Prospects Mount For Special Dividend From Air NZ

This story features AIR NEW ZEALAND LIMITED. For more info SHARE ANALYSIS: AIZ

-Trans Tasman JV likely unaffected
-Probable sale of remainder in time
-Timing of any capital return uncertain
 

By Eva Brocklehurst

Brokers have responded positively to Air New Zealand's ((AIZ)) intention to sell down its stake in Virgin Australia ((VAH)) and retain a marginal holding.

The airline will sell 810m shares to a Chinese conglomerate, Nanshan Group, to realise around $268m, conditional on Chinese regulatory approvals. The sale price indicates 33c per share and an 18% premium to the last closing price of Virgin Australia stock. Air NZ will retain a residual holding of around 2.5%.

Deutsche Bank welcomes the deal, having expected a sell-down was a likely alternative to a complete exit. The residual could eventually be sold, possibly even on market given the small size. The sale is understood to occur after Virgin Australia's $159m equity placement to HNA Aviation, which is also pending Chinese approval.

Macquarie notes Air NZ will consider its options for the remaining holding and HNA, having recently acquired a 13% stake in Virgin Australia, has expressed an intention to go to 19.99% over time.

Divestment should reduce Air NZ's gearing levels, which at 53.8% in the first half was near the top of its 45-55% target range. Deutsche Bank expects gearing should fall to the lower half of the range. The company still has $2.3bn in new aircraft capital expenditure to be undertaken until FY19 and a deteriorating operating landscape, so the broker suspects a cautious approach will be taken to capital management, despite the capacity for a special dividend.

From an accounting perspective, the broker expects material mark-to-market losses on disposal of the stake, given an estimate of the first half carrying value of NZ$400m. The main near-term risk to Air NZ's stake was a discounted equity raising, with either Air NZ contributing further capital or being diluted.

Hence, Deutsche Bank considers this sale at a premium to the market price is a good outcome. The outcome suggests a takeover bid for Virgin Australia may now not be forthcoming given several potential blocking stakes.

Nanshan has its own emerging airline, Qingdao, and will have a holding in Virgin Australia as a result of the deal at just under 20%. It follows Virgin Australia's new strategic alliance with HNA Aviation, and both parties have stated an intention to support the outcome of the upcoming capital structure review. UBS believes the joint venture between Air NZ and Virgin Australia on the trans Tasman route will be unaffected by the likely change to Virgin Australia's share base.

The broker expects net proceeds of the sale are likely to be returned to shareholders via a special dividend but the timing is difficult to ascertain, although this could occur before the end of August. Net proceeds are expected to be around NZ25c a share. The broker also expects its shareholder loan to Virgin Australia, around $131m, to be re-paid.

UBS calculates fair value for the Air NZ stock at around NZ$2.60 a share, excluding any potential capital return. A Neutral rating is retained to reflect the valuation support, offset by heightened short-term earnings uncertainty that is created by greater competition on the long haul, and rising fuel costs.

The main consideration for the use of the capital is balance sheet strength, Macquarie contends. A modern fleet and the resultant lower capex requirements – the company expects maintenance capex around NZ$250m by FY19 versus the NZ$1bn in expenditure occurring at present – should underpin cash flow. This can be used to lower debt and provide some flexibility to counter changes in the operating environment, the broker surmises.

Air NZ has the ability to pay a special dividend while Macquarie also estimates a buy-back for the full proceeds would be around 10% accretive to FY17 earnings estimates. The stock's de-rating now makes the company more attractive on a valuation basis but the broker expects the market to be driven by sentiment, and operating statistics will be scrutinised to obtain an indication of yields for FY17.

The potential for a capital return is likely to be weighed against both the balance sheet capacity and the banked capex in later years, as well as the macro headwinds from rising fuel costs. Based on FY16-20 forecasts and FY11-15 actuals, Macquarie estimates an average return on invested capital at around 15%, in line with the airline's long-term aspirations.

Air New Zealand has three Hold ratings on FNArena's database.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms