QANTAS Airways Ltd. (ASX:QAN)
Emerged from turbulence, Australia’s phoenix
is soaring to new heights
BUY
18.3% Upside
12 Month Price Target: $7.76
Last Close: $6.53
1 Month VWAP: $6.56
Andre Thomas | Jason Shi
Moniq Wever | Patrick
Mahony | Rachel Wang
Business overview
QAN is Australia’s travel provider of choice
The only Australian airlines with extensive international flights…
…renowned for its safety and quality
0
5th
Jet airliner fatalities
and hull losses
2022 World Airline
Awards ranking
…and dominates the world’s 5th busiest route
World’s busiest routes in Feb-23 by volume (m)
1.4
1.2
21m
1.0
passengers
in FY22
0.8
0.6
0.4
49
international
destinations
116
0.2
domestic
routes
0.0
CJU-GMP
Overview
Source: Company data, SURG analysis
Demand
Profitability
Diversification
ESG
HAN-SGN
Valuation
CTS-HND
Risks
FUK-HND
MEL-SYD
Appendix
2
Industry and market overview
QAN holds steady course in a favourable domestic market
Travel demand continues to recover to pre-COVID levels…
…and QAN is well positioned to capture this demand
Australian Passenger Volumes (% of 2019)
Australian Domestic Airline Market Share
120%
100%
QAN 62%
5%
80%
35%
60%
33%
40%
Domestic
Overview
Source: ACCC, BITRE, SURG analysis
International
Demand
Profitability
27%
FY25E
HY25E
FY24E
HY24E
FY23E
FY22A
HY22A
FY21A
HY21A
FY20A
HY20A
FY19A
HY19A
FY18A
HY18A
FY17A
-
HY23E
Recovery has been
sustained post
reopening
20%
Total
Diversification
Qantas
ESG
Valuation
Jetstar
Virgin
Risks
Rex
Appendix
3
Share price
Despite structural improvements, QAN still flies below peers
QAN’s discount to global peers is 1.9 standard deviations below pre-COVID averages…
Global Peer Set
20%
COVID Distortions
10%
Relative EV / EBITDA
0%
(10%)
(20%)
(29.5)%
(30%)
(40%)
(46.0)%
(50%)
(60%)
(70%)
(80%)
Mar-15
Mar-16
Mar-17
Mar-18
± 1 Standard Deviation
Overview
Demand
Profitability
Diversification
Mar-19
Mar-20
QAN discount
ESG
Mar-21
Mar-22
Mar-23
CY15-CY19 Average
Valuation
Risks
Appendix
4
Executive summary
QAN is set to soar after experiencing turbulence
We issue a BUY recommendation, with a 12-month target price of $7.76, a 18.3% premium on the 1-month VWAP
QAN’s domestic market advantage is underappreciated
Cost discipline and accretive CAPEX enhance profitability
Diversified portfolio reduces cash flow risk
BUY RECOMMENDATION
Overview
Demand
Profitability
Diversification
ESG
Valuation
Risks
Appendix
5
1. An underappreciated domestic market
Taking off globally: Virgin’s IPO roadshow will drive awareness on the advantages of Australian aviation
QAN’s domestic market
Qantas’ domestic market possesses structural advantages
With a dispersed population and no substitute for air travel…
… with Qantas at the helm of a functional monopoly
Distance​
High speed rail
alternative
Melbourne - Sydney
900km
X
Brisbane - Sydney
900km
X
Brisbane - Melbourne
1,800km
X
Adelaide - Melbourne
730km​
X
Melbourne – Perth
3,400km
X
Perth – Sydney
3,900km
X
City pair
Airlines with
<1% share
Airlines
with <1%
share
… Australia’s domestic aviation market is uniquely income inelastic…
Income Elasticity
6
Income elasticity of airfare demand
Market
leader
(QAN)
4
2
Market
leader
Market
leader
0
MAL GER
Overview
ITA
SIN
UK
IND
TAI
Demand
Source: SURG Analysis, BTS, Qantas, Australian Financial Review
JAP KOR USA
Profitability
NZ
AUS
Diversification
Europe
ESG
USA
Valuation
Australia
Risks
Appendix
7
QAN’s domestic market
Qantas’ structural market advantages will be uncovered by Virgin’s IPO roadshow
Despite structural advantages, QAN’s discount to peers has widened
Virgin’s international roadshow will educate investors…
