Qantas shares fell below $5 for the first time since the Airline Partners Australia bid was launched more than a year ago on a downgrading by investment bank, Merrill Lynch, to a "sell' recommendation yesterday.
Qantas shares fell 28c, or more than 5% to a day's low of $4.85 before recovering slightly to finish around $4.90, down 23c, after news of the Merrill Lynch rating cut became known.
That was the lowest since before the APA offer (which later failed miserably), was launched in November 2006.
Qantas shares have taken a hit over the past week on those worries about faulty drip trays, that loss of power on the flight from London into Bangkok, rising oil prices, union and wages concerns and shifting sentiment caused by fears a slowing global economy will cut air travel.
The airline lifted earnings guidance for the year before Christmas and will now earn well over $1.4 billion pre tax in 2008. The airline reports interim profits early next month. The guidance is for a 40% lift in pre-tax profits and the airline's operation figures for the first five months of the 2008 financial year back up that confidence.
But that solid outlook hasn't encouraged some analysts and Merrill Lynch's local Australian arm put a sell on the airline, citing "Rising competition, rising wage pressures, higher capital costs and a weakening economic backdrop".
Merrill said in a note to clients that this background meant "that Qantas is close to the end of its earnings up-cycle".
"We expect earnings and ROE (return on equity) to peak this year, at record levels, and then for both to decline in FY09. With Qantas' Price/Book still well above its historical average the earnings slow down is not yet reflected in the share price. Sell.
"Ticket prices will be under pressure by the end of calendar 2009. Qantas faces rising competition with new airlines entering its domestic and international markets and existing competitors such as Emirates planning to significantly increase capacity into Australia. Some of these competitors have significant operating and capital cost advantages versus Qantas.
"Two of Qantas' main unions are asking for wage increases of 5% and 10%. Given the tight labour market they may get much of what they are requesting. We estimate a 1% rise in labour costs lowers NPAT by A$24m. Moving capacity to Jetstar and some costs offshore will only partially mitigate labour cost pressures.
"Our FY08 forecast is unchanged, and we still expect Qantas to beat its current FY08 guidance of 40% earnings growth. However, we expect earnings growth to turn negative late in calendar 2009 and have lowered our FY09 forecast by 20% reflecting cost and competition concerns. Our fair value of A$4.60, is based on 1 year forward P/B of 1.5x, which is a 20% premium."
"Qantas faces rising competition domestically and internationally from low cost and full service carriers who are either entering the market and/or planning significant expansion.
"We think the greatest competitive threat is on international routes where competitors have a cost advantage and where Qantas dominant domestic market position is less relevant.
"If we look at the two new entrants for the domestic market, we think there is a real chance that Lion Air's plan may not come to fruition.
"We think Tiger Airways will have some impact but that it poses little threat on the key trunk routes to/from Sydney, Melbourne, Brisbane, Perth and Adelaide." (Tiger is suffering poor publicity at the moment with delays caused by crew shortages and other staffing issues).
Merrills said the airline was facing rising labour costs and capital equipment costs.
"Two of Qantas's main unions are asking for wage increases of five per cent and 10 per cent.
"We estimate that a one per cent increase in unit labour costs reduces Qantas's net profit after tax (NPAT) by $24 million. Given the tight labour market, they may get much of what they are requesting."
Citigroup though has kept a "buy" rating on the stock.
It says strength in domestic demand, continued growth in Jetstar International and potential restructure options are expected provide real scope for continued growth and market support for Qantas.
Goldman Sachs JBWere also has a "buy" rating on the stock.
The Merrill's commentary sounds a bit like the sort of commentary we have come to expect from Qantas CEO, Geoff Dixon, who every now and then gets a gloomy outlook on life.
It's only a year ago that the Airline Partners Australia leveraged buyout, with full support from Dixon and other senior managers, was in full swing.
Merrill Lynch has missed the biggest unknown about Qantas: it's not financial (the airline's financial position is very strong). Its management succession and just who will succeed CEO Dixon next year.
That is the biggest and toughest question confronting the board which now has a different leadership group now that Dixon's biggest supporter, Margaret Jackson, has gone.
