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 public. More seats without growth in the market will drive down yield in both companies.
Webster Limited (WBA)
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 1-for-4 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 (FNP)
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 P/E multiple of around 80 times. Let's hope A2 can increase 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.
matthewjkidman@gmail.com
The Age takes no responsibility for stock recommendations.
Frequently Asked Questions about this Article…
What is a pairs trade and why do investors use it with airline stocks?
A pairs trade is when an investor goes long one company and short another in the same industry, betting the long will rise and the short will fall. Investors applied this to Australia’s two listed airlines—going long Virgin Australia and short Qantas—because one airline was outperforming the other, allowing traders to profit from relative performance while limiting some market risk.
Why has the long-Virgin / short-Qantas pairs trade recently reversed?
Over the past two weeks Qantas shares rose about 8% while Virgin fell about 15%. The reversal was driven by Qantas reporting a much-improved half-year result that reduced its cash burn, a cost-saving international sharing deal with Emirates, and Qantas aggressively adding domestic capacity to counter Virgin’s move into the corporate market—factors that have improved Qantas’s outlook and hurt Virgin’s near-term prospects.
How does Qantas’s sharing deal with Emirates affect its international division?
The Qantas–Emirates sharing arrangement is intended to lower operating and capital costs and help fix Qantas’s loss-making international division. According to the article, the deal should reduce the financial pressure on that part of the business and was a key catalyst for Qantas’s recent share improvement.
What does Qantas flooding the domestic market mean for yields and for Virgin Australia?
Qantas increasing domestic capacity to counter Virgin’s corporate push means more seats are available without growth in overall demand. That excess capacity will likely drive down yields (average ticket revenue per seat) for both airlines, which is a particularly bad sign for Virgin given its weaker recent performance.
Who is Chris Corrigan and why is his investment in Webster Limited (WBA) notable for investors?
Chris Corrigan is a high-profile corporate figure (former BT Australia and Patrick boss) who invested nearly $7 million in Webster by taking a placement at roughly 50c a share, giving him about a 17% stake. He’s also participating in a 1-for-4 rights issue at 50c. His involvement helped lift the share price to about 60c and signals long-term commitment, which has attracted investor interest.
Is Webster Limited expensive and what are the main risks or timelines investors should know?
On the face of it Webster looks expensive: after the rights issue its market capitalisation would be about $65 million while ongoing earnings are roughly $4 million. Also, its walnut trees take about eight years to reach maturity, so earnings growth could be slow. The company plans to use proceeds to build a walnut cracking plant and expand farms, and management could consider selling the onion business to reduce earnings volatility—factors investors should weigh against Corrigan’s commitment.
Why has Freedom Foods Group (FNP) risen sharply and should investors worry about its valuation?
Freedom Foods has more than doubled over the past year. Its fully diluted market capitalisation is about $93 million and enterprise value about $122 million, against EBITDA of $5.3 million—an EBITDA multiple near 23x. Much of the investor enthusiasm is driven by Freedom’s 25.8% stake in listed NZ dairy group A2 Corporation, which is worth about $70 million. That stake makes Freedom’s multiples look more reasonable, but the underlying earnings picture still warrants caution.
How does A2 Corporation’s financial performance affect Freedom Foods’ valuation?
A2 Corporation earned NZ$4.4 million in its most recent year, which puts A2 on a P/E of around 80x. While Freedom’s 25.8% stake in A2 is a major part of its value (about $70 million), A2’s high P/E means investors are paying for expected future earnings growth. The article warns investors to be careful until longer-term earnings from A2 and Freedom materialise, especially as A2 expands into the British market.
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