From here, we will most likely see QAN consolidate in a range between $1.81 and $2.30. -- Moon

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Date Posted: 05:44:08 04/16/10 Fri
Author: Share Suggestion for Thursday 9 July==Hold 2009
Subject: From here, we will most likely see QAN consolidate in a range between $1.81 and $2.30.

QANTAS AIRWAYS LIMITED (QAN)
Last Price Change +/- Risk Level
HOLD Minor turbulence $ 2.98 +$0.020 CORE

Event
Retreating oil prices easing cost pressure

Key Points
Aussie dollar higher and fuel prices safely down

Slashing jobs and seats in order to bolster balance sheet

FY09 underlying profit downgraded to $100-$200 million

Fundamental Analysis
Qantas Airways Limited (QAN) is one of the world’s leading airlines and an Australian icon.

On top of its standard domestic and international flights, QAN also owns budget airline Jetstar, regional airline QantasLink and related travel businesses Qantas Flight Catering.

QAN has had a difficult time recently, as a slowing global economy has impacted on passenger numbers and high fuel prices mid-2008 and a sluggish Aussie dollar belted the airline.

However, since then QAN has gone into damage-control, cutting back on staff and seat capacity in order to save cash. Also promising is a stronger Aussie dollar and falling oil prices.

Despite an improving horizon, QAN still forecasts underlying FY09 profit of $100-$200 million, down from its previous forecast of $500 million, and compared to FY08’s result of underlying profit of $1.41 billion.

Oil issues fading

When oil prices hit all-time highs in mid-2008, QAN was one of the most at-risk local companies.

With the record oil price being the second major catalyst for global sharemarkets falling behind the financial crisis, the oil crash saw transport companies amongst the worst hit.

The higher oil prices lead to a major increase in airlines’ jet fuel bills, and took a massive chunk out of the industry’s profits. The result was that QAN saw its shares down over 60% in 2008 alone.

Lower oil prices in 2009 have brought some relief to QAN on this score. QAN has now hedged 67% of its expected fuel requirement in 2009/10 at a worst-case crude oil price of US$92 per barrel.

QAN has 78% participation in falling oil prices for the rest of the year and has hedged 8% of its expected fuel requirement in 2010/11 at a worse-case scenario of US$70 per barrel.

With crude oil futures plunging 4.4% to $60.14 a barrel last night, and inventory levels on the climb, high oil prices are increasingly looking only like a temporary nightmare.

Moreover, a strengthening Aussie dollar – which has hovered around 80 US cents of late – will mean that QAN will now really benefit from the fall in oil prices.

Addressing problems

The hype over QAN’s Boeing 787 aircraft has been ongoing for a while now, though on 26 June QAN confirmed it had cancelled delivery of some of the aircraft and deferred orders for 15 others until 2018-19.

The aircraft cutback announcement – which will save the airline $1 billion - was far from a surprise to the market, owing to a tough climate for QAN, which has been suffering from a sharp drop in passenger traffic.

Fortunately for QAN, reducing seat capacity has improved its revenue seat factor, which rose by 1.5 points to 80.4% in April from a year before.

QAN cut back on capacity for June and July by 30%, with the airline hoping to return to its usual schedule in August.

The latest move to cut back on the Boeing 787 aircraft base will save QAN US$3 billion in capital expenditure, a move which has been applauded by the market.

Another smaller issue QAN has had to address is that of swine flu, which has affected business particularly for its discount carrier Jetstar and its operations in Japan.

Jetstar has made significant changes to its Japanese schedule to cope with the drop in the Japanese market, though with swine flu concerns starting to fade and vaccines becoming available, this problem should only be a short-term one for QAN.

WOW, good idea

On 1 June, QAN announced it was starting up a loyalty partnership program with Woolworths, starting 22 June.

QAN customers can now earn one frequent flyer point for every Aussie dollar spent above $30 in a single transaction at Woolworths supermarket and liquor operations.

The scheme will eventually pertain to WOW’s other brands including its Big W discount department store chain and its liquor, petrol and retail outlets.

The deal followed QAN’s December announcement that it was signing up with WOW in the first place via an Everyday Rewards program offering QAN Frequent Flyer points when WOW customers shop for fuel, liquor, general merchandise or consumer electronics.

Competition concerns

QAN was talking about a potential US$6 billion merger with British Airways late last year, which had the market excited, though the deal fell through when both parties failed to agree on key terms.

