MARKETS SPECTATOR: Capacity catalyst

In a research note to clients, Macquarie Group has upgraded the airline sector given the improving outlook for capacity growth in the Australian domestic market.

The broker notes that, encouragingly, the latest schedules released by Virgin Australia show a slowdown in capacity growth to around 4.7 per cent in the second half, which is below its guidance of 5 to 7 per cent and further to 3 per cent growth in the first half of fiscal year 2014.

This is a good sign for the sector and should show more rational capacity behaviour from Qantas, too, which in turn should allow for a swift recovery in both load factors and yields.

Macquarie sees the aviation market in Australia becoming more normalised in the coming years.

“Historically we estimate domestic earnings before interest and tax margins for the industry to be about 9 per cent compared to an estimated ~5 per cent in fiscal year 2013. With demand holding firm and a moderation in seating growth, aligned with a more rational Tiger (if Tiger remains at all), we would expect industry EBIT to start moving back towards a normalised run rate of $900 million compared to the $515 million in fiscal year 2013.”

The broker also notes that while the amended capacity outlook is positive for both Australian carriers, Qantas has more to gain from a turnaround in its international business. Macquarie believes that if the Emirates benefits start flowing through in the next six months, then Qantas’ loss-making international division may be able to achieve a break-even result by the end of fiscal year 2014.

Subsequently, Macquarie has lifted its recommendations on both Qantas and Virgin Australia to outperform with price targets of $2.09 and $0.53, respectively.