A More Favourable Risk-Reward Balance For Qantas

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

By Chris Shaw

First it was higher oil prices and then lower demand as the past 12 months or so have marked a tough time for Qantas ((QAN)), particularly as these themes have played out at a time when competition in the airline’s marketplace has been intensifying.

Macquarie takes the view much of this is now priced into the stock and so the broker has upgraded to a Neutral rating from Underperform previously, arguing the group’s outlook is actually showing some signs of improvement and the earnings impact of lower yields is now being appropriately recognised.

The broker takes the view the recent improvement in measures such as business sentiment and some consumer numbers is likely to create a gradual lift in demand for Qantas’s services. This will flow through to improved earnings but only slowly in the broker’s opinion given excess capacity remains on a number of the Flying Kangaroos’ international routes.

The airline also recently announced the deferral of some aircraft orders and this plus an enhanced frequent flyer program has strengthened the group’s balance sheet on the broker’s analysis, while with free cash flow likely to return to positive levels in FY10 there is an increased chance of a dividend being paid, something the broker currently hasn’t penciled in.

There is also scope for Qantas to lock in a greater portion of its FY10 oil requirements at lower prices given the oil price looks to be weakening. The broker sees this as another potential positive for earnings. To reflect these factors Macquarie has lifted its earnings per share (EPS) forecast for FY09 by 8.8% to 3.7c, with an increase to 4.7c forecast in FY10 and to 13.2c in FY11.

By way of comparison, the FNArena database shows consensus EPS forecasts of 6.8c this year and 13.6c in FY10, which suggests Macquarie may still be too conservative with its numbers. Bank of America Merrill Lynch is one of those more bullish as its EPS forecasts are currently 5.1c this year, 20.2c in FY10 and 23.4c in FY11.

The broker suggests the entry of Tiger Airlines into the Sydney-Melbourne market will actually have a minimal impact on earnings of about 2% as Tiger is chasing price sensitive passengers and not the schedule sensitive passengers on which Qantas makes higher yields.

As well the broker points out Qantas’ budget airliner Jetstar is offering more flights at lower prices than Tiger anyway and even allowing for this Qantas group is still generating a solid yield advantage over the likes of Tiger. BA-ML sees nothing in the move to cause significant concern for Qantas.

Based on its earnings forecasts the broker has a $2.15 price target on Qantas, while the average target according to the FNArena database is $2.23. Given the stock is trading around 30c below that level there is enough value to justify a Buy rating on BA-Merrill Lynch’s view, while the database shows a total of five Buys, four Holds and one Sell.

The latter comes from RBS Australia, which argues tickets pricing remains weak and is likely to remain so for some time, which would keep earnings under pressure. As well, recent updates to the broker’s oil price and Australian dollar forecasts meant minor downward revisions to earnings forecasts, supporting its negative view.

Shares in Qantas today are slightly higher and as at 12.00pm the stock was up 3.5c at $1.885. This compares to a trading range over the past year of $1.38 to $3.75.

Click to view our Glossary of Financial Terms