as a good opportunity to trim.

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