Qantas: Interim result 2019

To appreciate Qantas's profitability, we need the big picture: the company had earnings per share of 30 cents in the six months to December, which may be acceptable were it not for the fact that - coincidentally - this is exactly what it earned in the six months to December 1999. 

Over the past 20 years, the company's earnings per share have been as high as 56 cents and as low as minus $1.37. Today's price-earnings ratio of 11 isn't that great when you take the 30,000 foot view of this highly cyclical business that hasn't grown earnings per share in 20 years.

Qantas's pre-tax profit fell 19% compared to last year, mainly due to rising fuel costs. Management estimates that $416m was cut from the company's earnings due to fuel prices alone. 

This sums up why we think it's wise to avoid the stock. Qantas's profitability and future are dependent on factors largely outside its control: volatile fuel prices, an oligopoly of suppliers (Boeing and Airbus), heavy regulation, government subsidisation of Middle Eastern and Asian airlines, unionised labour, capacity changes at other airlines, and large fixed costs. Sure, year-to-year, you may see profitability rise - sometimes dramatically - but predicting how the company will be doing a decade from now is anyone's guess. 

Nonetheless, Qantas's domestic operations had a decent year, with revenue increasing 6%, though underlying earnings before interest and tax (EBIT) rose only 1% due to the increased fuel costs. While margins shrank, Qantas still has a sizeable margin advantage over its main competitor, Virgin Australia. Qantas's local EBIT margin was 14%, compared to 8.5% for Virgin. In other words, Qantas has more room to cut prices during difficult times and still remain profitable.

Now, the bad news

The company's budget Jetstar division had a poor year, with revenue up 5% but underlying EBIT down 20%. The company said it was due to fuel costs as well as higher airport charges and taxes.

The real dead weight, however, was the company's International division. Revenue rose 7% due to higher seat capacity, but EBIT fell 60% due to rising fuel costs as well as increased general activity, commission and selling costs. With a high proportion of fixed costs and low margins, small changes to variable costs like those above can lead to big changes in profitability.

Thankfully, Qantas's loyalty program offset some of the damage. The division increased revenue 8%, to $809m, and underlying EBIT was up 4%.

As we explained in Why Buffett loves airlines but you should still avoid Qantas, the Loyalty division is about the only part of the business we like due to its ability to generate lots of free cash flow and its dominant share of the market. Issuance of Qantas-branded credit cards grew 4% during the period, compared to a 1% decline for the overall market, which suggests its advantage continues to grow. Management targets are for the division's underlying EBIT to grow 40-70% between now and 2022.

Management expects a strong second half, with forward bookings up 7% as of December. Fuel costs, however, are expected to cut at least $250m from earnings. Qantas has some advantages in the Australian market but it continues to struggle internationally. Rising fuel prices and aggressive competition only add to its troubles and we continue to recommend you AVOID.