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Morningstar | Air New Zealand Delivers Modest Earnings Growth in Fiscal 2018 Despite Spike in Fuel Cost

Air New Zealand reported fiscal 2018 net profit after tax of NZD 390 million, up 2% on the prior year and in line with our estimates. This is a solid result, given the 20% jump in fuel costs, and the intense competition on the international routes. We maintain our NZD 2.60 per share fair value estimate, along with our no-moat rating. We still believe the stock is overvalued at the current price, and we expect higher fuel prices to weigh on near-term earnings. The board declared a final dividend of NZD 0.11 per share, taking the full year dividends to NZD 0.22 per share (fully imputed for New Zealand tax residents), a 5% increase on the prior year and equivalent to around 64% of EPS.

Management guided to fiscal 2019 EBIT of between NZD 425 million and NZD 525 million, which implies a decline of between 3% and 21%. We believe this wide range reflects the volatility of the airline industry, and the jet fuel price is likely to be the main driver. Domestically the company has some pricing power, and for the most part should be able to pass through the higher fuel bill. However, the international segment is likely to be the hardest hit by the higher fuel price, and given the competitive intensity, passing through the prices will be more challenging, as evidenced by the fiscal 3% decline in yield during fiscal 2018. We expect the company’s operating margin to get hit during fiscal 2019, declining by over 200 basis points to 8%.

We forecast oil prices to taper off from fiscal 2020 onwards (driven by additional shale production coming on line), before levelling off at our midcycle forecast of USD 60 per barrel. We expect the company to pick up some modest margin benefit as the fuel cost declines. This lower price also means higher-cost carriers can break even and typically return to the market, driving down prices. While the company has previously benefited from lower fuel prices, with EBIT margins spiking as high as 16%, this has proved unsustainable, and the additional competing capacity coming on line forced margins back down to 11% and returns on capital back down to the firm’s cost of capital.

Accordingly, we believe this 11% mark is the long-term midcycle for EBIT margins.
We still expect low- to mid-single-digit domestic capacity growth for the foreseeable future. This reflects healthy domestic demand, higher frequency of flights to Queenstown, and strong growth in the regional markets. Demand remains strong in the Tasman and Pacific Islands routes--we expect around 7% growth for the next three years on average, supported by increased flight frequencies, new services to Brisbane from Wellington and Queensland, and the introduction of the larger A321neo aircraft into the fleet. Air New Zealand has a solid track record of managing capacity, and we are confident the load factor (utilisation) should remain at above 80% long term.