Back on schedule: Why this company's earnings runway proves it's best in class
It was the question heard most often during the depths of lockdown... "Where do you want to go when the borders reopen?" Whether it be family reunions in China or that long-awaited holiday with the kids to Disneyland, our pent-up demand for travel is palpable.
But while we were all busy daydreaming of holidays during lockdowns, the panic was breaking out at the world's airlines - including the national carrier Qantas (ASX: QAN). From closed borders and stranded planes in a Californian desert to mass layoffs of its staff, there was a lot going on at the Alan Joyce-led company.
Speaking of staff, Joyce revealed today that the company has let go of more than 10,000 people since the start of the pandemic. The redundancies added more than $1 billion in costs, and now it's even more as the "flying kangaroo" tries to restaff those same planes.
And yet, despite these increased costs, the airline is buying back $400 million worth of shares. That's a move being described by Atlas Funds Management's Hugh Dive as potentially problematic.
"The market is distracted by the buy-back and rosy outlook statement (which costs nothing)," Dive said.
"I have never seen a company record a significant loss of $1.86 billion, face an uncertain outlook, significantly higher costs (fuel) in the coming year, and then announce a buyback," Dive added.
But Kyle Macintyre of Firetrail Investments doesn't agree. Macintyre has held the company on behalf of clients for nearly a decade, and told me the thesis for this stock is still "intact". In this wire, we'll discuss the how's and why's of Qantas' results.
Note: This interview took place on Thursday, 25th August 2022. This stock is a top holding across Firetrail's portfolios, including the Firetrail Australian High Conviction Fund.
Qantas (ASX: QAN) FY22 KEY RESULTS
- Revenues up 54% to $9.11 billion
- Net loss improves by 49% to $860 million
- EBITDA down 31.5% to $281 million
- Cash at bank of $2.67 billion
- No final dividend but a $400 million share buyback has been announced
What were the key takeaways from this result? What surprised you the most?
You had underlying earnings, once you strip out the depreciation of the airplanes, come in at $281 million. That was actually higher than what the market expected. When you looked at expectations, they were sitting at $268 million. The thing that surprised me is just how strong operating cash flows are. You have $2.67 billion of operating cash flow come in, which actually drove Qantas' debt levels down to below $4 billion.
Qantas has a target range for its debt profile to between $4.2 and $5.2 billion, and so given they have this excess cash and the debt profile is below the range, they announced a buyback. That surprised us and the market - and it shows the strength of the position that Qantas is in despite the fact that things are slowing down at the moment.
It makes sense that they've announced a buyback now, and it's in line with their financial framework. It was a pleasant surprise for us, and it shows things are moving in the right direction despite the headwinds coming into FY23.
The thesis remains intact - they've got pricing power in the Australian market, a rational competitive environment, and one additional thing is the underlying loyalty business actually upgraded their outlook for earnings. Things seem to be going well at Qantas.
What was the market’s reaction to this result? Was this an overreaction, an under-reaction or appropriate?
Qantas had sold off going into this result, so I think the market was concerned about this one. What you've seen in the share price reaction since is that markets liked this result - and the outlook for Qantas is not as bad as expected.
There was no official guidance but there were parts of the outlook that we really like. They're also going to continue to be very rational in the domestic market with regards to managing capacity and really focusing on ticket prices as supposed to big market share wars with Virgin. As a shareholder, that's what we want to see - offsetting this higher-cost environment with higher prices and staying rational.
Would you buy, hold or sell Qantas on the back of these results?
Rating: HOLD if you've got it, but BUY if you don't have it!
We're a Qantas shareholder, so we're happy to hold off the back of this result. We think it's trading at a very attractive valuation, but you do need to think a couple of years forward. If you put it on FY24 earnings, it's trading at six times price-to-earnings. That means it's six years' worth of earnings for a business that's got an improving profitability profile, as things continue to open back up. You have a strong domestic aviation business, and a strong loyalty business that we think the market is ascribing very much valuation to. For us, Qantas will continue to be a buy.
What’s your outlook on Qantas and the travel sector over FY23? What is the biggest risk going forward?
We're quite pragmatic on the outlook for travel as a whole. We are going into an environment where things are slowing down and the consumer is going to come under more pressure as higher rates flow through the economy. In Qantas' case, a lot of [the headwinds] are in the price. We do believe the domestic aviation market will be somewhat insulated from that slowdown as a result of there being two players that control 95% of the market. You can offset some of those headwinds through price.
Qantas faces headwinds - a slowing consumer and higher oil prices. But we think you've got the right competitive environment where they can offset a lot of that. You can see earnings growth over the next few years, particularly driven by domestic and loyalty businesses.
They've got a 70% market share, they have rational competition in Virgin - and we believe they will list eventually thanks to its private equity shareholder. We believe they [Virgin] will focus on profitability, which is great for Qantas as it will grow domestic profits for all players in the Australian market. We still think the outlook for Qantas, despite the tougher environment, looks strong in our view.
From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?
At a stock-specific level, it's probably a 2 - maybe even closer to a 1. The opportunities we are seeing on offer today in the Australian market are material. Whether it's in energy, healthcare, or businesses that are a little more cyclical. From a stock-picker's perspective, I'd say it's a 1.
On the market more generally, I would say it's closer to a 3. We're trading pretty close to normal valuation levels. In fact, if you look at where the market P/E is, it's a little expensive considering we are going into a consumer slowdown. You need to be selective in the current market environment. If you're just looking to invest passively, things will be more challenging over the next 12-24 months.
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Hans is one of Livewire's content editors. He created Signal or Noise and helps write the LW-MI Morning Wrap. Previously, he was the market open producer at ausbiz TV and wrote for Bloomberg, Reuters, and The Australian.