The meandering course of the coronavirus pandemic continues to play havoc with the outlook for Qantas ((QAN)) yet the airline’s update has signalled a recovery is underway.
Second-quarter domestic capacity has risen to 40% and should increase to almost 68% of pre-pandemic levels by the end of the year, then to 80% in the March quarter. This is well ahead of most broker estimates and Morgan Stanley now incorporates 95% domestic capacity in FY22. Negligible international capacity is assumed in FY21, rising to 50% in FY22.
UBS assesses the recent news around a coronavirus vaccine now outweighs the risk of further domestic border closures and capacity appears to be returning in a disciplined way. Virgin Australia is making a slow start with capacity share expected to be below 20%.
The broker considers the Qantas share price is not fully incorporating the upside from domestic travel and, as flying resumes, domestic competitor behaviour should remain rational following the failure of prior strategies undertaken at Virgin Australia.
Yet, Credit Suisse points out Virgin Australia has been “reasonably rational” over the past five years in terms of capacity, albeit ineffective in reducing costs. This enabled Qantas to enjoy a 10 percentage points profit margin advantage and take 90% share of the domestic profit pool.
Now that Bain has ownership, the broker suspects Virgin Australia may be more effective at controlling costs and, therefore, gain a higher share of the domestic profit pool, reducing the Qantas profit margin advantage.
Competition?
Qantas is taking share, disclosing that 25 corporates have switched to its aircraft in the past six months, anticipating it can retain more than 70% of the domestic market. Yet, Credit Suisse considers this confidence misplaced and the domestic market will be structurally worse for Qantas after the pandemic.
Regional Express ((REX)) intends to enter the mainstream domestic market starting with Sydney-Melbourne in March 2021 and expanding to all major cities in Australia after that. This has been made possible as slots at airports have become available because of the shutdown of international travel, with a full recovery in international not expected until 2024.
As Regional Express has attractive lease terms for main routes on its Boeing 737-800NG aircraft, and without any legacy labour agreements, it could be cost competitive, Credit Suisse asserts.
Furthermore, Regional Express is selling tickets for nine daily return flights on the Sydney-Melbourne route and in FY22 this should provide an 11% capacity share based on pre-pandemic capacity levels, in the broker’s calculation, given Tigerair has closed.
Assuming pre-pandemic capacity levels are achieved Qantas/Jetstar would then have 60% and Virgin Australia 29% and, therefore, Credit Suisse is sceptical that Qantas can maintain 70% domestic market share.
Liquidity
UBS estimates Qantas has enough liquidity at close to $5.7bn, including the refinancing of unencumbered aircraft. Moreover, if refinancing the aircraft becomes difficult, Qantas could choose to access the debt markets again.
Qantas has been using the downtime to reduce costs and if the target of -$1bn in cost reductions is achieved then there would be material upgrades over the next 2-3 years, the broker adds. Credit Suisse expects Qantas to initially retain a significant portion of cost reductions and then ultimately pass this on via lower ticket prices, given a three-player market will have developed.
Qantas expects a substantial loss for FY21 but underlying operating earnings (EBITDA) in the first half should be “close to break even”. Morgan Stanley allows for a return to profit in FY22 after a pre-tax loss of -$1.5bn in FY21.
The broker assesses, while cash burn will be affected by restructuring, incremental capacity will be only added on a cash positive basis and therefore Qantas should be positive on free cash flow in the second half of FY21.
With a vaccine expected to be distributed over the next 12 months the balance sheet risk is materially reduced, UBS believes, and as a result of positives changes to market structure the shares should perform.
Yet Ord Minnett considers the balance sheet is in a slightly worse condition compared with prior expectations. Net debt has risen to $5.9bn as of the end of November and the company will increase its facility limit by a further $500m for the short term.
Qantas has indicated that close to 50% of 8500 redundancies have been paid in the first half but the broker is unsure just how many will occur in the December half and, as a result, where net debt will end up.
Credit Suisse remains surprised that market capitalisation for Qantas is at an all-time high and, while the near-term outlook and liquidity position have improved, Citi is wary about the longer-term impacts of the pandemic on the airline industry.
FNArena’s database has three Buy ratings, two Hold and one Sell (Credit Suisse) for Qantas. The consensus target is $5.21, signalling -3.0% downside to the last share price. Targets range from $3.00 (Credit Suisse) to $6.20 (UBS, Morgan Stanley).
