EUR 850.00 For Business Accounts Only

Morningstar | Softer Near-Term Outlook for Air New Zealand as Lower Fuel Price Unable to Fully Offset Soft Demand. See Updated Analyst Note from 30 Jan 2019

No-moat Air New Zealand cut expectations for fiscal 2019 earnings. Lower jet fuel prices aren't able to offset the softening domestic travel outlook and slowing revenue growth. We lowered our near-term forecasts although our long-term projections are broadly unchanged, as is our NZD 2.60 per share fair value estimate (AUD 2.50 per share based on the AUD/NZD 1.05 exchange rate). Having fallen by around 15% on release of the earnings downgrade, shares in Air New Zealand are trading slightly above our fair value estimate. As well, the firm expects to declare a dividend of NZD 11 cents at first-half results on Feb. 28, 2019, flat on last year despite the expected fall in earnings. This is in line with our current forecast albeit implies a higher payout ratio.

Management guided to fiscal 2019 profit before tax of NZD 340 million-NZD 400 million, including NZD 30 million to NZD 40 million (nonrecurring) impact of Rolls Royce Trent 1000 engine issues. At the midpoint, this implies a 15% downgrade on prior guidance and falls approximately 10% short of our previous NZD 453 million underlying forecast. Accordingly, we’ve cut our fiscal 2019 profit before tax forecast by around 10% to NZD 370 million (NZD 400 million excluding cost of Rolls Royce engine issues) roughly in the middle of the guided range, although, we believe this softening demand is cyclical and should normalise over time. We don’t see any structural reasons for slower demand, and our long-term projections and fair value estimate are unchanged.

The downgrade reflects revised revenue forecasts based on softer forward booking trends. Forward bookings should continue to grow, albeit at a slower rate than recently experienced. This reflects softer leisure travel within domestic New Zealand and softening inbound tourism. In light of softer demand, the firm has cut its capacity growth guidance to 4%, the bottom end of previously guided capacity growth of 4% to 6%, lowering near-term revenue growth expectations.

Partially offsetting the softer demand is the lower fuel prices. The firm expects average jet fuel costs in the second half of fiscal 2019 of around USD 75 per barrel, and around USD 81 per barrel for the full year on average. This compares with previous expectations of approximately USD 85 per barrel. However, from our experience, lower fuel prices can be a double-edged sword. As one of the largest operating costs for airlines, competitors will share this advantage, and the lower fuel price will often attract additional competition into the market. This puts pressure on ticket prices--especially on the international routes which remain highly competitive. Air New Zealand appears to be feeling this impact with softer yield growth, especially on the United States inbound routes, with additional competition from American and Australian carriers. Additional pricing pressure has occurred as a result of fewer late bookings which typically generate a significant price premium, but again we believe this is nothing to be concerned about over the long term.