Qantas Update (QAN)

Submitted by Craig Strzelecki on 25 May, 2007 - 20:45

Qantas has a Buy 2 broker call and a $5.90 share price target from sharemarket analyst UBS. Loyalty Demerger, and Capital Management: At least another 12 months of tight supply and strong demand: They are raising their FY08 forecasts by 11% and reinstating a rating with Buy 2 following the breakdown of APA's bid. Qantas achieved a record 15% growth in international unit revenue in the March quarter driven by no growth in market capacity and strong demand. The analysts expect these conditions to continue for at least another 12 months, which should drive earnings momentum. Management could demerge the Frequent Flyer program: They believe APA's bid is likely to encourage the Qantas Board to become more proactive on shareholder value initiatives. Amongst various options, one such strategy which the analysts believe APA was intending to pursue was demegring the Qantas Frequent Flyer Program in a similar fashion to Air Canada's Aeroplan. They estimate this could add 70c per share in value. A$2bn of capital management still retains BBB+: They also expect a review of the airline's capital management policy and believe Qantas could sustain a A$2bn buyback without jeopardising its BBB+ rating. At 12x, they estimate such a buyback would be 9% EPS accretive and add a further 40c of value. In their view, unwillingness to act by management and the Board may be the biggest barrier to this upside. Management and Board appear proactive: Qantas' briefing to the market post the APA deal collapsing confirms its intention to execute on some of the strategies contemplated by the consortium, including demerging the Frequent Flyer Program and capital management. Their report published on 22 May discusses in detail the potential upside of 70c and 40c per share respectively from such strategies. Strong operating conditions continue: Management also stressed the strength of the current operating environment and that it expects the current tightness of widebody capacity to underpin the international business for another 12-18 months. This accords with their above-consensus forecasts in FY08, where they forecast 5% growth in unit revenue. Forecasts will need to be reviewed further: Management's prediction of 4% capacity growth in FY08 and 10% thereafter in the international business is much higher than their expectation, which will require them to revisit their fleet capacity forecasts. The analysts' A$5.90 valuation is based on 12x their FY08 EPS forecast, which is in the middle of the current trading range of Qantas' peers and at a 35% discount to the Australian Industrials. Their current price taregt does not take account of the additional A$1.10 in value highlighted in our previous report.

Meanwhile, another stockmarket analyst, Macquarie Research Equities have reviewed their model for QAN and have upgraded their recommendation to Outperform with a lifted share price target of $7.05. Yesterday, shares in Qantas (QAN) rallied to all-time highs after Chief Executive Geoff Dixon said the airline would capitalise on strong operating conditions to engage in a wide-ranging restructure. The analysts have lifted their price target to $7.05 based on an enterprise value to earnings before interest, tax and depreciation (EV/EBITDAR) multiple of 5.5x, in line with the Singapore Airlines and Cathay trading range. Qantas and indeed the industry are in a sweet spot, which is set to continue. Loads and yields are high and QAN's superior franchise and two brand strategy have positioned it capitalised on the strong capacity growth expected in the coming years. Business well positioned for growth: Qantas is looking to lift its international capacity by a compound annual growth rate of 8% over the next three years. With yields and loads at near record levels and the delayed A380s creating pent up demand, the analysts see this capacity providing strong earnings growth in the coming years. The introduction of the fourth cabin will also help to support yields. The domestic business is also expected to grow significantly, with Qantas' two brand strategy and wide body planes positioning it well against growth from VBA and new entrants like Tiger. At least $2bn to shareholders: The recent bid has compelled management to undertake a comprehensive review of its capital management. The analysts are confident that the business can support a return of a least $2bn or 97¢ per share, which would lift gearing to 55%. The cashflows of the business are strong enough to repay this amount over the coming three years. Other businesses under review: Management is also undertaking reviews of Qantas' other businesses. A review of the Frequent Flyer program could see an immediate uplift in cashflow, with some major partner contracts up for renewal. Qantas also highlighted its intention to build a fully fledged express logistics business. Since the market is unlikely to fully value this business within Qantas, The analysts see it as a prime candidate to be demerged, providing further opportunity for capital returns, albeit in the long term. Qantas operates a strong franchise and is well placed with its dual brand strategy to leverage industry growth for the next three years.

Qantas Airways Limited is listed on the Australian Stock Exchange (ASX) under stock code QAN. You can view their investor website here. QAN was listed on the ASX on 31 July, 1995. Margaret Jackson is the chairperson for Qantas and Geoff Dixon is the CEO. The company is involved in the operation of international and domestic air transportation services, the sale of worldwide and domestic holiday tours and associated support activities including catering, information technology, ground handling and engineering and maintenance. They also also operate subsidiary businesses including other airlines, and businesses in specialist markets such as Qantas Holidays and Qantas Flight Catering. Find out the meaning of the recommendations in this primer. Browse for other stockbroker recommendations. You can use Instalment Warrants to trade QAN. Check your charts and good luck with your share trading!

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