Why we don’t buy airlines

Editorial director of Switzer
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Airlines have never been a favourite buy at the Switzer Super Report, although we do occasionally run analysis by other commentators. The goings on at Qantas over the past weeks again highlight why companies in this industry are inherently risky.

Last week, Qantas said it expected an underlying loss before tax of between $250 to $300 million for the first-half of fiscal 2014. Standard & Poor’s then downgraded the company’s credit rating one notch to BB+ (outlook negative) from BBB- (outlook stable). The new rating is now what is sometimes referred to as “junk” i.e. it is below investment grade.

In a statement, Qantas chief financial officer Gareth Evens said a downgrade was not “unexpected” and reiterated the company’s line about an “uneven playing field”.

“We are continuing discussions with the Australian Government regarding the uneven playing field in the local aviation sector, which has distorted the fundamentals of the market,” Evans said.

Don’t touch

Switzer Super Group director and expert, Paul Rickard, says there are three reasons why he never buys airlines. In a nutshell, they are:

  • The massive capital risk involved;
  • Industry profitability is impacted by “ego” investors;
  • The many uncontrollables, such as the impact of a plane crash, volcanic ash, 9/11, SARs etc.

“There are all these things you just can’t control. And you’re competing against people’s egos and governments,” Rickard says.

Because it is seen by many as a “national icon”, the fate of companies such as Qantas makes big news and often governments are called on to “rescue them”. Whether they do or don’t often depends on the political whims of the day. But those things don’t make Qantas, or other airlines, necessarily attractive for long-term investors.

“Qantas gets a massive amount of coverage, disproportionate to what it is,” Rickard says.

The ego factor refers to the kind of personalities that are often in control – Richard Branson and Nicki Lauda immediately come to mind, but they’re not the only ones.

“They are run by all these people that buy big toys. They come into the industry, try to build market share by cutting prices, and then lose money,” Rickard says.

Other risks

Morningstar Research also lists increases in jet fuel prices and sustained economic downturns as reasons for potential poor performance.

“Long-haul flights are particularly affected, given the higher fuel consumption. More discount carriers will also pressure local earnings, as excess capacity pushes both ticket prices and take-up of available seats,” the researcher’s latest update on Qantas says.

Morningstar Research downgraded the company to Hold, based on poor earnings visibility and significant volatility in the airlines industry.

Citi and UBS have also downgraded it to Neutral from Buy (see Buy, Sell, Hold – what the brokers say), while BA Merrill Lynch, CIMB Securities, Macquarie and Deutsche Bank all rate it as Hold or Neutral and JP Morgan and Credit Suisse have it at Underweight or Underperform.

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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