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Morningstar | Strong Passenger Volume and Lower Fuel Price to Buoy Air New Zealand’s Medium-Term Earnings. See Updated Analyst Note from 18 Dec 2018

No-moat rated Air New Zealand’s performance is looking positive in the first four months of fiscal 2019, as capacity and demand rose by 5% and 6%, respectively. This is broadly in line with management guidance and implies a 100-basis-point improvement in utilisation, a positive outcome especially given the airline’s already strong load factor. This strong momentum was seen across most regions, and revenue per average seat kilometer, or RASK, was also strong, rising by 2%, At the current pace the group is tracking in line with our full-year expectations.

We continue to project low- to mid-single-digit domestic capacity growth for the foreseeable future, reflecting higher frequency of flights to Queenstown and strong growth in the regional markets. The Tasman and Pacific routes were the strongest performers during the year, delivering 10% growth in revenue passenger kilometers (RPKs), and we forecast 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 A321 neo aircraft into the fleet. Given the company’s strong track record of managing capacity, we forecast utilisation to remain at just over 80% for the foreseeable future.

During the past few months, oil (and consequently jet fuel) prices have been lower than we had previously expected, and we now expect oil price to remain at around the current USD 60 per barrel for the foreseeable future. Accordingly, we have lifted our EBITDA forecasts by around 6% on average during fiscal 2019, 2020, and 2021, and we project mid-single-digit growth on average during this period. Despite raising our near-term projections, our long-term oil price forecast and earnings estimates are unchanged, as is our NZD 2.60 fair value estimate. However, our Australian dollar fair value estimate raises by 4% to AUD 2.50 per share, based on a 1.05 AUD/NZD exchange rate.

The stock remains overvalued relative to our fair value estimate, and we believe the market may be assuming the lower fuel price benefit will be retained by the company into perpetuity. We expect the company to pick up some modest margin benefit as the fuel cost declines. However, the lower price also means higher-cost carriers can break even and typically return to the market, driving down average ticket prices. While the company has previously benefited from lower fuel prices, with EBITDA margins spiking as high as 25% in fiscal 2016, this has proved unsustainable, and the additional competing capacity coming on line forced margins back down closer to 20%, which is where we expect them to remain for the foreseeable future.