Ord Minnett Research Recommendation: Qantas Airways (ASX: QAN)
Ord Minnett maintains high conviction in its positive view of Qantas Airways, supported by a favourable Australian industry structure that should lead to market share gains and an impressive loyalty arm that we believe is underappreciated by the market.
We believe Qantas is well placed versus its US airline peers, and when we consider its performance over the five years pre pandemic and in previous downturns (2000–03 and 2008–12), Qantas has held up relatively well. We also view the airline’s fuel hedging (being 75% hedged for remainder of FY23) as an attractive characteristic versus US airlines, which are largely unhedged.
With key US airlines having used respective frequent flyer programs as collateral to secure funding during the pandemic, valuations reveal implied enterprise value to operating earnings multiples of 10–15x for such businesses. We value Qantas’s loyalty business at 10x EV to earnings before interest and tax (EBIT), and so we see potential upside to our valuation if recently implied loyalty multiples are adopted.
Should management hit its FY24 targets – 18% and 22% EBIT margins for Qantas Domestic and Jetstar Domestic, respectively, loyalty EBIT of $500–600m, and a return on invested capital of more than 10% for the International business – we believe FY24 EPS could hit 94cps, versus consensus of 74cps. Based on the long-term average price to earnings multiple, we calculate this could equate to more than $2 a share.
We have made minor revisions to our earnings forecasts over FY23–25 after tempering our airline yield estimates, which are offset by slight revisions to our operating expenditure estimates, while incorporating a stronger outcome for the loyalty business than we expected. We also now estimate net debt to remain towards the lower end of management’s target range, consistent with recent commentary in Qantas’s post-FY22 result briefings.
Given its superior domestic market structure and share, a restructured and more variable cost base, a strong balance sheet and potential upside from the loyalty program, we believe a premium for Qantas is warranted. We maintain our Buy recommendation and have raised our target price to $7.40 from $7.20.
Walter Watson
RESEARCH EDITOR
Walter is the Editor of Ord Minnett's retail investor publications, such as the Opening Bell, Ords Weekly and the Ords Monthly, along with various investment guides and investor information published by Ord Minnett.