Relative EV / EBITDA to Global Peer Set
20%
Virgin IPO pitch starts with ABCs of
Australian aviation – Mar 22, 2023
0%
(20%)
(29.5)%
(40%)
(46.0)%
... providing exposure to Qantas, the industry’s market leader
(60%)
(80%)
Mar-15
Mar-17
± 1 Standard Deviation
1.9
Mar-19
Mar-21
QAN discount
Mar-23
4%
CY15-CY19 Average
Duopoly market structure with rationalized competition
drives industry leading margins
standard deviations below historical global peer discount
Overview
Demand
Source: Eurostat, BTS, BITRE, SURG analysis as at 12-Mar-23
20-year Australian domestic aviation demand CAGR
Profitability
Diversification
ESG
Valuation
Risks
Appendix
8
2. Elevated post-COVID unit profitability
The sky’s the limit: a renewed cost base and accretive CAPEX enhance earnings power
Higher post-COVID unit profitability
QAN has emerged a more agile, cost-efficient airline
In a disciplined market, QAN has flexibility to adjust capacity….
IPO
Recovery Plan and Transformation delivering cost savings
$828m
Virgin is unlikely to irrationally expand capacity
…supported by a materially reduced fixed cost base
Structural reduction in OPEX post-inflation
…with consensus underappreciating operating leverage
Overview
Demand
Source: Company filings, ACCC, SURG Analysis
Fixed Manpower/ASK
Profitability
10%
5%
EBITDA Margin
Diversification
ESG
Valuation
SURG Forecast
Risks
FY28E
FY27E
FY26E
FY25E
FY24E
FY23E
FY22A
FY21A
0%
FY24E
Total Fixed Cost/ASK
15%
FY20A
FY19
20%
FY19A
0.4
25%
FY18A
0.7
30%
FY17A
3.6
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
FY16A
-50.2%
4.1
EBITDA Margin
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Cents/ASK
Cents/ASK
-11.3%
Consensus
Appendix
10
Higher post-COVID unit profitability
Domestic fleet project renewal Project Winton to bring medium-term margin uplift
…with the new Airbus narrowbodies to boost unit metrics
QAN is better placed than peers to undertake fleet renewal…
18.0
5.0x
16.0
4.5x
4.0x
2
CASK benefits from higher capacity, aircraft utilisation,
fuel efficiency
3.5x
3.0x
10.0
2.5x
8.0
2.0x
6.0
1.5x
4.0
1.0x
2.0
Project Winton Unit Benefits
Cents/ASK
12.0
-
RASK benefits from maximising Sydney airport slot
usage and route optionality
Net Debt/EBITDA
Average Freight Age (Yrs)
14.0
1
0.5x
United
Airlines
Qantas
Airways
Korean Air
Lines
Fleet Age
Overview
Source: Company filings, SURG Analysis
Lufthana
American
Airlines
Delta Air Air Canada
Lines
Japan
Airline
-
Profitability
11.3
10.9
9.8
8.6
RASK
Pre-Winton
FY23E Net Debt/EBITDA
Demand
12.0
11.5
11.0
10.5
10.0
9.5
9.0
8.5
8.0
Diversification
ESG
Valuation
CASK
Post-Winton
Risks
Appendix
11
3. A diversified, resilient portfolio
QAN’s portfolio flies under the radar: quality revenue diversification reduces cash flow risk
A diversified, resilient portfolio
Freight is an underestimated element of QAN’s business
…where QAN will capture 3.9% more freight market share
Australia to catch up in eCommerce uptake…
Weekly Online Shopping Frequency Adoption Curve
Unique Value Drivers
60%
$1.4bn Australia Post
contract
South Korea 2022: 53%
50%
40%
China 2022: 50%
US 2022: 39%
An Amazon fleet contract
UK 2022: 34%
30%
Australia 2022: 25%
A high-value chain across ANZ, SE Asia and
USA
20%
10%
Australia 2020: 6%
2
Air freight meeting consumers’ next-day
delivery mindset
-
Overview
Demand
Source: AusPost, IBISWorld, QAN Company Filings
Profitability
Diversification
ESG
Valuation
Risks
Appendix
13
A diversified, resilient portfolio
QAN’s world-class customer Loyalty program helps to stabilise EBIT
A best-in-class Loyalty program….
