Qantas flies on a subliminal win

The $100 million Qantas buyback is a crafty way of returning cash to shareholders while sending subtle messages to targeting the group's ailing share price.

In the context of a group with a market capitalisation of around $3 billion Qantas’ announcement of a $100 million buyback would appear of little consequence.

The decision to give some of the cash generated by the recent sale of Qantas’ interest in the StarTrack freight business and a settlement with Boeing related to its restructuring of its B787 order, however, appears designed to send a number of subtle messages to the market.

While most of the cash released from those deals – $650 million of it – will be devoted to paying down debt early as part of a $1 billion debt-reduction program, using a small proportion of it to effectively return cash to shareholders is clearly targeted at the ailing Qantas share price, which has been trading at around half the group’s book value.

Qantas, which incurred its first loss since its privatisation 17 years ago in the financial year just passed, hasn’t been paying dividends as it has sought to preserve its cash and protect its precious investment grade credit rating during a period of massive structural change.

Given its paucity of franking credits because of the accelerated depreciation charges associated with its fleet renewal program, it actually doesn’t make a lot of sense for Qantas to reinstate dividends at this point even if it were confident enough about its prospects to do so. The buyback of about four per cent of its capital is a more tax-efficient way of delivering some value to shareholders and getting a little leverage into its financial performance statistics.

Perhaps of more significance, it is also a way of demonstrating the Qantas board’s conviction that Alan Joyce and his team are on the right track and that the restructuring of the group’s loss-making international business is on a path to stability – that the second half of last year was a real inflection point in the group’s recent fortunes.

Qantas chairman Leigh Clifford referred to the group’s continued progress in turning around the international business, saying it had given the directors the confidence to approve some capital management measures.

The board, and management, having already had one prior brush with private equity, would be well aware that the sagging share price has left Qantas notionally vulnerable and would be hearing the persistent rumours that former chief executive Geoff Dixon and other former managers have, with private equity players, been running the numbers on the group.

Emirates chief executive and would-be alliance partner with Joyce, Tim Clark, while strongly endorsing the turnaround strategy actually referred to those rumours, and implicitly criticised the previous Qantas management, in a briefing with journalists in Dubai yesterday.

The proposed alliance, which requires Australian Competition and Consumer Commission approval, has a termination clause if there is a change of chief executive and strategy in either airline that adversely affects the alliance, which tends to underscore the strength of the personal relationships the two management teams have developed.

That alliance, which is being supported by the Federal Government and the Department of Infrastructure and Transport, is regarded as critical to creating a sustainable future for Qantas’ international business and enabling it to leverage off Emirates' Dubai hub and customer base. It will also enable Qantas to reorganise its Asian network to create a stronger regional base.

An ACCC draft decision is due by the end of this year and a final decision by March next year.

Qantas and Emirates received some perhaps unintended support from a competitor overnight when Etihad’s James Hogan extolled the virtues of partnerships as a way of overcoming the legislative and regulatory obstacles to conventional consolidation in an industry plagued by over-capacity and poor returns. Emirates’ partnerships, he said, would deliver about 20 per cent of its revenues this year, extended its reach, provide customers with more choices and delivered savings and synergies.

Since the Qantas alliance with Emirates was announced there has been a string of similar alliances proposed, including Singapore Airlines’ alliance and equity tie-up with Virgin Australia, Air New Zealand’s alliance with Cathay Pacific, Etihad’s relationship with Air France and a potential joint management proposal for Lufthansa and Turkish Airlines.

With the debt reduction and buyback announcement, Qantas also issued guidance for the first half of this financial year, saying it expects an underlying profit of between $180 million and $230 million. Last year it generated an underlying profit of $202 million in the first half.

That would be a creditable achievement in the circumstances, with continuing losses and upheaval within the international business and something of a price and capacity war occurring within the domestic market – although the comparison would be with a first half last year that was disfigured by $194 million of costs relating to the grounding of the Qantas fleet and the guidance for the first half of this year may include the settlement with Boeing, estimated at around $135 million.

"Normalising" the two halves would suggest that, while it has pulled itself out of the red that it experienced in the second half of last year, the group’s real underlying profitability is still quite modest relative to where it was in 2010-11 and where it would have been last year if not for the industrial disputes.

Qantas said total domestic capacity was expected to increase by between seven per cent and nine per cent in the half relative to the same half previously but group yields were expected to be lower.

That’s a function of Qantas’ response to Virgin and Tiger Airways’ aggression. Virgin has announced plans to acquire a majority interest in Tiger’s Australian business, as well as regional airline Skywest in an effort to broaden its assault on Qantas and its Jetstar brand. The intense competition is producing capacity growth well ahead of demand growth, hence the lower yields and profitability.

The $1 billion debt reduction program Qantas announced today does highlight its unusual balance sheet strength (for an airline) and therefore its ability to withstand the financial consequences of the increased competition from its smaller and more financially constrained competitor, albeit one that counts as its allies (and in most instances shareholders) a raft of Qantas’ fiercest international competitors. That may have been another layer in the messaging implicit in the announcement of the buyback.


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