Treasure Chest | Mar 15 2013
By Greg Peel
Earlier this week the ACCC announced it would require more time to look over the proposed merger of Virgin Australia ((VAH)) and Tiger Airways, thus postponing the scheduled March 14 decision to sometime “soon”. This is not necessarily a negative for Virgin given a delay suggests the ACCC is not dismissing the idea offhand, and may perhaps simply demand the odd caveat or two.
After a weaker than expected result release last month, Virgin will be sweating on a positive outcome. The airline has been shifting itself up the quality curve of late in an attempt to be more of a competitor with Qantas ((QAN)) and its Jetstar service. Business bookings have been improving, transforming Virgin from merely a budget airline for domestic holidaymakers, but investment in increased aircraft capacity means Virgin needs to see yields catch up to justify the transformation.
Brokers are mostly waiting to see whether yield improvement can be achieved before becoming more positive on the stock. Two brokers in the FNArena database have applied Buy ratings but the remaining five covering the stock are content with Hold.
Ratings thus suggest Qantas is seen as the better risk at present, given the database shows four Buy ratings to three Holds. Yet Virgin’s increased capacity, and the potential for the airline to successfully exploit this capacity, provides a concern for analysts with regard to Qantas. The domestic market is oversupplied with aircraft at present and analysts believe it will be another 12 months before this oversupply can be overcome. Improvement in domestic earnings will be important for Qantas at a time when the Emirates deal is offering upside to international earnings.
Credit Suisse was one broker to retain an Outperform (Buy) rating on Qantas post the company’s earnings result last month, citing an expectation of the reinstatement of dividend payments in the near future as offering support for the stock price. CIMB nevertheless pointed out yesterday that a lack of available franking credits would mean a reinstated dividend for the second half of FY13 could only be partially franked, reducing some of the appeal. CIMB sees Qantas taxing down a different path.
The CIMB analysts estimate Qantas has the capacity to commit at least $100m to further capital management in the short term, with the potential for this to be increased over the next couple of years to perhaps $300m. Capex will wane over that period and a less panicked global economy means volatility of operating conditions is reducing, allowing the potential for improving earnings going forward.
CIMB suggests an extension of the current share buyback may be the best solution for capital management in the interim. While a buyback in lieu of a dividend provides no income payment for shareholders, the consolidation of share count automatically improves market value.
It has long been the belief of FNArena and others that airlines are not particularly attractive to the longer term, passive investor, given the fickle cyclicality of the business, the lumpy capex required, and fluctuations in fuel costs and currency (not to mention the sensitive industrial relations issues). They are nevertheless attractive trading stocks over shorter timeframes given the ups and downs airlines endure, so to speak.
CIMB is maintaining a Buy rating on Qantas given the support provided by capital management potential. The consensus target price for Qantas in the database is $1.86, offering 7% upside.
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