Company Overview: Qantas Airways Limited is an Australia-based company, which operates domestic and international airline. The Company is engaged in the operation of international and domestic air transportation services, the provision of freight services and the operation of a frequent flyer loyalty program. Its segments include Qantas Domestic, Qantas International, Jetstar Group, Qantas Freight, Qantas Loyalty and Corporate. The Qantas Domestic, Qantas International and Jetstar Group segments include passenger flying businesses. The Qantas Freight segment is engaged in the air cargo and express freight business. The Qantas Loyalty segment is engaged in the customer loyalty recognition programs. Its main business is the transportation of customers using two airline brands, which include Qantas and Jetstar. It also operates subsidiary businesses, including other airlines and businesses in specialist markets, such as Q Catering. Its airline brands operate regional, domestic and international services.
 

QAN Details
 
Over last few years, Qantas (ASX: QAN) has emerged as a dominant player in the airlines sector. The group’s Jetstar’s earnings have increased under the tenure of Jayne Hrdlicka, who has lately resigned as the CEO of the Jetstar Group. The top-line growth in terms of market penetration in Asia and oil prices scenario had benefitted Jetstar last year. However, the group has been lately impacted by Virgin Australia’s (ASX: VAH) planned capacity increase and its full-service carrier, Qantas Domestic, and low-cost carrier, Jetstar have lost up a bit of the shares in the key routes (including the Golden Triangle), to VAH over the past one year. With the news on privatisation of Virgin Australia and any relief on oil prices, coupled with company-wide efforts are expected to set a different track for the group. The game-changing aircraft, Dreamliner linking Australia to Europe is also expected to reap benefits. The domestic WI-FI project is also anticipated to help Qantas become more efficient and deliver a revenue premium.
 
Tracking well in 2018: Recently, Qantas came out with its market update with regards to performance during the first quarter of FY18. There was a 5% rise in total revenue ($4.19 billion) for first three months over prior corresponding year, owing to improved domestic and international markets’ performance. Particularly, the result was driven by major improvements in its domestic demand and proactive capacity management, which led to an increase in its unit revenue per available seat kilometre. The conditions in the international market also improved despite an increase in its competitor capacity. Overall, Qantas hopes to achieve a major step change in global aviation in the coming period while some headwinds on fuel prices and unit revenue impacted by international capacity growth are expected to hit the second half of FY18.
 

Trading Update (Source: Company Reports)
 
Financial Performance: QAN reported an Underlying Profit Before Tax of $1,401 million in FY17 which is the second highest performance in its history. The group saw an improvement of conditions in the second half post a subdued first half and posted an Underlying EBIT of $327 million. Qantas Loyalty booked a record of $369 million of underlying EBIT which is a 4% increase in revenue as it continued to diversify its earnings. During 2017, it further strengthened its capital position through a sustained free cash flow. The net debt fell by $434 million to $5.2 billion as compared to prior year and it was at the lower end of the target range. More than 60% of the group’s fleet became debt-free which represents an unencumbered asset base of around US$3.8 billion. In 2017, a total of $627 million was distributed to its shareholders by buy-back and ordinary shares. The Cost of Capital also minimised by using cash in excess of its short-term requirements to refinance its operating leases. The group’s strong result was achieved in mixed global trading conditions which resulted in a 2% decrease in Unit Revenue, which was partially offset by a total unit cost improvement of 1%. On the other hand, the group indicated that the Unit Revenue growth in Domestic is forecasted to slow in the second half of financial year 2018.
 

Shareholders’ Returns 2016 onwards (Source: Company Reports)
 
Segment-wise Performance: Its domestic business got stronger with a growth in leisure segments. Combined, Qantas and Jetstar have around 90% of the domestic profit pool and have a widening margin advantage over their competitors. This made Qantas witness another record year for its group Domestic segment. The Jetstar Group Limited delivered its second highest result with a decent performance from domestic and international flights and from its operations in Asia. As far as its international cargo market is concerned, there was a slowdown but still Qantas freight remained profitable and if we look at the Qantas Loyalty Segment, it again recorded profits and it was driven by new and existing partners in the traditional Frequent Flyer business and earnings were also recorded from its new businesses like health insurance.
 
