In 2007, Warren Buffet famously wrote this about investing in airlines: “If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success.”
Buffet ignored his own advice and started investing in airlines again in 2016, building up positions of almost 10% in each of United, American, South West and Delta. Just after Covid hit in 2020, he sold out entirely, booking losses of around US$4 billion.
If Buffet can get investing in airlines so horribly wrong, anyone else writing on this industry has to be particularly careful. But here goes with respect to Qantas, because the question, “is the worst over?” is on everyone’s lips.
Let’s start by reviewing what we know.
Firstly, the ACCC is taking court action against Qantas alleging that it advertised flights it had already cancelled and continued to sell tickets. This relates to more than 8,000 flights scheduled to depart between May and July 2022. ACCC Chair Cass-Gottlieb said in a media interview that she was seeking a fine of more than $250 million, twice the current record for a breach of consumer law.
Qantas has agreed to waive the expiry date on $570 million of Covid travel credits that were due to run out at the end of the year. They will also facilitate cash refunds if requested. The backdown by Qantas, announced on 31 August, technically won’t cost Qantas anything because the expense was already on the balance sheet. The policy change will stop Qantas from writing some of it back early as a profit.
Following the High Court loss last Wednesday relating to the illegal sacking of 1,700 baggage workers, Qantas faces a fine of up to $100 million from the Court plus civil penalties that could be another $100 million. Potentially, $200 million plus further compensation costs.
Most likely, there will be a Board spill, including the exit of Chair Richard Goyder. Notwithstanding what the media will have to say, this will be taken as a “positive” by the market.
There could be shareholder class actions or a class action from consumers. Despite media “beat ups” that class actions are “big”, these tend to be settled around the size of the company’s insurance cover (plaintiff lawyers aren’t risk takers), so the near-term cost to the company is unlikely to be that material.
Sometime before the release of the Qantas Annual Report (and Remuneration Report), Mr Joyce will probably lose his performance bonus. And ASIC may have a look at his sale of 2.5 million Qantas shares at $6.75 (worth almost $16.9 million) on 1 June. But neither of these items will have any negative impact on the share price.
Let’s have a look at what we don’t know.
The biggest question is how much Qantas will outlay to improve service and build trust back in the brand. Unlike the other costs above which are “one-off”, this is likely to be a permanent cost because it will involve hiring additional staff, cancelling fewer flights (so load factors will fall) and potentially waiving fees/incurring additional costs.
There is a risk that disenfranchised customers could take their business elsewhere and bookings will fall, but I think this is low probability given the pent-up demand for travel and price being such an important motivator in consumer behaviour.
Another question, which is often raised by the AFR’s Rear Window columnist, Joe Aston, is whether under Alan Joyce, Qantas massively under-invested in new planes. The implication being that if Qantas was seeking to rebuild trust with the flying public, capital expenditure (capex) would need to increase.
In its FY23 profit announcement in August, Qantas guided to capex for FY24 of $3 billion to $3.2bn, up marginally on FY22. It also announced a further $500m on-market share buyback. Qantas’s net debt of $2.9 billion is comfortably below its target range of $3.7 billion to $4.6 billion, and with an investment grade credit rating and debt to EBITDA of only 0.8 times, it has considerable capacity to increase capex.
What do the brokers say?
With the caveat that the Qantas “drama” is a fast-moving feast and much of the brand damage has been incurred in the last couple of weeks (after the brokers’ valuation updates), the major brokers are very bullish on Qantas. With 4 “buy” recommendations and 2 “neutral” recommendations, the consensus target price is $7.78, 38.7% higher than Friday’s closing ASX price of $5.61. As the table shows below, the range is a low of $6.10 through to a high of $9.
On multiples, the major brokers have Qantas trading on an incredibly low number of just 5.3 times forecast FY24 earnings and 5.1 times forecast FY25 earnings. This is based on EPS (earnings per share growth) of 11.8% in FY24 and 2.7% in FY25. Most brokers forecast that Qantas will commence paying dividends in FY25.
Bottom line
Experience tells me that the sort of brand crisis that Qantas finds itself in tends to go on longer and bite harder than one imagines upfront. Hence, it pays to sell early and be very patient before buying back in again.
However, when I look at the multiple of just 5 times, consider that the bad news is largely out, that most of the costs are “one-off” and not that significant for a company which booked an underlying profit before tax for FY23 of $2.45 billion and which has robust demand prospects, I think “Qantas looks cheap”. There will be additional ongoing costs that impact the multiple and reduce broker valuations, but I think they are in the “hundreds of millions” not “billions” range.
Leaving Buffett to one side, Qantas looks like a “buy”.
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.
