Clear Sky To Qantas Dividends

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

-Significant momentum
-10% return target on capital
-Benign domestic market
-International more competitive
 

By Eva Brocklehurst

Qantas ((QAN)) is making progress. Brokers hail a disciplined approach to spending and efforts to generate returns ahead of the cost of capital. The company is on track to deliver over $875m in transformation benefits in FY15 and its latest investor briefing exuded confidence.

Qantas has guided to a $3.9bn FY15 fuel bill, with FY16 capped at a similar level and 74% participation in lower fuel prices. UBS expects debt to be reduced by $1.4bn in FY15, ahead of forecasts, and this rapid de-gearing should make way for capital management to be announced later this year. The broker expects this to be initially in the form of a buy-back, given a lack of franking.

As the stock has outperformed the ASX200 by 183% over the past 12 months, JP Morgan suspects the positive outlook is well understood. That said, the stock is still cheap relative to other airlines and the broader industrials, while the broker envisages further scope for upgrades to forecasts over the next 12 months. Hence there is upside for the share price and JP Morgan upgrades to Overweight from Neutral.

The data suggests there is significant momentum in the business, with rational capacity growth and strong sales demand, which contributes to a 115 basis point improvement in domestic load factors, in JP Morgan's calculations. The broker believes the capacity war domestically may be coming to an end and a more rational duopoly will emerge. UBS continues to expect the recovery in domestic market revenue will be the biggest contributor to group returns.

Qantas is targeting a return on invested capital greater than 10% through the cycle. All business units, except the Jetstar joint ventures, are expected to exceed this hurdle in FY15. Most of the current initiatives are seen as removing some volatility from the earnings cycle. On JP Morgan's estimates the airline fulfills the credit requirements for an investment grade rating by the end of FY15, which might open the door to capital management, probably a buy-back.

Deutsche Bank notes Qantas is rapidly moving to use data to market to customers. This not only helps operational efficiencies but, as the analyst notes from a personal experience, enables the airline to target and cross reference a great deal of information from loyalty cards about spending behaviour. While Qantas expects to maintain positive free cash flow the broker cautions that it will need to retain funds for increased expenditure on new international aircraft from FY17, particularly in order to develop more point-to-point services into Asia. Hence, any resumption of dividend payments is expected to be small.

There is scope for $350m in capital management, in Morgan Stanley's view, even at the FY15 result, with the quantum increasing sharply thereafter as debt is paid down. This could accelerate a multiple re-rating in the broker's opinion. Morgan Stanley considers the stock is cheap and retains an Overweight rating.

Fuel pricing and a lower Australian dollar are providing a tailwind but company has learnt from the crisis in 2013, in Citi's view. Customer engagement has improved and management is also expecting a salary freeze to benefit by an additional $125m in FY17. Qantas' international operations are in a stronger position now with a lower cost base and, with international carriers expected to increases capacity by only 1.0% in FY15, Citi suspects the lower Australian dollar will have lowered their revenue on Australian routes by around $1.5bn.

The main outcome from the briefing, from Macquarie's perspective, and aside from the performance benchmarks, was the continuing benefit of a benign competitive environment domestically and a more competitive international offering from Qantas, with a significant opportunity to leverage the brand and loyalty program across the group. While the possibility of capital management becomes more likely, this will be delivered in conjunction with capital discipline, Macquarie suggests. Critical to this premise is the 10% return on invested capital target along with cost cutting and debt reduction targets. On that basis the broker envisages clear sky to dividends from FY16.

Qantas has a suite of seven Buy ratings on the FNArena database. The consensus target is $4.28, suggesting 20.8% upside to the last share price, which compares with $3.94 ahead of the update. Targets range from $3.65 to $5.40.
 

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