Qantas CEO Alan Joyce is not going out with the sort of bang he envisaged after 22 years with the airline and 15 years as CEO. What is indisputable is that QAN is in rude good health despite the customer anger Mr Joyce is leaving behind in his wake. The short term negative reaction to the customer flight credit fiasco, the Qatar shoulder bump and the hubris from the CEO has chopped the share price back into buy territory, in our view. We upgrade our recommendation to Buy on valuation grounds.
Mr Joyce’s tenure has not been without controversy, most notably in 2011 when he effectively shut down the international airline to combat union strikes which were terminated by Fair Work Australia. Contending with Union issues has been the most common feature of his tenure and will certainly be a key item for Vanessa Hudson to grapple with.
Ranking ahead of all issues for Ms Hudson will be repairing the customer damage brought on by the flight credit scandal. A potential $250m ACCC penalty for selling tickets to already cancelled flights is a material negative. Customer satisfaction will take plenty of time to repair such is the reputational damage QAN has self-inflicted through its tone deaf handling of complaints. The question is whether this will have a permanent or extended impact on QAN’s dominant ~65% domestic market share or its strong international share.
Related to this question is the resolution of the Qatar Airways imbroglio that has raised criticism of the Federal Government. The government’s decision to prevent Qatar from increasing frequency into the major Australian gateways of Sydney, Melbourne and Brisbane has failed the pub test. The public knows that more seats means lower prices, so the government needs to reverse its decision regardless of what QAN may say. The post-COVID revenue recovery for QAN has created a huge buffer in terms of balance sheet stability, so it can afford some degree of slippage in air fares due to more competition. We note that international capacity into Australia from foreign airlines is still well below pre-COVID levels, so QAN still has a period of competitive advantage.
The recent FY23 result not only reported a record pre-tax profit of $2,465m but announced a further $500m buyback and greater detail on the fleet replacement program and its associated capex. Consensus earnings forecasts have mostly captured the outlook and while the noise surrounding Mr Joyce’s retirement has been louder than a B717 taking off, we do not envisage material changes to forecasts.
But the share price has been hit hard by the negative publicity. Since Mr Joyce sold $17m worth of shares in June (2.5m shares at $6.75/share), the share price has fallen around 16%. On consensus earnings forecasts, QAN is being valued at 5.1x FY25 EPS which, in our opinion, is inexpensive.
QAN is clearly in a strong position to compete internationally while it retains its domestic hegemony. The potential IPO of Virgin Australia next year may only tell us what we already know – QAN has double the domestic market share to Virgin Australia but earns 4x the profit.
At a group level, QAN’s capacity is 22.5% below June 2019, but its FY23 revenue was 10.3% above. In addition, group RASK (revenue per ASK – a measure of growth) is rising quickly to historically high levels while its CASK (costs per ASK) are falling. This is resulting in higher operating margins which QAN is explicitly targeting – Jetstar domestic 15%, Qantas domestic 18% and Qantas International 10-12% in the long term.
QAN has used the upheaval of COVID to its advantage by taking out $1bn of cost. It expects to reach 100% of pre-COVID international capacity by March 2024 although it has the flexibility to move this target around by diverting domestic capacity onto international routes. The Qantas Loyalty business will easily achieve its goal of $500-600m EBIT by FY24 (CY23 EBIT will be ~$500m).
IATA said the northern hemisphere summer travel season had begun brightly with international traffic climbing 34% compared to June 2022. Double digit demand growth and average load factors around 84% is good news for airlines and travel and tourism, according to IATA Director General, Willie Walsh. Asia-Pacific carriers had a 128% increase in June 2023 traffic yoy. Demand continues to outstrip capacity growth as new aircraft delivery is slow and spare parts for existing aircraft remain hard to obtain.
Investment View
The change in CEO does not change the earnings outlook for QAN which in our view remains positive. The airline certainly has some challenges ahead but is facing these from a position of financial strength. The new CEO may be less abrasive in her approach, but the decisions will still require fortitude.
The new Western Sydney Airport is on track to open in 2026. Qantas and Jetstar are already signed up as the first customers of the 24-hour airport. WSA will change the dynamics of travel in Australia and QAN will want to play a substantial role in that.
The broader domestic and global travel industry is still in a long term growth pattern. The pandemic merely interrupted it.
Risks to Investment View
Global air traffic may be affected by the potential for recession in various regions and the slow return of China to world aviation markets. The Russia/Ukraine conflict is restricting global air traffic routes and may continue to do so. High fuel prices may persist, and this could affect profitability of airlines.
Recommendation
We have upgraded our recommendation to Buy.
