Qantas Cleared To Fly, Say Brokers

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

-Falling oil, cost cutting benefits
-Turnaround on FY14 first half loss
-Margin expansion to continue
-Capacity outlook benign

By Eva Brocklehurst

What a difference a fall in oil prices makes. As brokers ratchet down oil price forecasts a more flattering light is cast on the transport sector, none the least being Australia's major airline, Qantas Airways ((QAN)). That is not all. Qantas has defied the gloom merchants on several fronts, pulling out of a steep slump over a number of years to reveal a substantial return to profit and shaking off concerns regarding the competitive threats that prevailed in broker analyses a year ago.

Qantas has guided to pre-tax profit of $300-350m for the first half. This compares with the $364m Deutsche Bank had forecast for the whole year and has resulted in several brokers making substantial upgrades to estimates. UBS observes updated guidance is a significant turnaround on an underlying loss of $252m in the first half of FY14. The broker considers the stock is much more than just a play on falling oil, based on management achieving on its transformation targets. The company has outperformed expectations on cost cutting, while its restraint on capacity growth has stood it in good stead amid a soft domestic economy. A much lower oil price and expectations that oil will remain under pressure into 2015 add the final fillip.

Citi believes this is an accelerated turnaround for the airline and the increased pace of change should continue. Lower capacity additions in both domestic and international markets, coupled with lower Australian dollar fuel expense, reflect a positive operating environment and highlight the airline's significant operating leverage to higher yields, with increased revenue benefits also coming from passenger growth in key markets. Deutsche Bank calculates the reduced oil price will provide around $30m in benefit in the first half and provide upside leverage that should continue well into FY16. Nevertheless, while fuel reductions are important, the broker notes these really only kick in in the second half of FY15 while the company's transformation plan is on track to deliver a FY15 benefit of $650m.

What about those fuel surcharges that were brought into the equation some years ago? Qantas has said it generates around $1bn in fuel surcharges from international operations and has not yet recovered the previous fuel price increases. Still, Deutsche Bank has started moderating yield expectations over the next 18 months to include some reduction in these surcharges. Offsetting this is an increase in the forecast load factor.

Morgan Stanley acknowledges it was wrong just six months ago with a bearish outlook for Qantas. Instead, the airline is lauded for its capacity discipline, yield recovery, a weakened competitor and cost cutting. Morgan Stanley envisages few hurdles in the near term and upgrades to Overweight from Equal-weight. The broker does not believe the airline's margin expansion is done with yet and another $12.6bn in cost reductions is expected over the next 24 months. Material fuel benefits and a cash-flow starved competitor do the rest. Morgan Stanley's earnings estimates are upgraded by 20% over the forecast period.

Morgans suspects lower oil prices should be around for some time while the capacity outlook should stay benign. Despite the re-rating in the share price over the past 12 months the broker considers there to be plenty of upside still to come, retaining an Add rating and raising its target to $3.50 from $2.37.

Goldman Sachs offers some cautionary words. While the operating environment is currently favourable, a deterioration in demand has potential to erode some of the benefits from cost cutting and lower oil prices. The broker's sensitivity analysis suggests a 1% change in group yield has a 25% impact on FY15 pre-tax profit. Goldman Sachs retains a Neutral rating and raises its target to $2.74 from $1.54.

On FNArena's database there are six Buy ratings with a consensus target of $3.02, suggesting 20.6% upside to the last share price. This target compares with $2.33 ahead of the announcement.
 

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