Even if the deal hadn’t fallen through, a merger to bolster QAN’s balance sheet may prove tough - single foreign investors can’t own more than 25% of QAN, and another airline can’t own more than 35% of the flying kangaroo – unless laws change.

Since then, competition concerns have emerged for QAN, in the form of other budget airlines upping their stock via JVs and growth plans.

Tiger Airways will now become part of the Sydney-Melbourne route, which will cut back slightly on QAN’s group earnings but hopefully by no significant amount.

Fortunately, QAN’s own domestic airline, Jetstar, remains cheaper than Tiger in terms of internet-priced Sydney-Melbourne tickets.

Meanwhile, today Virgin Blue Holdings (VBA) and Delta Air Lines announced plans to form a JV that will expand each carrier's reach between the US and Australia and across the South Pacific.

VBA buoyed on the news, which will strengthen its competitive position.

Half-hearted half

In February, QAN announced it first half results, which included a 66% dive in earnings to $210 million from $617.6 million a year earlier, marginally beating profit forecasts of around $203.7 million.

Wild oil prices and a weak Aussie dollar were the major external factors behind the fall, with high-end passenger numbers also falling away as the economic crisis spread across the globe.

Group revenue rose 1.7% to $7.92 billion though passenger revenue from its flying businesses fell 0.7% to $6.4 billion.

Revenue seat factor for the half fell 2.4% to 79.7% whilst the airline carried 19.6 million passengers, around 144,000 less than a year ago.

Pre-tax profit from Jetstar fell 48% to $72 million, whilst QAN announced an interim dividend of six cents per share.

Outlook

In April, QAN downgraded its underlying FY09 profit forecast to $100-$200 million from its previous forecast of $500 million and compared to FY08’s result of underlying profit of $1.41 billion.

On the same day of the announcement, QAN confirmed it was slashing 500 management positions and another 1,250 jobs as a last resort against the deteriorating global economy.

Since then, QAN’s outlook has started to improve. The Aussie dollar has strengthened against the US dollar, oil price has fallen and the company’s management reshuffling and seat capacity reductions have put it in a stronger financial position.

QAN currently has strong liquidity with $3.2 billion in cash, with no significant debt re-financing requirements until February 2011.

Despite improving conditions, the fact remains that QAN’s FY09 underlying profit outlook of $100-$200 million is significantly down on the FY08 result, and is still subject to further changes in market conditions and fuel prices, which remain volatile.

Therefore we currently rate QAN a Hold, as it is looking stronger on improving conditions but isn’t out of the woods yet.

Key Data - Ratios (Guide)
Sector Transportation
Weight in Sector 19.60% Market Cap $ $6.8 b
Year Hi/Low $3.06 - $1.74 Next Report August
Dividend Months Sep 10 Apr 11 Apr 11 Ex-Dividend Date N/A
1 Yr Return + 2.53% 1 Yr Return vs Market + 2.17%
Net Tangible Assets (NTA) $3.18 Price/NTA 0.94
Return on Assets (ROA) 14% Return on Equity (ROE) 17%

Forecast Numbers Current 1 Yr(exp) 2 yrs(exp)
Net Profit After Tax (NPAT) $969.0 m $326.0 m $516.5 m
NPAT Margin 6% 2% 3%
Earnings Per Share (EPS) $0.50 $0.17 $0.28
Price/Earnings Per Share (P/E) 6.0 17.5 10.6
Operating Cashflow $2.7 b $2.5 b $2.1 b
Operating Cashflow Per Share $ 1.19 $ 1.11 $ 0.93
Price/Operating Cashflow Per Share 2.5 2.7 3.2
Earnings Yield 16.78% 5.70% 9.40%
Dividend Yield 11.74% 3.36% 6.38%
Franking Credit Level 0% 100% 100%

Technical Analysis

We can see QAN has been in a relatively sharp downtrend, but has been showing signs of strength over the last few months.

There is support at the $1.81 level that should hold firm, as the volume on down days has mostly been weak.

There are enough signs to rate QAN, but we wouldn’t be buying just yet.

The stock would need to move higher, breaking through resistance around $2.30, which would also put QAN above its 50-week moving average.

Strength should then be maintained, as QAN has suffered enough of a downtrend and looks oversold.

From here, we will most likely see QAN consolidate in a range between $1.81 and $2.30.

Although a break of the range in either direction is possible, QAN’s recent strength suggests an upside move is more likely.

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