Foreign and other holdings: As per ASX Listing rules, Qantas needs to notify ASX whenever foreign persons will be holding the relevant interest in Qantas equal to or exceeding 44 per cent and to update the ASX whenever the level of foreign ownership will change by more than 1% or if it falls below 44%. So, based on the recent reconciliation, foreign persons potentially hold relevant interests in 43.60% of the issued share capital of Qantas as at December 29, 2017 (against 46.72% as at December 04, 2017). This still indicates for a good provision in terms of group’s targets over the next few years. Other than this, BlackRock Group became the substantial holder of Qantas by holding 88,608,881 shares with 5.07% voting power. On the share buy-back update, Qantas had cancelled 15,694,985 shares due to non-compliance of the minimum holding of buy-back shares, as updated in December 2017.
 
Lessening of competition for Jetstar: Late last year, ACCC proposed to re-authorise the coordination involving three Asian based Jetstar branded joint ventures namely, Jetstar Asia, Jetstar Pacific and Jetstar Japan, for a further five-years; and this will result in public benefits and will help Jetstar branded airlines to operate as a single fully integrated organisation on matters such as flight scheduling, sales and marketing and pricing.
 
Transformational Spree: Qantas three-year’s $2 billion turnaround program, which was started in 2014 to make Qantas Group sustainably profitable got over now, and has delivered good outcome. The group also indicated for a clear program to deliver $400 million benefits every year and it has already started delivering on this. Its main objective is to improve every part of its customer journey and to have the right aircraft on the right route. It is planning to increase the size of its Premium Economy cabin and is also completing the refurbishing of its First Class to make its seats more comfortable. The process of overhauling the lounge space at the front of the upper deck and reconfiguration of this part of the aircraft to create more rooms for its customers to relax are also tracking well. QAN is also working with Airbus on the more effective use of cabin space and has also added more premium seats to improve the overall economics of the Aircraft.
 

Transformation Program (Source: Company Reports)
 
Outlook: Qantas Group expects to report an Underlying Profit Before Tax in the range of $900 million to $950 million for 1H FY18 against the Underlying Profit Before Tax of $852 million of 1H FY17. While, unit Revenue growth in Domestic is expected to slow in the second half, Group International capacity will increase by around 5% in the first half and 3% in the second half due to previously announced network changes targeting growing Asian markets. There are many projects in the pipeline which will improve the experience of its customers with an improvement expected in the return on investment. The group is also welcoming the game-changing Dreamliner into Qantas International, which is an aircraft that will open-up unique routes such as Perth-London and will also deliver on lower operating costs. The group also started targeting an annual average of $400 million in gross cost and revenue improvement and it focuses on its continuous improvement which will drive cost and revenue benefits from new technology and will help in creating more efficient operations while ensuring that the group holds and strengthens its competitive position in the market. A forecast of 6% to 7% increase in international competitor capacity has been indicated and a rise in oil prices is expected to lead to slightly cap earnings growth in FY18. Nonetheless, the benefits of the changes in international network and efforts in domestic market are significant and expected to start flowing fully through from FY19.
 
Stock Performance: Over the past 3 years, Qantas share price has increased tremendously driven by the sustainable structural changes delivered under the Transformation program. Its Total Shareholder Return (which includes share price growth and dividends) of +372% over the 3 years positioned Qantas as the best performing stock of all the companies in the ASX100 in 2016/17 and also the best performing stock of the 17 airlines that comprise its Global Listed Airlines Peer Group. QAN’s profit margin has been expanding over the last few years and is expected to continue to expand further, with rising annual revenue growth and annual net income growth. Cost efficiency and revenue increases will drive earnings growth. The stock price has decreased by 11.75% in the past six months owing to volatility and concerns over increased competitor capacity; but this seems to proffer an investment position given the potential of the group. We give a “Buy” on the stock at the current price of $5.18
 

QAN Daily Chart (Source: Thomson Reuters)

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