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Morningstar | Qantas Performing Well in the International Market Although Domestic Demand is Subdued

Our AUD 5.00 per share fair value estimate for no-moat-rated Qantas is unchanged following its third quarter update. The shares currently trade at a slight premium to our valuation. The company reported fiscal 2019 third quarter revenue of AUD 4.4 billion, a 2.3% increase on the previous corresponding period, despite the shift in the timing of Easter which fell in the fourth quarter of fiscal 2019. Unit revenue increased by 4%, and the firm remains on track to offset higher fuel costs. After normalising for Easter, group unit revenue during the first four months of calendar 2019 would’ve increased by 5.5%.

At the current pace, Qantas is likely to fall just shy of our prior full-year forecast. Accordingly, we trimmed our fiscal 2019 forecast by 5% to AUD 980 million, to account for softer domestic demand. The oil price will remain a key driver of performance, and we forecast the price of Brent Crude to increase slightly in the near term. Consequently, we see the firm’s fuel bill rising by approximately 8% during fiscal 2020 to AUD 4.2 billion. We think the firm can recover part of this through higher unit revenue although not all of it, due to soft domestic demand. Longer term, we forecast the oil price to fall to our midcycle forecast of USD 60 per barrel. While in the short term this will boost margins, it will also incentivise international carriers to add capacity, which is likely to weigh on utilisation and average unit prices, offsetting the lower fuel price. Our long-term projections are unchanged, and we expect EPS growth to be constrained to the low-single digits on average, during our explicit five-year forecast period.

Qantas continues to demonstrate disciplined capital management, reducing group capacity by 1% during the financial year-do-date. In our view, the reduction of capacity reflects the elevated fuel price environment which is disincentivising rival carriers to add capacity. This is tracking marginally below our forecast for flat capacity, although we expect a slight pick-up in the final quarter due to the strong Easter period. The firm’s rational capacity management has seen utilisation increase by 1% to just over 84%, an improvement over recent years, albeit consistent with our expectations.

The performance in the domestic market is mixed, with strength in the resources sector and strong leisure demand over the Easter period, partially offset by parts of the domestic corporate market including financial services, telecommunications and construction. Year to date domestic revenue passenger kilometres fell by around 2%, slightly below our negative 1% forecast. The fairly subdued domestic economy should see demand growth of around 1%-2% on average during the next five years.

International, on the other hand, is performing relatively well, growing revenue passenger kilometres by around 2%, broadly in line with our expectations. In addition to the healthy demand growth, group international unit revenue rose by just over 6% as the firm was able to pass through higher fuel costs, amidst a reduction in competitor capacity. The near-term outlook for international travel is positive, and the firm should benefit as total market capacity shrinks in response to the higher fuel price.

Qantas and Melbourne Airport reached an agreement for the sale and lease-back of the company’s airline terminal. The terminal was sold for AUD 355 million, most of which will be received in cash during fiscal 2019. However, this will have little bearing on the balance sheet, with net debt/EBITDA (lease adjusted) likely to remain at around 1 for the foreseeable future, a healthy position in our view.