Today, we will look at why we like Qantas Airways Limited (ASX QAN) shares.
In 2020, the coronavirus outbreak battered the aviation and travel sectors in an unprecedented manner.
The aviation industry has been brought to a near-standstill in just a matter of weeks. Given the importance of commercial aviation to an economy and the fact that Qantas is a national carrier, it is very unlikely that the company will suffer the same fate as an erstwhile rival (and now bankrupt) Virgin Australia (ASX VAH).
The company took decisive measures to combat COVID-19, including suspending international operations, curtailing domestic capacity and standing down employees.
As of May, the company has $3.5 billion in near-term liquidity after issuing fresh debt of $1.555 billion in 2020.
The total debt of the company now stands at $5.8 billion with no major maturities over the next 12 months.
Despite the pandemic, the company has outperformed the ASX index by 29.4% over the past 5 years.
Source – Google Finance
About Qantas Airways Limited (ASX QAN)
Qantas is the national carrier of Australia and the largest airline of by far in Australia market share.
The airline flies to 115 destinations across 23 countries and operates a fleet of 314 aircraft across all divisions.
The group has two major airlines under its banner, the legacy Qantas Airlines and wholly-owned, low-cost airline Jetstar.
This two-tier structure has allowed Qantas to tap both market segments and become the largest airline in the country by a significant margin.
Qantas Has the Lion’s Share of Australia’s Air Travel Market
Qantas is by far the largest carrier in Australia. According to a company report, Qantas and wholly-owned subsidiary Jetstar together hold a 61% share of the domestic travel market and 26% of international travel.
The company flies to-and-from 59 destinations in Australia, more than any other airline.
This market domination and the scale of its operations give Qantas clout in the post-COVID recovery, as and when it happens.
Source – (Qantas Data Book 2019)
Strong Liquidity and Lift in Capacity Forecasted
Qantas is well-placed on liquidity, though like all other airlines, the group is currently focused on maximizing its resources and minimizing cash-burn until demand recovers.
In a shareholder presentation last month, the company stated that it had raised $1.555 billion in total so far this year against the pledge of 10 Boeing 878’s from its fleet.
The company also has another $2.7 billion in unpledged aircraft that it can borrow against, should the need arise.
The report also anticipates a cash-burn of $40 million a week, assuming market conditions as prevailing in May.
This puts the company on a strong financial footing as its cash runway of $3.5 billion can last over 20 months, even assuming only 5% capacity utilization.
However, the current situation has substantially improved from last month.
Earlier this week, Qantas announced that it expected capacity to ramp up from 5% of pre-pandemic to levels to 15% by the end of this month, and 40% of pre-pandemic levels by the end of next month.
This will further enhance its cash position.
Meanwhile, in a favourable development, the Australian government has extended its Domestic Aviation Network Support program, launched on April 17, past its original June 7 cut-off date to September 30.
The government will also extend fee waivers and refunds on various government charges covering operations, security and fuel excise until December 31, funds permitting.
In addition, the crash in oil prices should prove to be a major boon for airlines such as Qantas, as a large chunk of their costs come from fuel.
Challenges Ahead for Domestic and International Travel
However, Qantas may have to endure a slow and gradual recovery in international travel.
To prevent a potential explosion in virus cases, countries may continue with quarantine restrictions on incoming travellers.
On the flip side, Qantas’ solid domestic network will be a revenue cushion – a key advantage over a rival such as Singapore Airlines.
A potential risk, however, is a forced transition to virtual work environments which might permanently damage the business travel sector, especially cross-border business travel.
Both these factors combined may affect Qantas’ international travel operations adversely.
Qantas To Gain from Disruption at Rival Virgin Australia, But COVID is a Concern
The company’s domination of the domestic market presents it with a huge post-pandemic opportunity.
In the first half of this financial year, Qantas generated almost 4x more EBIT from domestic services than international services.
Due to the bankruptcy of arch-rival Virgin Australia, the company has an opportunity to further consolidate its position in the domestic market.
As Virgin gets taken over by new owners, the airline will perhaps be much smaller than it was before the pandemic and will focus on becoming leaner and profitable, rather than expansion.
It will most likely have to consolidate its fleet and remove a lot of regional routes from its offerings.
This leaves us with Regional Express Holdings (ASX REX), the next biggest domestic player after Virgin.
Compared to Qantas, however, it has a much smaller footprint and its fleet comprises only prop-driven aircraft.
Hence, the void left by Virgin will create a significant opportunity for Qantas, which it can exploit given its strong financials and scale of operations.
On the flip side, however, due to the coronavirus outbreak, social distancing norms have become the new normal.
These restrictions could lead to massive fare increases to compensate for lower capacity utilization because of forced empty seating.
Late last month, Qantas announced it would not implement social distancing on flights.
However, air travel-related infections could spike after the lifting of lockdowns and travel bans.
The airline may then be forced to retract its decision and operate at reduced capacity with higher fares.
Unfortunately, higher fares may crimp demand, which could prove financially detrimental to Qantas.
Qantas Is More Profitable and Asset-Efficient Than Singapore Airlines
Since Qantas’ biggest rival, Virgin Airlines, is now amid a restructuring, we will compare Qantas to Singapore Airlines and Regional Express Holdings (ASX REX).
The next largest domestic operator after Virgin Australia is Tiger Air, a wholly-owned subsidiary of Singapore Airlines, which is also one of Qantas’ biggest rivals in the international market.
REX Air is the fourth-largest domestic operator in Australia.
We will use the price-to-book ratio to compare valuations, gross-margins to compare profitability, and asset-turnover to compare the efficiency of the company to its peers.
We will use gross-profit margin instead of net-profit margin as REX and Qantas are taxed in Australia, while Singapore Airlines is taxed in Singapore.
It is observed that in terms of valuation, Qantas is significantly overpriced compared to both Singapore and REX having a P/B of 2.52 compared to 0.78 and 0.59, respectively.
On profitability, Qantas has a nearly 10% gross-profit advantage over Singapore, but a 15% deficit to REX.
However, it should be noted that large operations and scale have high fixed costs and that REX is a much smaller airline.
Qantas is also much more efficient in the use of assets compared to Singapore, having an asset-turnover ratio of 0.94 compared to Singapore’s 0.56.
At 1.19, REX has the highest asset-turnover, but again, it is a much smaller company.
Qantas in Pole Position to Ride Competitor Disarray and Post-COVID Recovery
Qantas could capitalize on the void left by Virgin and further cement its dominance of the domestic Australian aviation market.
Due to its high market share and ample liquidity, the company is well-positioned to profitably participate in a recovery in the aviation market after the lifting of COVID-19 related restrictions.
Though more expensive, Qantas’ stock price may recapture pre-COVID levels quicker than rivals.
Even though the stock has more than doubled from its COVID lows, QAN is still well off its pre-COVID highs and a pullback may offer investors a long-term buying opportunity.
