Earlier this month I covered Auckland Airport AIA in A Defensive ASX Share to Own Forever.

This aviation feature moves closer to home as we explore Qantas Airways Limited (“Qantas”) after their recent annual general meeting (“AGM”) where they provided an updated guidance for FY25.

Qantas has been championed as a turnaround success story after accruing more than $7 billion in losses throughout the pandemic. The domestic business exceeded pre-covid levels by the end of FY23 with the international business forecasted to return to pre-covid levels by the end of FY25.

Qantas Airways Limited QAN ★★

Qantas operates international and domestic air travel, the provision of freight services and the operation of a frequent flyer loyalty program.

As Australia’s largest domestic airline, Qantas holds two thirds of market share via its dual brand strategy with low-cost carrier Jetstar, complementing the full-service Qantas brand. It operates a competitive duopoly with formerly troubled Virgin Australia, who has since seen a resurgance under private equity firm, Bain Capital

  • Fair Value: $6.10
  • Share Price: $8.08 (as at 30/10/24)
  • Price to Fair Value: 1.32 (Overvalued)
  • Uncertainty Rating: High
  • Moat Rating: None

The Jetstar effect

Qantas subsidiary, Jetstar, was established in 2003 to compete with formerly budget airline Virgin Australia. The budget airline helps Qantas defend its leading market share, with Jetstar now accounting for over 20% of domestic market, whilst allowing Qantas to retain its premium brand status.

The latest AGM guided for a 1% decrease in both domestic and international capacity growth. However, the group capacity forecast growth (~10%) remained unchanged, indicating the downgrade is only minor. Jetstar deserves credit with much of the domestic outperformance attributed to its low-cost value proposition amid ongoing cost-of-living pressures. The flagship Quantas brand still retains more than 40% market share and has been a key driver of positive earnings momentum pre-covid.

Competitive pressures have returned

The international segment has seen fierce competition with many carriers aggressively adding capacity in recent years, weighing on Qantas’ returns. Downward pressure on ticket prices have led to international yields falling and a 15% earnings margin. This is significantly lower than the 26% margin generated by the domestic division.

The carrier expects domestic revenue to increase by 2 – 4% in the first half of FY25 while international revenue is expected to fall by 7 – 10% over the same period. Noteworthy names like Turkish Airlines and Singapore Airlines have already confirmed an enhancement to their flight operations to Australia. Notably the Federal government blocked a request from Qatar Airways last year, to add 21 additional flights to Sydney, Melbourne and Brisbane, citing that the proposal was not in Australia’s interests.

Qatar Airways has since announced it intends to extend an existing partnership with Virgin Australia to a 25% minority stake, driving increased competition with Qantas. Subject to ACCC authorisation, this cooperation will enable Virgin to launch flights from key Australian cities to Doha, connecting into Qatar’s global network.

Falling fuel costs provide minimal relief

Qantas is now forecasting lower-than-expected jet fuel costs after a drop in global prices to A$140 a barrel, lower than previous estimations of A$150.

Movements in oil prices only provide short-term swings in return on invested capital and little sway on long-term profitability as fuel costs affect all players almost equally. Reductions in fuel and other input costs are typically competed away, and any savings are passed through to customers driven by competitive pressures within the sector.

Challenges lay ahead despite restructuring

Qantas has enacted major route overalls, exited loss-making routes and cut ~10,000 jobs during the covid era. This has led to a temporary improvement on earnings; however, we still believe there are significant structural challenges that lie ahead. Meaningful cashflow and returns to shareholders will be constrained by fleet expansion, replacement and refurbishment of its existing fleet of 300+ planes.

Last year the group announced the final piece of its jet fleet renewal program with a multi-billion-dollar investment in 24 new aircrafts to progressively replace its existing A330s at the beginning of FY27.

Are the shares worth it?

The balance sheet remains in a strong position with net debt of $4.1 billion (bottom of target range) and $2.7 billion cash and undrawn facilities. Net debt to EBITDA hovers below the target range of 2.0 – 2.5x but is expected to rise naturally as Qantas continues a major fleet refresh.

The group recently announced an additional $400 million on-market share buy-back for 1H25. Shares are currently expensive therefore this may be slightly dilutive to valuation; nonetheless, we do not believe this materially shifts the dial.

Prior to the pandemic, Qantas was a consistent distributer of dividends that generally attracted a fair yield, however, they have since been suspended after covid induced losses. Morningstar expects a reinstatement of dividends during FY25 of ~30% underlying earnings per share as the company begins to pay tax and can attach franking credits for investors.

At current prices, Qantas screens as ~30% overvalued by our fair value estimate of $6.10. We believe the market is extrapolating cyclically elevated profits longer-term.

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Terms used in this article

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.