Air New Zealand has completed the restructuring that Alan Joyce has begun at Qantas. The flying fern is not going to shoot the lights out – but it should leave Qantas stranded on the tarmac.
It’s a national embarrassment. Quite simply, Air New Zealand has left Qantas for dead, as an airline, as a business and as an investment.
There is plenty of evidence that airlines are not good investments. Planes are expensive, fuel prices are volatile, many employees have very specialised jobs and demand higher wages; regulation and union issues often make it difficult for the company’s managers to manage the business; economic cycles affect patronage; and then there are the "uncontrollables" that can affect the business – as Malaysian Airlines has recently found.
Competition is usually bitter among airlines, but their suppliers – the airports and the plane-maker duo of Boeing and Airbus – are price-setters, not takers. Many airlines do not return the cost of their capital.
When the doyen of modern-day investors, Warren Buffett, describes airline stocks as a “death trap” for investors, that just about sets the industry’s pariah status in stone.
But somebody forgot to tell Air New Zealand (AIZ).
The Middle-Earth airline – which has been listed on the Australian Securities Exchange (ASX) since 1997 – has in recent years been an excellent investment. Here are its figures on total return (including dividends):
- 1 year: +64.3%
- 3 years: +40% a year
- 5 years: +24.2% a year
The comparison with Qantas (QAN) makes uncomfortable reading for patriotic Australians – not that patriotism should ever enter into investment discussions. The flying kangaroo’s “return” figures – Qantas has not paid a dividend since FY09 – stand at:
- 1 year: –32.1%
- 3 years: –16.8% a year
- 5 years: –8.2% a year
Not surprisingly, on the ASX, as recently as mid-2012, Air New Zealand (AIZ) was trading at 66 cents. It has since tripled that, to $1.94.
Over the same period, QAN has moved from 97 cents to $1.22.
On the last full-year result, Qantas reported a wafer-thin net profit of $5 million, after a loss of $245 million in FY12. Underlying profit before tax, which excludes one-off items, doubled to $192 million. The company’s major problem area, its international division, lost $246 million for the year, an improvement on the $484 million loss in FY12.
In stark contrast, Air New Zealand reported its best result in five years in FY13, more than doubling its net profit to NZ$182 million, and bringing in its highest ever operating cashflow, at NZ$750 million. The fully franked (for NZ shareholders) dividend for the year was boosted by 45% to NZ8 cents. The company committed to investing NZ$1.8 billion in aircraft over the next three years.
Then came Qantas’ horror interim result, in February, which revealed a record half-year net loss of $235 million, accompanied by the airline announcing plans to cut 5,000 full-time jobs, abandon its less popular routes, scale down its ageing fleet and implement a wage freeze until it returns to profit.
Qantas Domestic reported a profit of $57 million, down 74% on the from $218 million in the same period a year earlier, while the international division’s loss blew out to $262 million from $91 million previously. Revenue slipped 4% to $7.9 billion, while fuel costs rose 3% to $2.2 billion.
In the same week, Air New Zealand rubbed its rival’s nose in it with a 40% rise in interim net profit to a record NZ$140 million. The Kiwi carrier lifted its interim dividend by 50% to NZ4.5 cents.
It wasn’t just the numbers: where Qantas took the knife to its international capacity to cut costs, Air New Zealand said investment in fleet renewal – particularly in the Boeing 787-9 Dreamliner – would lead to an 8% rise in capacity in the 2014-15 financial year. Air New Zealand said it was looking to growth as a cost-cutting measure: growth allows it to improve economies of scale and lower its unit costs.
Despite passenger revenue remaining virtually static at $NZ1.93 billion in the first half, the company was able to cut fuel costs by almost 10% to $NZ572 million, helped by efficiency measures and the benefits of a strong kiwi dollar.
Air New Zealand said it was reaping the benefit of having reduced its capacity flown overall as it realigned its long-haul network. The overhaul included shedding about 700 jobs, which the airline said had increased its flexibility in dealing with a tough global environment.
In effect, Air New Zealand has completed the restructuring that Alan Joyce has begun at Qantas.
That is not to say that life has always been rosy for Air New Zealand shareholders: in 2001, when its wholly-owned Australian subsidiary Ansett collapsed, the company racked up a NZ$1.4 billion operating loss, and effectively had to be re-nationalised, with the New Zealand government bailing out the company to the tune of a NZ$885 million equity injection. In 2013, the NZ government sold 221 million shares, or about 20% of the company, at NZ$1.65 each, netting it NZ$365 million. The NZ government retains a 53% stake.
Air New Zealand, of course, owns 24.5% of Virgin Australia, and is one of the trio of Virgin shareholders – along with Singapore Airlines and Etihad Airways – that Qantas has described as “predatory, state-owned airlines” that are trying to damage it financially by running Virgin in a non-commercial fashion, forcing Qantas to match it in a capacity war. Air New Zealand counters that Virgin Australia is a “natural investment” for it because the smaller airline operates in a larger market that is adjacent to New Zealand.
Air New Zealand’s status as partially government-owned is a very sore point with Qantas, which has been lobbying for some form of government assistance, arguing that moves by the big three Virgin shareholders to support a $350 million entitlement offer has tilted the playing field in the Australian skies.
But for investors, there is really only one victory that matters, and that is in the investment stakes – and there, Air New Zealand is comfortably ahead.
Air New Zealand expects normalised pre-tax earnings for the year to the end of June to come in at more than NZ$300 million, compared to $256 million the previous year and $91 million the year before. Brokers think somewhere around NZ$327 million is achievable, which would put earnings per share (EPS) at about NZ21 cents, and enable a dividend of NZ11 cents. (The New Zealand imputation credits are not available to Australian residents but the New Zealand government refunds the imputation amount to foreigners, minus 15% withholding tax. This refund is paid as a supplementary dividend.)
Air New Zealand is trading at NZ$2.09 at present, and $1.91 on the ASX. Following the interim result, broker UBS has upgraded its target price on the stock from NZ$2.02 to NZ$2.35, so there is a nice bit of capital gain to be reasonably expected, with some dividend help as well. The flying fern is not going to shoot the lights out – but it should leave Qantas stranded on the tarmac.