…allows QAN to weather all storms
Loyalty Revenue (A$m) and
Points Earnt and Redeemed (billions)
200
2000
150
1500
125
1000
Source: QAN Company Filings, SURG Analysis
21%
26%
22%
FY23E EBIT
Points redeemed
Qantas
Profitability
FY27E
FY26E
FY25E
FY24E
FY23E
FY22A
FY20A
FY19A
FY18A
FY21A
Demand
15%
FY19A EBIT
-
Overview
7%
50%
75
Points earnt
4%
55%
500
Revenue
QAN beta sits below the pureplay airline average of 1.55
FY28E
100
Points Earnt and Redeemed (billions)
2500
175
Loyalty Revenue (A$m)
1.36
3000
Diversification
ESG
Valuation
Jetstar
Loyalty
Risks
Freight
Appendix
14
Environmental, Social & Governance
Improving shareholder confidence in QAN’s brand beyond the balance sheet
Environment, Social & Governance
QAN is becoming a mover and shaker with its growing green mindset
The only domestic airline linking remuneration with ESG targets…
FY22/23 Short Term Incentive Plan Scorecard
Category and Weighting
5%
… and leading the industry in Sustainable Aviation Fuel investments
million
A$50
FY22 R&D investment to establish Australia’s own SAF
industry
US$200
Market-first USD co-investment partnership with Airbus
million
15%
QAN Fuel Efficiency (bbl consumption per million ASKs)
255
245
235
20%
225
215
205
Overview
Demand
Source: QAN Company Filings, SURG Analysis
Profitability
Diversification
FY22 Weighted APAC Peer Set Average
ESG
Valuation
Risks
FY28E
FY27E
FY26E
FY25E
FY24E
FY23E
FY22A
FY21A
Customer Satisfaction
FY20A
Financial Performance (UPBT)
FY19A
Workplace Safety
FY18A
ESG
195
FY17A
Decarbonisation Targets
FY16A
Recovery Plan and Growth
QAN Fuel Efficiency
Appendix
16
Environment, Social & Governance
QAN is rejuvenating its reputation as Australia’s trusted and reliable airline
QAN’s reputation has resumed having emerged from turbulence…
Cancellation Rates
… supported by a diverse team
80%
5.0%
Peer Board Gender Diversity
60%
4.5%
4.0%
40%
3.5%
3.0%
20%
2.5%
-
2.0%
1.5%
1.0%
… and a strong governance pipeline
0.5%
Pre-COVID Aug-22
Sep-22
Cancellation Rate QAN
81.7%
Oct-22
Nov-22
Dec-22
Cancellation Rate Industry Avg
On-Time Performance will continue QAN’s reputational
ascent
Overview
Demand
Source: BITRE, Company filings, SURG Analysis
Forward planning for CEO Alan Joyce with ~15 year tenure
Jan-23
Profitability
Diversification
5.3yr
ESG
QAN’s track-record of in-house promotions and guidance
on 3 clear candidates for succession
Valuation
Risks
Appendix
17
Valuation and investment risks
Soaring with a margin of safety
Valuation
We calculated a share price of $7.76, a 18.3% premium to 1-month VWAP
We valued Qantas using a blended approach consisting of a discounted cash flow model (70%) and a relative valuation (30%)
Last Close
$6.56
52 Week Trading
Range
$4.21
Target Price
$7.76
Discounted Cash Flow Model Drivers
$6.87
Broker Targets
$5.68
$9.50
Blended Valuation
Methodology
$6.80
Discounted Cash
Flow Model (70%)
• Peers: 3 geographic peer sets; APAC, EU, NA
• Approach: application of historical
premiums/discount versus median approach
$8.53
$6.67
EV/EBITDA Relative
Valuation (30%)
• Flying: Yields, ASKs, RPKs, Load Factor
• Loyalty: 2 year weighted points lifecycle
• WACC 9.6% (forecast); 9.1% (terminal); TGR
2.5%
Relative Valuation Drivers
Bear Case Scenario
$8.50
$7.10
$8.61
Yields
-150bps
Load Factors
-350bps
