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Date : 20/10/2020

Qantas Airways Limited

ASX :

QAN

Market Cap : $8.14 Billion

Hold

52 Week Range : $2.03 - $7.46

Share Price : $4.36

A distressed firm navigating extreme uncertainty. We issue investors who are willing to take on the risk to "Hold" their positions as domestic travel opens in Australia.

Company Analysis

Qantas Airways Limited (ASX: QAN) needs no introduction. The airline is one of the oldest in the world and is a symbol of Australia – the same sentiment is why it was bailed out by the government of Australia. The $715 million government rescue package was deployed by the federal government to protect and aid the Australian airlines through the pandemic. This package was surrounding a lot of controversy as Qantas was accused of utilising its funds for share buy-backs just the previous year – resulting in increased share prices. Yes, the massive increase in share price you may have seen in 2019 was due to the firm buying back its shares and thereby reducing the total outstanding shares, and not due to the potential of better future performance.

The airline industry is the most at risk during the Covid19 outbreak because it is associated with huge fixed costs even when flights are not operating. Airplane parking charges, maintenance of aircrafts to always keep it in flying condition are just a few of the incredibly high fixed costs airline companies have to fork out.

As a result, the financials of Qantas reflect just that. The firm has performed miserably and reported a net loss of $1.9 billion. The firm has a total of 314 aircrafts in its fleet – includes Qantas, Jetstar, and freight.

Company Updates

As the firm has been wrecked by the pandemic, it has been taking measures to guide recovery in a market that would have changed completely. Qantas announced a three year plan for the post pandemic world in June 2020 where the firm is looking to reduce $15 billion over the course of the 3 years – mainly due to the predicted lower activity as the airline industry changing completely, and a cost saving plan of $1 billion a year from 2023 onwards.

We estimate most of these savings to come from the reduction in fixed costs as the firm is set to ground over 100 aircrafts for at least a year. The reduced fleet will result in reduction in workforce (airlines have not been shy of firing their staff), lower fuel costs, and a reduction in exorbitant fees airlines have to pay for operation (such as landing at an airport, parking the aircraft at an airport hangar, etc.).

Qantas also announced a $1.9 billion equity raise via a fully underwritten institutional placement for about $1.4 billion at $3.64 a share, and a liquidity measures – $3.6 billion in cash and $1 billion in undrawn facilities. The restructuring and recapitalisation of the firm is news that has been welcomed by investors as the firm slims down to navigate through the crisis.

Qantas reported that its fuel requirements were completely hedged for FY2020 and the first half of FY2021 – indicating that the firm would not be able to take advantage of the negative oil prices that we saw earlier this year to reduce costs in the immediate future. Hedging ineffectiveness is estimated to cost the firm close to $600 million as most of the option contracts will expire as grounded flights mean reduced consumption.


Source: Tradingview.com

Since the dip in March, or rather the crash in March, the announcements on restructuring we mentioned earlier was what carried the share price during the surge in May. However, it did not last as markets humbled investors on the news that international and domestic travel would stay banned for longer.

Recently, as New Zealand and Australia recover from the pandemic the governments have announced a travel bubble with air travel set to resume between the two countries. Domestic travel in Australia has already started and Melbourne’s recovery from the virus means another major destination that attracts a lot of travellers will open up. All this good news about resumption in travel has resulted in the stock gaining momentum again. That being said, we do not expect the travel industry to completely recover either. Most business travel will take a hit as more firms have now got used to remote video conferencing solutions such as Zoom. With business travel accounting the largest portion of domestic travel, we may not see levels we were used to prior to the pandemic. International flights will remain affected as the ANZ travel bubble will not be enough to carry the firm out of crisis mode with high passenger numbers.

Industry Analysis

The founder of Virgin Group – Richard Branson has a famous quote that goes – “If you want to be a millionaire, start with a billion dollars and launch a new airline”. Due to the pandemic, the airline industry is distressed as never before. Aircrafts in excess of 16,000 have been grounded globally. Firms are finding it hard to find space to ground their fleet and maintain them.

