Qantas is back in the black. The re-opening of Australia’s borders and the resumption of air travel has been a bumpy ride, for customers and company alike. QAN has deliberately held back on its capacity recovery in the face of multiple challenges, copping plenty of criticism in the process, but shareholders are at last seeing earnings heading in the right direction. Consensus forecasts are scrambling to keep up.
Profit guidance lifted. QAN is guiding to a 1H23f profit before tax of $1.2-1.3 billion. Business and leisure revenues are both ahead of pre-COVID levels. Other than fuel costs being 75% above pre-COVID levels there was no overall cost guidance provided. Otherwise, we can assume the improvement is a combination of much higher airfares, packed planes, offset by higher fuel and labour costs among other factors. We know that fuel costs are materially higher, but it seems revenue has outstripped that growth to produce a startling profit guidance range that is well ahead of consensus forecasts.
As a reminder, QAN reported pre-tax losses totalling $3.5 billion in the last three financial years spanning the pandemic.
Capacity buffer. Managing the reintroduction of idled capacity (labour and aircraft) has proved to be very tricky. There has been a lot of sick leave taken by staff (possibly COVID-related) that has played havoc with operational efficiency. The management of rosters and schedules across every aspect of operations (ground crew, call centres, cabin and flight crew, baggage handling, engineering etc) has not been perfect and has resulted in poor customer service generally. Additional factors such as bad weather and a delay in replacement parts have exacerbated the operational underperformance.
QAN is addressing this by introducing a much larger buffer in its operational capacity. This includes 20 aircraft to be on standby, together with the rostering of additional crew to be called on to reduce delays and cancellations. QAN will spend $200 million over the remainder of FY23f to achieve this buffer.
Curiously, despite the apparent surge in demand for travel, QAN has lobbed an additional 1 million ‘sale’ fares to 67 domestic destinations. This will undoubtedly tempt Christmas travellers to get over the fear of disruptions. To cater for this potential lift in travel demand, QAN is now expecting to increase its 1H23 domestic capacity to 95% of pre-COVID levels, heading towards 97% for FY23f. QAN had previously targeted FY23f capacity at 106% of pre-COVID levels.
International capacity targets have been trimmed from 65/84/75% in 1H/2H/FY23f to 61/77/69% (Figure 2). This does not mean that fewer people are travelling internationally (no data provided) but those that do are paying handsomely for the privilege. Anecdotes of exorbitant fares (across all airlines) abound.
Fuel. At the FY22 result, QAN said it expected its FY23 fuel bill (Figure 3) to be around $5 billion (net of hedging benefits) based on fuel consumption at 80% of FY19 levels, a Brent oil price of US$97/bbl and the AUD:USD at 0.6887. At $5 billion, that would represent the highest ever fuel bill for the company and could be much higher if international capacity increases more quickly than currently planned. While all three of these factors will move around throughout the year, the consumption factor is the one within the company’s control.
Balance sheet. Remarkably, QAN will likely report net debt around $3.2-3.4 billion at December 2022, comfortably below its target of $3.9 billion. The $400 million buyback is currently 26% complete. Fleet renewal is already underway with the arrival of the first of 300 new narrowbody jets to be delivered over the next decade. The international fleet is to be boosted by 12x A350-1000 aircraft with the first of these due by late 2025. These will form the backbone of Project Sunrise enabling non-stop travel to London, New York et al. The existing A380 fleet is not yet fully re-established but it will fill the international gaps in due course.
Loyalty pays. Qantas Loyalty as a division of the company has been the steady Eddy of the Group. It remains on target to achieve FY23f EBIT of $425-450 million.
Investment view
When air travel restarted in earnest, QAN had initially added more capacity than it was operationally capable of handling efficiently. The resulting furore over poor customer service caused a change in strategy. By reducing capacity, it gave the airline a better chance to manage its operations while simultaneously improving its yield. The addition of further capacity will be aligned with the company’s ability to reliably support it operationally, in our view.
Domestic travel is now ostensibly back to pre-COVID levels with 20 new destinations added. QAN is in a very strong position domestically against Virgin Australia and we see a long term market share of 70% as very achievable.
Recovery of international travel is dependant on the re-opening of other country’s borders and the travel conditions facing customers. Travel to Japan is quickly re-opening but China remains problematic. Travel to the UK, Europe and North America is increasing and most Asian and Pacific destinations are busy.
The company is still waiting for ACCC approval to acquire the remaining 80% of Alliance Aviation (AQZ), but this is not straightforward. If it does go ahead, this provides another avenue of growth in chartered domestic flying, particularly in the resources sector.
Globally, airlines are beginning to return to profitability for the same reasons as QAN. Even Air New Zealand is expecting a 1H23 profit before tax of NZ$200-275 million. QAN is emerging with its finances in order and just needs to get itself into shape operationally to fully capitalise on the recovery.
QAN’s cost transformation program has been fundamental to getting the airline back to profitability, as much as the return of fare-paying passengers. Additional staff wages ($40m), bonuses and share rights ($200m) have added to the cost side but this is a small price to pay for operational dependability (ie happy customers).
Following the FY22 result in August, consensus pre-tax profit forecasts for FY23 were $831 million. Forecasts have since been upgraded to $1.1 billion for the full year, prior to the latest trading update. Consensus upgrades have taken it to $1.5 billion for FY23f. The FY25f consensus PE ratio is now 6.6x and this is well below the mid-cycle PE range of 8-10x.
Risk to investment view
A recurrence of COVID-19 restrictions, including international border closures, would affect earnings. Jet fuel prices, labour availability and passenger demand are all crucial factors in determining earnings. Changes in demand for travel would affect earnings. Regulatory oversight, particularly for safety, is a key risk factor.
Recommendation
We have retained our Buy recommendation.
Figure 1: Divisional performance
FIGURE 2: Capacity guidance/strong>
FIGURE 3: Fuel consumption and spend
