Strengthening Tailwinds For Qantas

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

-More upside probable from lower oil prices
-Capital management as soon as first half result?
-International capacity growth considered rational
 

By Eva Brocklehurst

Strong tailwinds from weak oil prices and positive trends in foreign exchange means Qantas ((QAN)) has guided to robust pre-tax profit of $875-925m in the first half.

This is a little below many broker forecasts, the reason likely being the interruptions from the Bali volcano, but the complaints are only half hearted, given the company is continuing to turn around.

UBS suspects yield growth is soft but further evidence of the sustainability of earnings and capital management initiatives should drive ongoing stock performance. In this aspect, the broker estimates that around 60% of divisional earnings are underpinned by the more stable domestic and frequent flyer business.

The case for capital management remains strong, brokers contend. Citi assumes 60c per share of capital management in FY16. UBS continues to forecast a further $1.5bn will be paid out over the remainder of FY16 and FY17, with $500m likely at the first half result in February.

JP Morgan updates its models to account for the guidance and oil price revisions, which are expected to reflect a “lower for longer” scenario. The net effect is a 2.4% reduction in net profit forecasts. The broker takes account of the slightly lower revenue because of the interruption from the Bali volcano, and slightly higher costs given workforce reduction targets.

Volcanic activity in Bali has resulted in several brokers paring their estimates for FY16. Around $42m in one-off items were included in the guidance. Given the nature of the airline industry, Morgans warns against stripping out such external events as they have a habit of recurring.

Typical seasonality implies an FY16 pre-tax profit of around $1.6bn on the back of first half guidance and the broker expects, given a falling oil price, this is achievable. Morgans now factors in a US$60/bbl crude oil price in FY17 and believes there is more upside to come for Qantas as the market revises FY17-18 expectations on lower oil price assumptions.

Qantas continues to re-shape its cost base and make improvements to utilisation and, from an investor perspective, Macquarie highlights the importance of this, as it provides critical cash flow. The business model is now more sustainable and increased returns should result through the cycle, the broker maintains.

Traffic trends are positive, with Qantas November capacity growth of 4.2% and revenue per kilometre growth of 5.5%. Domestic capacity growth is subdued but international is growing strongly, up 9.0% in November, Macquarie observes. From a Qantas perspective the broker considers the market rational, given the capacity growth is principally being driven by utilisation.

Macquarie remains buoyed by Qantas commentary regarding improving revenue per average seat kilometres (RASK). Load factors are also supportive, improving 1.1 percentage points in the first half and particularly strong across the Jetstar and international business.

The broker also notes that, since the market update on October 21, the Singapore jet fuel price has fallen a further 16%. The broker's research suggests this will remain at subdued levels throughout FY16 and into FY17.

Morgan Stanley is increasingly confident in both its earnings forecasts and in capital management expectations. This is underpinned by the new guidance as well as scope for further oil-driven upgrades.

Composition and quality of earnings remain to be dissected but, on the quantum of earnings forecasts alone, this should be enough to underwrite capital management initiatives. The broker suspects a buy-back of $700m could be announced at the first half results

Morgan Stanley suspects the market is still discounting the sustainability of the airline's revival and expects revenue will return to being the main driver of FY16 earnings, above the less definable factors such as oil prices and cost reductions. The total underlying yield of the airline is 15% which the broker compares to US carriers at 0-11%.

Qantas has seven Buy ratings on FNArena's database. The consensus target is $4.82, suggesting 26.4% upside to the last share price. Targets range from $4.30 (UBS) to $5.40 (Morgan Stanley). The dividend yield on FY16 and FY17 forecasts is 5.8% and 3.7% respectively.

In late mail, Credit Suisse has now "initiated" coverage of Qantas, although the broker had previously covered the stock up to 2013. The broker estimates that a combination of lower fuel prices and management's cost efficiency drive and capacity restraint could lead to the generation of free cash flow equivalent to 40% of the company's market cap over the next two years. Credit Suisse further believes consensus forecasts are too low on the basis that Qantas will not likely pass all the benefits of fuel cost reductions onto customers.

The broker's profit forecasts thus sit some 30% above the market. An outperform rating has been set, providing Qantas with the highest possible eight-from-eight Buy equivalent ratings from FNArena database brokers. Credit Suisse's target of $5.50 is the new high marker, lifting the consensus target to $4.91 (29% upside).
 

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