Good for the Long-Haul
Since our last coverage in October, Qantas (ASX:QAN) shares have been drifting downwards despite reporting a solid start for the year in their first quarter trading update. This is likely owing to the recent spike in oil prices which are a major input cost for airlines. Nevertheless, the company has made tremendous improvements over the past few years which we expect to continue in the foreseeable future.
Recap and What’s new?
Back in Mid-October (FAT-AUS-844), we covered Qantas Airways’ press release which highlighted the details of their new Jet Airliner model, the Boeing 787 Dreamliner which is part of the management’s efforts to retire the older and less efficient B747s and revamp the line-up.
The company’s share price also been drifting downwards after peaking in October, this is likely due to the oil price movement with the shares down ~19% since the last coverage. Oil prices have been on a tear since November 2016 after OPEC agreed to extend production cuts through 2018. Furthermore, Hurricane Harvey impacted the Mexican Gulf region forcing US Shale Oil producers to take a backburner adding more fuel to the oil price hike.
As shown in the chart below, we put a comparison of the NYSE Arca Airline Index (Blue line) versus the WTI Light Crude Oil (Black & Red) which we view as an appropriate proxy to represent the general relationship between the airlines and fuel prices. Unsurprisingly, airline shares suffer during periods of higher oil prices as earnings expectations for the sector take a hit.
Source: StockCharts.com
Moving on, another area we covered was a brief discussion on the relationship between Qantas and the Emirates airline which has been long running and a profitable relationship worth over $80 million per annum while allowing both airlines to expand their reach and benefit from joint marketing. As of now, both airlines are awaiting a ruling from the regulators including the Australian Competition and Consumer Commission (ACCC) and the New Zealand Minister of Transport for the extension of their “alliance” to 2023.
Since then there have been a few updates from the airline with the most notable being the company’s First Quarter 2018 (1Q18) trading update, which will be the main focus of today’s report.
Trading Update – 1Q18
The First Quarter trading update from the group indicated signs of a strong start for the year with Group Revenue for the 3-month period up 5.1% year-on-year to $4.19 billion compared to last year’s $3.98 billion. Group Unit Revenues were also up, increasing by 3.1% compared to the previous corresponding period.
According to management, this was consistent with their guidance estimates provided at the Group’s 2017 annual results and was a result of better performances in both domestic and international operations.
In fact, Group CEO Alan Joyce mentioned that “we’re making good progress towards our annual target of $400 million in cost and revenue improvements, with the Dreamliner and domestic WI-FI two examples of projects that will make us more efficient and deliver a revenue premium.” Additionally, he also noted that “… despite an uptick in fuel costs and the challenges from competitor capacity growth on the international side, the Group remains on track for another strong underlying first half and a successful full year.”
Looking closely at the breakdown, Domestic Unit Revenues (comprising Qantas Domestic and Jetstar Domestic) increased 8.0% year-on-year as the domestic demand environment benefited from the subdued demand overhang of the 2016 Federal Election. Conditions in the international market eased slightly with International Group Unit Revenues (covering Qantas International, Jetstar International and Jetstar Asia in Singapore) increasing by 0.2%, note that this includes headwinds as competitors reported a 3.0% increase in capacity.
Below, the company provides a summary of operational results across different segments.
Source: Qantas (ASX:QAN) Press Release
Going forward, we believe that the airline has made noticeable adjustments in their strategy and direction with an upgrade to their line up of planes. While the continued alliance with Emirates, in our view, will be highly beneficial to the group given that Emirates will focus on long-haul routes while Qantas will focus on shorter flights to London via Singapore direct from Perth which is more fuel efficient and aligned with their new smaller 787 Dreamliners.
On that note, amidst rising oil prices, CEO Alan Joyce also mentioned that they have solutions to combat the price hike in oil which has spiked to a 2-year high. According to Mr Joyce, they employ hedges to put a cap on fuel expenditures and he added that it “allows us to participate if fuel was to fall … and that’s actually helped us to be quite competitive. We are coping quite well with fuel at the moment.”
Flight to 1H18
Going forward, the airline is expected to report 1H18 results this coming 22 February 2018 and has announced that profits may grow by up to 12% year-on-year while underlying profit before tax in the range of A$900 million and A$950 million, this figure compares with A$852 million in the previous corresponding period.
Turning to the daily chart, prices are in flirtation-mode with dynamic support at the 50-day moving average (red line) of $5.32. Should prices lift from this indicator, then a near term advance towards resistance evident at the $5.44/49 region is feasible. This is made up of the 38,2% Fibonacci retracement and 200-day moving average (green line) respectively. A sustained break above this price range would bolster upward momentum. Consequently, an upward rotation in share price towards the next band of resistance sighted between $5.65 and $5.86 could potentially be on the cards. This consist of the 50% and 61.8% Fibonacci retracement levels respectively.
With reference to the monthly chart, support was respected at the 38.2% Fibonacci retracement of $5.02 (blue set of retracements) in January, which is deemed positive price-action. Should follow-through to the upside evolve over the near term, then this would imply that the correction evident during the last quarter of 2017 to be complete. If our analysis proves to be true, then a resumption of the broader uptrend would likely follow. Above, key overhead resistance is sighted at the aforementioned October 2017 high of $6.53. A definitive clearance of this level would likely yield a longer term advance towards the 127.2% Fibonacci extension of $7.45. This price level was triggered when prices closed (on a monthly-basis) above the 78.6% Fibonacci retracement of $4.97 in May 2017 (red set of retracements).
Summary
The fundamentals are strong for Qantas (ASX:QAN) having achieved over $2.1 billion in transformation benefits to bring the airline back to sustainable profit levels. Transformation benefits are expected to add another $400 million by the end of next year. Going forward, we believe there is growth on the horizon with plans to grab more of Asias’ routes.
On the valuation front, Qantas (ASX:QAN) is currently trading at 9.0 times earnings with a prospective yield of 3.2%. We like the direction management is taking the company, although we are also conscious of the level of foreign ownership in the airline which (as of 12 January 2018) is at circa 43.6% (49% federal limit) if breached, this would lead to an automatic sell down. Given that the shares are trading near 10-year highs amidst rising oil prices, we believe it to be prudent to maintain our HOLD rating on Qantas (ASX:QAN).
