A pairs trade is when an investor takes a long position in one company and a short position in another. The bet is the long position will rise in value and the short position will fall and you can profit from both sides of the trade.
Usually a pairs trade is placed on two companies operating in the same industry and one company is performing well at the expense of its competitor.
For the best part of the past year, many professional investors placed a pairs trade on Australia's two listed airline stocks. The combination of going long Virgin Australia and short Qantas has delivered a phenomenal return.
Over the past two weeks, though, it would seem the trade has been reversed. After a shocking year, Qantas' share price has sprung to life, rising about 8 per cent. Over the same period, Virgin has declined 15 per cent.
There have been several catalysts for this change and it would seem these could drive the new pairs trade further.
The latest Qantas result for the six months to June 30 was a marked improvement on the previous six months. Qantas managed to stem the massive cash burn that threatened its existence. More recently, Australia's largest airline has done a lot to fix its haemorrhaging international division by signing a sharing deal with Emirates that will lower operating and capital costs.
Just as importantly, Qantas has taken an aggressive stance in the domestic market against Virgin, which made a strategic move to take on Qantas in the domestic corporate market. Qantas is flooding the market with extra capacity to counter Virgin's move. This is a bad sign for Virgin, with the only winners being the general public. More seats without growth in the market will drive down yield in both companies.
Webster Limited
THE arrival of Chris Corrigan on the register and the board of walnut farmer Webster has got investors excited. The former BT Australia and Patrick boss ponied up almost $7 million to take a placement at 50? a share that will deliver him 17 per cent of the company. He will also participate in a one-for-four rights issue at 50?.
Investors keen to get a piece of the rights issue pumped the price up to 60? a share on Friday.
Webster hopes to raise close to $20 million from the placement and rights issue. The funds will be used to build a walnut cracking plant and expand farming lands.
On the face of it, Webster looks expensive. It has a market capitalisation of $65 million, after the rights issue, and ongoing earnings are only about $4 million. It takes about eight years for each walnut tree to reach maturity, and the earnings should follow suit.
The commitment shown by Corrigan suggests he is in it for the long term and potential for earnings growth.
It would make a great deal of sense for the company to offload its onion business and become a pure walnut play. The onions can be a profitable division but earnings suffer from volatility.
Freedom Foods Group
ONE of the best ways to find stocks to buy is to scan the 12-month rolling highs and lows. Perversely, it is usually the 12-month highs that provide the most fertile ground for buying opportunities. This, though, does not mean you jump in without a close look.
Health and wellness group Freedom Foods Group has a long and chequered history on the sharemarket. The stock, though, has more than doubled over the past year. Fully diluted for the exercise of options and convertible notes, the company has a market capitalisation of about $93 million and an enterprise value (includes debt) of $122 million.
This is a remarkable valuation given the company posted earnings before interest, tax, depreciation and amortisation of $5.3 million for the year to June 30. This places the company on a lofty EBITDA multiple of 23 times.
Investors, though, are buying the stock for Freedom's 25.8 per cent shareholding in the listed New Zealand dairy group A2 Corporation. A2 has a market capitalisation of $273 million, meaning that Freedom's shareholding is worth $70 million. This would seem to make Freedom's EBITDA multiple look more reasonable at around 11 times historical earnings.
But A2 Corp earned only $NZ4.4 million in its most recent financial year, placing that stock on a PE multiple of around 80 times. Let's hope A2 can ramp up its earnings at a dramatic pace as it launches into the British market.
All this means we should be careful until we see the longer-term earnings come through.
Frequently Asked Questions about this Article…
What is a pairs trade and how did investors use it with Qantas and Virgin Australia?
A pairs trade is when you go long one stock and short another in the same industry to profit from relative performance. Professional investors recently used a pairs trade by going long Virgin Australia and short Qantas, banking on Virgin outperforming Qantas — a strategy that delivered strong returns until the trade started to reverse.
Why has the Qantas‑Virgin pairs trade started to reverse recently?
The trade reversed after Qantas’ share price jumped about 8% over two weeks while Virgin fell roughly 15% in the same period. The swing was driven by positive Qantas results, cost‑saving moves such as the Emirates sharing deal, and aggressive domestic capacity moves by Qantas that hurt Virgin’s outlook.
What did Qantas report in its latest result and why does it matter for investors?
Qantas’ six‑month result to June 30 showed a marked improvement versus the prior six months: the airline stemmed a large cash burn and improved performance. That matters because it reduced short‑term survival risk for the company and helped trigger renewed investor confidence in the stock.
How does Qantas’ deal with Emirates affect its operating costs and investor outlook?
Qantas signed a sharing deal with Emirates aimed at lowering operating and capital costs in its international division. For investors, that deal is a catalyst because it can reduce losses from the international business and improve Qantas’ profitability over time.
How is competition on domestic routes between Qantas and Virgin Australia affecting fares and yields?
Virgin moved into the domestic corporate market, and Qantas responded by flooding the market with extra capacity to defend share. More seats without market growth tend to push down yields for both airlines, which is a negative for profit margins if demand doesn’t rise.
What happened at Webster Limited and why did Chris Corrigan’s involvement excite investors?
Former industry boss Chris Corrigan took a large stake in Webster Limited, paying about $7 million in a placement at 50¢ a share and securing roughly 17% of the company, plus participation in a one‑for‑four rights issue at 50¢. His commitment and plans to raise close to $20 million for walnut production and expansion helped lift the share price to about 60¢.
Is Webster Limited cheap or expensive for everyday investors?
On the face of it Webster looks expensive: the company’s market capitalisation was about $65 million after the rights issue while ongoing earnings are around $4 million. Also remember walnut trees take about eight years to mature, so earnings growth may be long‑dated — something investors should weigh carefully.
Why should investors be cautious about Freedom Foods Group despite its recent share price gains?
Freedom Foods has more than doubled over the past year but, on a fully diluted basis, its market cap is about $93 million and enterprise value $122 million against EBITDA of $5.3 million — an EBITDA multiple near 23x. Investors are buying partly for Freedom’s 25.8% stake in A2 Corporation (worth about $70 million), yet A2 itself earned NZ$4.4 million last year (implying a PE near 80x). That makes it important to wait for longer‑term earnings to materialise before assuming the valuation is justified.
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