There is not much that can be done during the crisis. Everything we wrote earlier about Qantas applies to all major airlines during this period. Some are affected more than others. What can be done though is prepare for a future that is extremely uncertain on demand – this means that airlines need to reduce costs. However, that is easier said than done. Airlines have high fixed costs and variable costs. While variable costs can be offset, the fixed costs cannot. Measures such as permanently grounding fleets to reduce variable costs that may arise will result in the assets of the firm declining as Boeing and Airbus planes are expensive. The average cost of an Airbus A320 passenger jet is north of 100 million dollars. Most airlines would suffer from taking deliveries of new aircrafts from orders that were placed in 2019 when demand was soaring.

Prospects for the industry are not good at this point in time. While the easing of restrictions is good news in ANZ, it is heavily reliant on the pandemic not re-emerging as both governments have not been shy of imposing restrictions again.

The demand for business travel is estimated to be a declining trend. While we may see a surge in travel as restrictions are eased, sustainability is still uncertain as firms may ultimately reduce business travel due to the cost benefits they have seen over the better part of this year.

Investment Thesis

So just how damaged are Qantas’ financials? The short answer is quite a bit. The long answer is as below:

Qantas domestic Earnings before tax was $173 million in FY 2020 with an operating margin of just 3.7% – a decline of 77% and 9.1%, respectively. The entire domestic fleet was pretty much grounded for the 4th quarter of the financial year.

Qantas international reported EBT of $56 million and an operating margin of 0.9% – declining by 82.6% and margins coming down from 4.4%. Jetstar group reported an EBT loss of $26 million for the year from the previous year’s $400 million profit.


Source: Qantas

The overall loss to the group before taxes was $2.7 billion in FY2020. We expect the firm to continue to be at a loss in the next couple of years as the airlines industry is forecasted to take longer to recover from the damage done by the pandemic.

The cash position of Qantas as of 30th June 2020 is $3.5 billion. While this is nowhere close to mitigate the risks the pandemic brings to the table for the firm, the majority of the risk mitigation will come from government bailout money through in the form of grants and from the reduction in costs that the firm has planned in its 3-year recovery plan.

To add to the exorbitant costs the airline has to deal with, it also carries $8.5 billion in debt. The firm’s debt maturity profile shows that it has around $800m of payments due in FY2021 and $870 million due in FY2022. The long-term financial health is at risk, while the short term can be mitigated with the bailout. The total assets of the firm stand at $20 billion and its total liabilities at $18.5 billion.


Source: Qantas

The capital structure of Qantas is not a pleasant sight for investors. The firm is capitalised by debt to the extent of 84.8% and just 15.2% by equity as of 30th June 2020. The high debt capitalisation being a lot of risk to investors along with the uncertainties that we have already discussed.

Dividends for the year were cut as Qantas’ earnings per share dropped to -$1.3 and are not expected to return for the next few years as the firm restructures its costs and hopes to become profitable.

The management of Qantas looks to have been taking strategic measures for capital management, cost reduction, and fleet maintenance. While the industry is not expected to rebound to previous highs, the recovery is forecasted to take around 3-5 years. The good news for Qantas investors is that the firm will emerge stronger than its peers from the crisis due to the support of the government. Intention to travel is a rather risky predictor as fears over travel can set in and change behaviour with a slight re-emergence of the pandemic.

Recommendation

The long-term outlook for the entire airline industry does not look good. Qantas may benefit from the resumption of domestic travel and the ANZ travel bubble. However, that is not remotely enough for the firm to be profitable in FY2021. The stock will be heavily dependent on how the pandemic plays out in Australia. Will there be a second wave once travel restrictions are eased? How will the government respond to it?

The future is uncertain, but we do see some light at the end of the tunnel as the firm becomes stronger than its peers in a post Covid19 world. We issue a “Hold” recommendation to investors who are willing to take on the risk of the worst of the pandemic being behind Australia and New Zealand.

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