Qantas's take-off plans

It’s always good to talk to a chief executive who has a spring in his step and believes that his company is on the way back with a vengeance.

I was talking last week to the chief executive of Qantas, Alan Joyce, who comes into that category. Joyce clearly believes that his shares are under-priced and is therefore a strong defender of the fact that he is using some $100 million of Qantas spare cash to buy back Qantas shares. And although current profits are depressed, there will be more cash available for buybacks. Shareholder dividends may be back in a year or two.

Underpinning that buyback decision is the fact that in just about all the areas where Qantas operates life is looking good. Even though the massive effort to establish Jetstar in Asia will be a drain on the group for the next few years, the strategy still looks like being a long-term winner.

An earnings take-off

Brokers are agreeing with Joyce and forecasting that while the current level of operating earnings per share of just under 6 cents might even slip in the current year, it is set to rise dramatically to above 11 cents a share in 2014-15, and in excess of 22 cents a share in 2015-16.

Joyce will not comment on forward profit estimates and points out that the airline market is notoriously volatile. Nevertheless, in the Qantas domestic business the retirement of the ageing 767 fleet over the next 18 months, and other measures, will substantially lower its cost base. At the same time, it has to rid itself of much of the industrial problems that did so much damage.

Very few Australian chief executives have had the courage to stand up to strong unions, let alone win. So Qantas has a cost base that is set to be much closer to that of Virgin. Joyce even thinks it may even get down to within 5% of Virgin, although Virgin itself will no doubt lower its own costs. Joyce believes that Qantas has an ability to gain a much greater airfare premium over Virgin than the cost-base differential. He believes Qantas is therefore in a winning position. Moreover, in the last two years Qantas has shown that if Virgin increases capacity so that its 65% market share is jeopardised, Qantas will respond, and respond aggressively, via fare reductions and extra capacity.

That sent Virgin into the red in the last financial year, while Qantas maintained profitability. The skirmish was akin to wrestlers testing their muscles and discovering their strengths and weaknesses. From now on we are more likely to see the traditional situation which arises when there are two powerful competitors who both want to make profits. It can be a very rewarding time for shareholders. Virgin will also benefit.

Emirates and Jetstar

On the international operation, the full benefit of the link with Emirates has not yet come through, but Joyce is very optimistic that in two years the international operation will break even. This will be a great boost to Qantas given the current loss rate.

His level of optimism is enhanced by the fact that United Airlines has lowered its capacity on the trans-Pacific route, which is Qantas’s main profit area. Lots of other airlines want to get into the Pacific route, and if that happened it would make the task of maintaining profits from the Pacific route that much harder. For Qantas, so far so good.

A large chunk of Qantas’s profits come from its rewards scheme, and that continues to go extremely well and represents stable growth. And in the case of Jetstar the group continues to perform well locally. But the big long-term growth potential is the attempt to establish a Jetstar network in Asia. The plan is to use the Jetstar formula, but for Qantas to have a minority stake in each of the Asian Jetstar airlines.

It is has secured a substantial share of the Japanese market, but it requires further market share to gain profits. It is now about to launch against Cathay in Hong Kong. Cathay has tried to prevent Jetstar from gaining access to the Hong Kong airport, and seems to be gaining traction, but Joyce remains very confident he will succeed given that the company is controlled out of Hong Kong and that the Jetstar stake is a minority one. Nevertheless, assuming Hong Kong Asia goes ahead there will be a fire storm of price cutting. But longer term, a valuable market share will be established and a unique network of Asian discount airlines created.

Australians are urging their companies to go into the growth markets of Asia, and that is exactly what Qantas is doing. It is doing this by establishing new businesses rather than paying top price for existing ones. That is not good for the bottom line in the short term, but the fact is that the Asian thrust is coming at a good time for Qantas.

Meanwhile, the fact that Tony Abbott has won office means that in due course the carbon tax will be removed, and that could add up to $100 million to the Qantas bottom line, assuming it does not end up being applied to lower fares. (Qantas had hoped to recoup the carbon tax via higher fares, but the war with Virgin prevented that. It may now get the higher fares and no carbon tax.)

At the same time, at least for the moment, it looks as though there is less chance there will be a US military engagement in the current war in Syria, so oil prices are falling. In the last few months, Qantas has experienced a fall in the Australian dollar but a rise in the oil price – a rare event. That means that, in Australian dollars, it has been paying record prices for its fuel and that will impact on the 2013-14 bottom line.

Qantas shares are not for the faint-hearted, because the airline business is high risk and it has turned out that the big rewards from airline travel go to airports rather than the airlines.

Nevertheless, when you see brokers predicting a company earning more than 22 cents a share in two or three years’ time, that means there is a lot of upside to this company.

Whereas Alan Joyce looked downtrodden a year or so back, now he believes the difficult times are behind him and he can start delivering rewards to shareholders.