Points Earnt
-200bps
CASKs
+150bps
Derives 7.2% downside to last close
$3.50
Overview
Source: SURG Analysis
$4.50
Demand
$5.50
Profitability
$6.50
$7.50
Diversification
$8.50
$9.50
ESG
Valuation
Risks
Appendix
19
Investment risks
Impact
High
We recognise two key downside risks to our BUY recommendation
C
A
A
Jet Fuel Margin Risk: Persistently elevated jet fuel margins could
reduce profitability
B
Macro Risk: Turbulence of macroeconomic downturn subdues
demand for air travel
C
Competition Risk: Increased competitive intensity from domestic
and international competitors affects yield performance
D
Succession risk: CEO Alan Joyce 14+ year tenure vacating position,
exposing risks within the successor pipeline
B
Low
D
Low
Overview
Source: SURG Analysis
Probability
Demand
High
Profitability
Diversification
ESG
Valuation
Risks
Appendix
20
Summary
QAN has weathered the storm and is set to soar
QAN’s domestic market advantage is underappreciated
BUY
Cost discipline and accretive CAPEX enhance profitability
Target Price: $7.76
18.3% Upside
Revenue diversification reduces QAN’s cash flow risk
Overview
Demand
Profitability
Diversification
ESG
1-Month VWAP
Valuation
Risks
Appendix
21
Appendix Network
1. Main Deck
2. Business overview
3. Industry and market overview
4. Share price
5. Executive summary
6. Thesis 1 – An underappreciated domestic market
7. QAN’s domestic market
8. QAN’s domestic market II
9. Thesis 2 – Elevated post-COVID unit profitability
10. Higher post-COVID profitability
11. Higher post-COVID profitability
12. Thesis 3 – A diversified, resilient portfolio
13. A diversified, resilient portfolio I
14. A diversified, resilient portfolio II
15. Environmental, Social & Governance
16. Environmental, Social & Governance I
17. Environmental, Social & Governance II
18. Valuation and investment risks
19. Valuation
20. Investment risks
21. Summary
22. Appendix Network
23. Appendix A - Overview
24. A1 | What has the market missed?
25. A2 | Catalysts
26. A3 | Operating divisions overview
27. A4 | Share price history
28. A5 | Current trading data
29. A6 | Asset ownership - Fleet
30. A7 | Network map
31. A8 | Market dynamics
32. A9 | Australian spending habits
33. A10 | Fuel price and FX
34. A11 | QAN’s hedging strategy
35. A12 | Virgin
36. A13 | Rex and Bonza
37. A14 | Domestic and international competitors
38. A15 | Alliance acquisition
39. A16 | Western Sydney Airport
40. A17 | Intercity rail network
41. Appendix B – Thesis 1
42. B1 | Margin profile vs peers
43. B2 | Effects of dominant market share (1)
44. B3 | Effects of dominant market share (2)
45. B4 | Historic Australian aviation entrants
46. B5 | Other leading indicators of travel demand
47. B6 | Load factor sensitivities
48. B7 | QAN’s demand environment
49. Appendix C – Thesis 2
50. C1 | Capacity and Virgin IPO
51. C2 | Cost savings breakdown
52. C3 | Cost inflation and mitigation
53. C4 | Past examples of successful transformation
54. C5 | Project Winton and Project Sunrise summary
55. C6 | Project Winton – Fuel CASK savings
56. C7 | Project Winton – Capacity CASK savings
57. C8 | Project Winton – Utilisation CASK savings
58. C9 | Project Winton – Upgauging RASK benefits
59. C10 | Project Winton – Optionality RASK benefits
60. C11 | Project Winton – Aggregated benefits
