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Flying kangaroo bounds ahead of itself
One of the stocks most hammered by the COVID correction in February-March was Qantas, which plummeted from $6.67 to $2.14, a fall of 68%, as the effect of the pandemic on air travel began to sink-in to the market.
Like most of its peers, Qantas found itself in “the most challenging period in its long history,” as a strong first half of the year ($771 million underlying profit before tax) was followed by a “near-total collapse in travel demand” and a $4 billion drop in revenue in the second half.
The interim underlying profit before tax of $771 million – a decrease of only $4 million from the prior year – was turned into an underlying profit of $124 million for the full year ended 30 June 2020. As revenue plunged by $4 billion, Qantas slashed the value of its airline fleet by $1.4 billion, and reduced its workforce by 6,000 employees. Qantas has had to borrow more money to meet the costs of running the company while flying is heavily restricted: total borrowings rose from $5.1 billion to $6.7 billion in FY20. However, Qantas conducted a highly successful $1.9 billion capital raising through institutional investors in July, which showed that investors see it as far from a basket-case.
It’s clear that international travel is not returning to pre-COVID “normal” anytime soon. Qantas thinks that international flights are “unlikely to restart before July 2021,” with the exception of mutual ‘travel bubbles’ with countries such as New Zealand, Singapore, and Japan as they bring COVID-19 under control.
At the annual general meeting in October, chief executive Alan Joyce said European and North American flights would be out of action until the “end of 2021”, but the national carrier was hopeful that travel bubbles with certain Asian and South Pacific countries could start in the near future. Joyce said the airline was looking for safe international travel routes to Japan, parts of South East Asia, and the South Pacific.
Joyce added that regular UK and US services remained impossible while both regions struggled to contain the virus and there was no vaccine readily available. “For some of our big destinations like the United States and the UK, it’s going to need a vaccine given the high prevalence of the virus in both of those locations,” he added.
On the domestic front, as borders re-open, Qantas is slowly adding capacity and re-activating routes – but again, it’s a long way back to normality. There is definitely pent-up demand waiting to book flights, in both international and domestic: border re-openings and “bubble” negotiations could accelerate this, although it is probably best not to expect international to contribute until FY22.
This week, the vaccine uncertainty appeared to have diminished significantly, with biotech giants BioNTech and Pfizer announcing that their coronavirus vaccine had proven to be more than 90% effective during its recent phase 3 study – conducted with more than 40,000 participants.
QAN surged more than 11%, to $5.20, on that news, which capped off an impressive 143% recovery from the $2.14 level the stock plumbed in March.
Like many companies in March 2020, Qantas was suddenly a value stock again, at below 4 times earnings, but it was a gutsy buy – you had to have believed that airline travel, both domestically and internationally, would (eventually) return to pre-COVID levels. It may still, and this week’s vaccine news may have helped that thesis. But there is a long way to go, and a lot of that value has been baked-into the QAN price.
At present, QAN changes hands at $5.12.
Thomson Reuters’ collation of analysts’ valuations (11 analysts) arrives at $4.93. FN Arena’s collation (six analysts) is even more bearish, at $4.45. Analysts think it is beyond fair value.
The most bullish broker on Qantas in FN Arena’s collation, UBS, has a target price of $5.25.
UBS says that about 70% of domestic travel is either banned or exposed to a quarantine period leading to airlines in Australia offering only about 25% of their pre-COVID capacity (the lowest among developed nations).
Assuming Qantas could get back to 70% of its pre-COVID capacity, UBS says the airline could generate $600 million in pre-tax profit and $800 million of free cash flow.
For FY21, UBS estimates a pre-tax loss of about $900 million, before an $800 million profit in FY22 and $1.7 billion in FY23 – numbers higher than the average profit result in the years FY16-19.
This translates to earnings per share (EPS) of 27.3 cents for Qantas in FY22 – which, at $5.12, implies a forward price/earnings (P/E) multiple of 18. 8 times earnings.
SImply put, we don’t see that as offering any value – the value in QAN has run out, for the time being.
We understand that earnings recovery for Qantas will come progressively as re-opens domestically, as it potentially starts flying in and out of New Zealand and other selected destination, and then eventually, as international recovers. But 18.8 times expected FY22 earnings is too steep for us – the stock is a sell.
