Come fly with me – a buy on Qantas

Chief Investment Officer and founder of Aitken Investment Management
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I remain very, very firm in my belief that you have seen the bottom in Australian GDP growth rates and that any pullback in the prices of the right Australian cyclical equities driven by US political theatre is a buying opportunity. In fact, it could well prove the last buying opportunity before consensus comes around to my view of a clearly recovering East Coast economy.

Every conversation I have had with private Australian business people since the Federal election has confirmed an uptick in activity. The consumer and business confidence readings lift is translating to both consumer and business spending. That won’t show up in the ABS data for a few months, but I have to set the domestic investment strategy and stock selection ahead of the confirmation in that official data that will lead to analysts upgrading currently pessimistic FY14 estimates for Australian cyclicals.

Even as recently as Tuesday I saw firsthand evidence of that pick-up in activity on a day trip to Brisbane. As per my day trip to Melbourne last week, on Qantas (QAN), the flights were so full you couldn’t even change seats or buy an upgrade to business class using frequent flyer points. The flights were full of people like me wearing suits and there was even a solid traffic jam at Sydney Airport just to get into the car park. I do travel a lot domestically and I can’t remember seeing SYD or QAN this busy in years.

QAN to me is one of those deeply cyclical stocks that will benefit the most from a sustained pick-up in consumer and business spending. They even doubly benefit from a pick-up in consumer spending as the credit card companies have to buy more points from them as activity picks up.

But the good news for QAN is that this recovery in consumer and business spending will be occurring right as their fleet is the most fuel efficient it has been.

Wednesday was a pivotal day for Qantas group with the first 787 Dreamliner arriving at Melbourne Airport wearing the Jetstar livery. To put it in context, that 787 is five years late and is the reason QAN is still flying those ancient 767’s on East Coast high traffic routes.

Yet the 787 did arrive and I think it’s little understood how young QAN’s fleet now is and how fuel-efficient it has become. QAN is in the process of a major simplification of fleet, even reducing configurations to one standard seating configuration per jet type.

On Monday, QAN released a chart pack titled “Fleet, efficiency & engineering”. With a public holiday in NSW it most likely slipped under the radar (pardon the pun), but I though there were some very interesting slides in the pack, which confirm QAN is an investment case where the top down and bottom up are both arriving concurrently. Here are a couple of key charts.

In simple terms, QAN is reducing the number of types of planes it flies, reducing the average age of the fleet, reducing the number of seating configurations, reducing fuel costs, reducing heavy maintenance costs and, at the same time, increasing the number of seats on planes. They are also ensuring the right plane is on the right route.

The other angle on QAN is you are picking up the high growth Jetstar brand for “free” inside the QAN group share price.

I believe legacy losses in the QAN International business mask the value in Jetstar, QAN Domestic and the Frequent Flyer programme. As QAN international losses slow quickly under the Emirates JV, I think the investment community will focus on the value of Jetstar, the 65% market share domestic business, and the powerful and highly profitable FF programme. You will even see analysts start thinking about “spin offs”.

It’s worth noting, to emphasise this point, that in FY13 Jetstar contributed $138m EBIT to QAN group, QAN domestic $365m and QAN Loyalty (FF Programme) $260m. Freight also contributed a handy $36m of EBIT. That was offset by a $246m EBIT loss in QAN international.
So let’s look forward and assume QAN international reverts to a breakeven result. QAN domestic, under my macro and pricing scenarios, could make $500 million in EBIT (it made $463M in FY12), Jetstar makes $200m (it made $203 million in FY12) and QAN loyalty makes $300 million. That sees QAN EBIT at $1 billion up from $372m in FY13.

I genuinely believe QAN can be a $1 billion EBIT company again by year end FY15 and, if that proves right under transformation above, then the current market cap of $3.1 billion is ridiculously undervalued. To put this all in context, the current QAN FY15 EBIT forecast is $550 million.

Yes, it’s an airline and it’s inherently volatile, but there is so much hidden value in this stock, hidden by the current losses in International.

QAN fits every macro and micro theme I believe in. It is a play on consumer confidence, business confidence and rising inbound tourism. But, even more importantly, it is becoming a far more efficient company and exiting its historic legacy businesses and inefficient aircraft.

I also expect load and yield traffic data to be strong from September on.

The company has 47 million shares left to buy on market, a buyback that confirms the Board sees the equity as undervalued. They are completely right in my view.

It’s not often I would recommend a stock with no dividend yield and consensus forward P/E of 26x, but in this case I think current multiples are not the way to look at QAN because they are representative of the past, not the future.

Over the next few years I think QAN shares can double as they execute all of the above and interestingly around $3.00 is where multi-year technical resistance lies.

QAN is a strong buy under $1.50.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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