61. C12 | Qantas Fleet forecasts
62. Appendix D – Thesis 3
63. D1 | Freight – changing consumer behaviour
64. D2 | Sensitivities
65. D3 | Fleet cargo capacity
66. D4 | Loyalty earnings
67. D5 | Loyalty partnership network
68. D6 | Loyalty Flywheel
69. D7 | Loyalty acquisitions summary
70. D8 | Peer Loyalty programs
71. D9 | Loan collateral case studies
72. D10 | Loyalty divestment case studies
73. Appendix E - ESG
74. E1 | ESG Scorecard
75. E2 | Operational KPIs
76. E3 | OTP vs peers
77. E4 | Succession plan
78. E5 | Executive incentive plans
79. E6 | Emissions
80. E7 | Diversity plan
81. E8 | QAN ownership
82. E9 | High Court Appeal
83. Appendix F - Valuation
84. F1 | Methodology weighting
85. F2 | Revenue derivation
86. F3 | Capacity analysis
87. F4 | Capacity mix
88. F5 | Domestic market share
89. F6 | Yield analysis
90. F7 | Load factor analysis
91. F8 | Passenger revenue analysis
92. F9 | Freight revenue analysis
93. F10 | Loyalty economics
94. F11 | Loyalty pro-forma revenue
95. F12 | Eliminations and corporate adjustments
96. F13 | Group revenue vs consensus
97. F14 | Historical revenue and capacity summary
98. F15 | Discounted Cash Flow model
99. F16 | FCF to Firm forecasts
100. F17 | Cost of debt
101. F18 | Cost of equity
102. F19 | WACC
103. F20 | Monte Carlo Simulation DCF
104. F21 | Terminal Growth Rate derivation
105. F22 | Scenario analysis
106. F23 | Terminal value sensitivity analysis
107. Appendix G – Financial analysis
108. G1 | Key ratios (1)
109. G2 | Key ratios (2)
110. G3 | Key ratios (3)
111. G4 | Book equity abnormalities
112. G5 | Profitability - RASK
113. G6 | Profitability – OPEX CASKs
114. G7 | Profitability – OPEX ratios
115. G8 | Profitability – One off costs
116. G9 | Profitability – Hedging policy (I)
117. G10 | Profitability – Hedging policy (II)
118. G11 | Profitability – Hedging Policy Limitations
119. G12 | Profitability – Fuel expenses (post hedging)
120. G13 | Profitability – Margin analysis
121. G14 | Capital management - Financing
122. G15 | Credit policy framework
123. G16 | Pro forma credit ratios and leverage
124. G17 | Dividends, payout and buyback
125. G18 | Capital expenditure
126. G19 | Treatment of lease liabilities post-AASB16
127. G20 | Revenue received in advance (RRIA)
128. Appendix H – Relative valuation
129. H1 | Methodology
130. H2 | Justification
131. H3 | Comparable sets
132. H4 | EV/EBITDA vs comparables
133. H5 | P/E vs compables
134. Appendix I - Risks
135. I1 | Macroeconomic risk
136. I2 | Fuel risk
137. I3 | Employee disputes
138. I4 | COVID-19 Risk
139. I5 | Reputation decline
140. Appendix J – Financial statements
141. J1 – Income statement
142. J2 – Statement of financial position
143. J3 – Cash flow statements
144. University of Sydney Team
145. Appendix K – Recent developments
146. K1 | COVID travel credits
147. K2 | Intent to travel
148. K3 | USYD survey details
149. K4 | Macro resilience I
150. K5 | Macro resilience II
151. K6 | New entrant threats
152. K7 | Free cash flow multiples
153. K8 | Virgin IPO
154. K9 | CEO succession planning
155. K10 | QAN employment relations
156. K11 | QAN safety concerns
157. K12 | Institutional hesitance towards airline exp.
158. K13 | Qantas EV/EBITDA
159. K14 | Group Emissions Pathway
160. K15 | ESG Regulatory risks