Qantas shares have taken a hit in the past week on those worries about faulty drop 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.
But the solid outlook hasn’t encouraged some analysts and overnight Merrill Lynch’s 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”:
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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.
That’s a pretty big call and sounds a bit like the sort of commentary we have come to expect from Qantas CEO, Geoff Dixon, who has a dose of the “chicken littles” at times about the outlook.
It’s only a year ago that the Airline Partners Australia leveraged buyout was in full swing, with full support from Dixon and other senior managers.
Merrill Lynch has missed the biggest unknown about Qantas: it’s management succession and just who will succeed Dixon next year.
Who becomes the new CEO will be as big a factor as any influencing market watchers and the airline’s ability to defend and sustain its strong position here and overseas.