Qantas Airways (QAN) has been my single best “trading idea” of the last 14 months. From a low point of 95c back in December 2013, Qantas shares have gained +200%. This week I am recommending “taking trading profits” in Qantas.

The trade

Airlines are trading stocks: always have been, always will be. They are not long-term investment grade, in my opinion, due to the fact they control very few of the variables in their business.

Qantas was clearly undervalued at the bottom of its earnings and sentiment cycle, yet now it is fairly valued with optimistic sentiment, and that means from a trading perspective, it is the right time to be locking in the substantial capital gains and look for other ways of making our capital work hard for us.

Pretty much everything went right in this Qantas “trading idea”. The oil price collapsed, the Australian dollar collapsed, the domestic capacity war ended and Qantas’s earnings recovered as confirmed in last week’s interim earnings result. The Qantas share price has tracked the FY15 consensus EPS revisions up as illustrated below.

That drove a 200% share price appreciation and that’s enough for me. Despite Qantas management doing an excellent job, I suspect the next 20% gain in the Qantas share price will be much harder and slower than the last 200%, and that is why I am recommending taking trading profits this week.

My final reason for recommending taking trading profits is all the analyst bears from 95c are now bulls with price targets above the current share price. The contrarian in me is happy to feed trading stock into that major sentiment change. The buy/hold/sell ratio is now 11/1/1 and median price target $3.49.

New ideas

So where do we reinvest our trading profits from Qantas?

Sydney Airport is a macro meets micro idea. The falling Australian dollar is improving Australia’s relative value as a tourism destination. Sydney Airport is Australia’s gateway airport. Airline capacity into Sydney Airport is increasing. Passenger numbers are increasing. Sydney Airport’s margin per passenger is increasing. The risk free rate is collapsing.

Sydney Airport is effectively a structural “growth bond” yielding 5.00% (unfranked) for 12 months. It’s yield premium of 2.45% to a 10yr Australian government bond (2.55%) will narrow in the years ahead. Inversely, Sydney Airport capital growth will come from yield compression.

Warren Buffett famously said “a monopoly toll bridge is my dream investment”. Sydney Airport is a “monopoly toll bridge” that now has strong macro tailwinds for activity and valuation.

Sydney Airport does have a genuine strategic, structural advantage over other Australian airports. Just consider the figures below. Look away good people of Melbourne, this might hurt a little.

Monopoly money

Sydney and NSW combined benefit from:

• 32% of Australia’s population;
• 41% of Australia’s top 500 companies’ headquarters;
• 90% of international banks’ regional headquarters;
• 34% of Australia’s international visitor bed nights;
• Sydney Airport’s 40% share of Australia’s international passengers;
• 42% share of Australia’s premium traffic;
• 37% share of Australia’s outbound leisure traffic;
• 517,000 tonnes or 47% of all international air cargo into Australia; and
• $65 billion value of air cargo each year.

Last week Sydney Airport confirmed CY14 earnings and confirmed a final distribution of 12c. They also guided to another 25c of distributions in 2015 (+6.5% on 2014).

I only EVER play yield-based strategy in individual stocks where the underlying earnings are RISING. Sydney Airport has a rising earnings base as confirmed in last week’s 2014 result.

Which is translating to distribution growth. This is a textbook “structural growth bond” with strong management extracting high levels of economic rent from the monopoly asset base. I can fully understand why Sydney Airport’s register is dominated by major pension funds, both global and local, looking for a predictable and growing income stream.

Sydney Airport also confirmed the data I used in my Crown note from last week about increases in bilateral air capacity between China and Australia. This remains big news yet not widely known.

I’d own Sydney Airport over any form of fixed interest, every day of the week. The confirmation of that view is long-term traffic growth data, which clearly shows structural passenger growth at Sydney Airport. This will continue and will accelerate in the years ahead as Asian capacity is added.

The valuation

The way I value Sydney Airport it is to consider it a “structural growth bond” and price it relative to Australian Government bonds. At $5.00 the prospective 2015 distribution yield is 5.00%.

Over the months ahead I expect Sydney Airport’s distribution yield to be bid down to 4.50%, a 200 basis point premium to a 10yr AGB yield.

A 4.50% distribution yield equates to a $5.55 12-month share price target on Sydney Airport.

With the potential for another 16% total return in the year ahead, I rate Sydney Airport a high conviction buy and the stock remains a core member of my high conviction portfolio as we enter a medium-term period of low or even lower cash rates and an associated lower Australian dollar.

Sydney Airport wins on yield compression and revenue growth in that scenario.

Take trading profits in Qantas, switch to Sydney Airport.

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.