Refuelling Rex comes at a price

Reinstating a government rebate will help Rex regain altitude – but it will need more to really take off again.

Summary: Regional Express, otherwise known as Rex, has hit turbulence over the removal of the enroute regional airline rebate by the former federal government. Its shares have fallen heavily this week, with the company announcing a profit downgrade. The new government intends to reinstate the rebate – which will help revive Rex – but more is needed for the airline to rebound.
Key take-out: Rex expected full-year net profit equates to a forward price-earnings ratio of around 12.9 times. Its average P/E hovers around six times.
Key beneficiaries: General investors. Category: Shares.
Recommendation: Neutral.

Shareholders of Regional Express Holdings (REX) have flown into a storm, with the aviation industry joining the chorus of blame directed at the federal government.

The regional carrier suffered its second-worst one-day fall of 10.6% to 80.5 cents on Monday after it warned investors its interim pre-tax profit would fall by around 40%. This is due largely to the removal of rebates and the carbon tax that were instituted under the previous Labor government.

Rex is putting pressure on the current federal government to act or risk grounding the regional airline industry after the recent collapse of two of its peers, Aeropelican and Brindabella.

The dire industry warning coincides with federal treasurer Joe Hockey’s declaration that the “age of entitlement is over”, when he refused to lend financial support to the automotive manufacturing sector and the Coca Cola-controlled fruit canning company SPC Ardmona.

Would the federal government apply the same hard-line approach to the enroute rebate that appears to be so necessary to the industry? Those wondering if Rex’s nosedive represents a buying or selling opportunity will want to watch this space, as the government rebate and carbon tax will have a very significant impact on Rex’s bottom line.

All signs indicate that the industry will at least see the return of the rebate in the short term. Advisors from the Prime Minister’s office have spoken to Rex this week about assistance to the industry. A spokesperson for Warren Truss, the Minister for Infrastructure and Regional Development, also confirmed with Eureka Report that the rebate is being finalised, although he backed away from giving a timeline or saying if the rebate will be structured the same way as before the Gillard government revoked it in 2012.

“The reintroduction of the enroute rebate scheme for regional commercial airline carriers is a government election commitment,” he replied to questions in an email.

“The scheme will contribute to the viability of airline services to regional and remote communities. It reflects the social benefits these services provide in connecting regional and remote towns with larger service centres.”

This social good is what makes the rebate stand apart from other government handouts, and the rebate is estimated to bolster Rex’s expected net profit by around 28%, or $2 million, on an annualised basis.

As the profit warning goes, the six months to end December would see Rex post its smallest first-half net profit of around $3.6 million since it delivered its very first interim result as a public company in 2005.

While Rex is playing up the threat of bad government policies to the industry, its general manager for corporate services, Irwin Tan, is down playing the risk of Rex going under like Brindabella or Aeropelican.

“I’d say we are a strong and efficient airline,” says Tan. “If Rex were to go under, other airlines in Australia would be in even worse trouble.”

Of the three ASX-listed airlines (the other two being Qantas Airways, Virgin Australia Holdings), Rex is the only one that’s expected to deliver a full-year profit for 2013-14.

Investors may be wising up to the probability of the government reinstating the rebate, as Rex’s share price jumped 5.6% to 85 cents yesterday.

Things may not be getting better, but they don’t appear to be getting worse – even if the government drags its feet on the rebate and carbon tax. This means Rex should post a full-year net profit that’s a little over $7 million. This equates to a forward price-earnings ratio of around 12.9 times.

That may not look obscenely high, but the stock is no bargain either given that its average P/E hovers around six times.

If you factored in the rebate and assumed no earnings growth for 2014-15, the P/E will drop to 10 times. With the rebate and removal of the carbon tax, the P/E will come in at eight times. The rebate is within Truss’ power to reinstate, but the carbon tax is more complicated as Labor and the Greens are blocking the legislation in the Senate.

But even if Rex gets its wish for both, I don’t think government action is enough to entice bargain hunters to buy the stock. What is also needed is for Rex to instil confidence that its earnings will grow from here to attract value investors.

That may be easier than you’d think. The fact that two of Australia’s oldest private regional carriers have gone bust will leave the market pretty open for the $94 million market cap airline. All it takes is for profits to return to Rex’s nine-year average for the stock to look compelling at current levels.

I am reserving my recommendation on the stock pending further updates from the company. Watch this space.

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