Airlines Soaring?

Thursday 31 August 2017 Airlines soaring? With reporting season pretty much over, it’s time to pick through the companies that stood out. Charlie Aitken says reporting season was “disappointing” overall, but one highlight was HUB24. Find out why. Also in the Switzer Super Report, have airline stocks hit cruising altitude or can they still soar higher? Tony Featherstone checks if there’s still value to be found. Plus, some of the world’s biggest investors have expressed concern about comments from President Donald Trump, so what does this mean for markets? Barrie Dunstan shares his views. Sincerely, Peter Switzer Inside this Issue 02 Big airline stocks have further to fly Two to watch by Tony Featherstone 05 HUB24: small cap structural growth idea Company highlight by Charlie Aitken 08 Trump and Wall Street What does it mean for markets? by Barrie Dunstan Big airline stocks have 10 Buy, Sell, Hold – what the brokers say Upgrades and downgrades further to fly by Staff Reporter by Tony Featherstone 14 Questions of the Week – minimum pension withdrawals 02 and transfer balance cap Reader queries by Questions of the Week Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No. 286 531 acting, consider the appropriateness of the information, having regard to the Level 4, 10 Spring Street, Sydney, NSW, 2000 individual's objectives, financial situation and needs and, if necessary, seek T: 1300 794 893 F: (02) 9222 1456 appropriate professional advice. Big airline stocks have further to fly by Tony Featherstone There are many reasons not to buy aviation stocks. from better resource sector activity. After a difficult Large airlines need huge capital investment, have few years, the regional airline has delivered a expensive, depreciating assets and no sustainable one-year total return of 53%. But the stock had flat competitive advantage. Their return on equity (ROE) return over five years and a slightly negative return has collectively been low and volatile. over 10. Then there’s the vagaries of weather, safety Across the Tasman, Air New Zealand has soared incidents, plane crashes and terrorism fears. Hardly 93% over one year. The airline’s latest full-year the stuff of dependable, recurring earnings growth result slightly beat market expectation. Like Qantas, that drives ROE higher, expands the airline’s intrinsic Air New Zealand is in its best shape in years thanks value and ultimately rerates the share price. to a good strategy and strong management execution. Some good judges I know avoid airline stocks. But every company has its price and some airlines, Airline bears, for the most part, have missed a mighty notably Qantas Airways, are rapidly improving and rally in the past 12 months. In a sluggish economy, still look OK value. Even Warren Buffett, a noted critic investors expected a more subdued performance of aviation stocks, started buying airlines again last from the cylical aviation sector. But they year. underestimated the turnarounds in Qantas and Air New Zealand. Qantas has delivered a 78% total return (including dividends) over 12 months, making it one of How high can airline stocks fly? Australia’s great corporate turnarounds. The company was on its knees a few years ago before The question now, is whether the rally can continue. management orchestrated a defining transformation Although recent gains impress, some airlines are still program. trading well below multi-year highs and have much ground to make up after earlier disappointments this In contrast, Virgin Australia Holdings continues to decade. The rally could run further. disappoint. The one-year total return is minus 15%; over 10 years Virgin has an annualised loss of almost I preferred to play the aviation theme through airport 20%. Virgin, at least, rallied in the past few weeks, stocks rather than airlines. Readers of the Switzer prompting speculation of a nascent recovering. Super Report know Sydney Airport was one of my favourite stocks for years (though it looks fully priced, Micro-cap airlines are also recovering. Mining for now). The boom in in-bound tourism is a mighty services group, Alliance Aviation Services, has a 47% tailwind for Sydney Airport and, increasingly, for one-year total return, having soared in the past few domestic airlines that benefit from extra travel activity. months after a period of heavy falls. Alliance is benefiting from a pick-up in resource sector activity Longer term, investors are underestimating four and higher aviation demand in remote areas. factors with airline stocks. The first is the purchasing power and preferences of Millennials (born between Regional Express Holdings (REX) is also benefiting 1983 and 2000). The Millennials are travelling far Thursday 31 August 2017 02 more than previous generations, much earlier in their A share buyback of up to $373 million suggests life. This demographic change is a key driver for Qantas is confident in its outlook and news of direct airlines, but analysts don’t seem to be factoring it into flights to London and New York is another positive. valuations. But the shares fell about 7% on the profit as brokers speculated on weaker domestic travel demand and The second is the potential for disruption through challenging international travel conditions. I suspect frequent-flyer programs. I wrote favourably about some investors were itching to take profits. Qantas’s program for this report in 2014, arguing that it had a lot more latent value than the market realised. The sell-off is good for prospective investors. At Analysts who argue airline stocks have no $5.61, Qantas trades on a forecast price-earnings competitive advantage underestimate the power of (PE) multiple of 10.7 times FY18 earnings, consensus giant frequent-flyer programs. Who needs Bitcoin analyst forecasts show. That is undemanding for a when Qantas frequent-flyer points are Australia’s company of its quality and just below the global de-facto second currency? average for airline stocks of about 11 times. As one the world’s most profitable airlines, Qantas arguably The third factor is the pick in the mining sector. The should trade at a small premium to the average fluorescent shirts that dominated regional airports at multiple for global airlines. the height of the mining boom, thanks to fly-in, fly-out workers, are starting to return. It’s nothing like A consensus price target of $6.20, from broking firms boom-time conditions, but there’s enough to suggest that cover Qantas, suggests the stock is undervalued regional aviation demand is slowing improving, giving at the current price. I’m expecting Qantas to recover a fillip to airlines. recent losses, and then some, within 12 months. A share price approaching $7, based on rising earnings The final factor is management. For years, investors and a slightly higher valuation multiple, would not marked down global airline stocks for poor surprise. The caveat is oil prices not racing higher. management. Qantas’s executive team has done a terrific job in a difficult sector that is highly unionised and regulated. Qantas’s ROE averaged about 4% for the five years to 2013. The current ROE is about 26%. A management premium in the valuation is warranted. When choosing airline stocks, stick to the big players. Speculators might focus on Alliance Aviation; it looks Source: ASX undervalued as mining service conditions improve. But most investors should stick with Qantas and Air Air New Zealand New Zealand. The prominent airline, dual listed in Australia and NZ, Qantas delivered a solid FY17 result that led to some broking firms upgrading recommendations and price targets. The Qantas FY17 result, released last week, slightly beat market expectation. Underlying profit before tax, Profit before tax of NZ$527 million was slightly ahead $1.4 billion, was the second highest in the of market expectation. A final 11 cent per share company’s 97-year history. dividend was 10% up on the previous corresponding period. A highlight was 6% growth in domestic revenue and 5% in international revenue in the fourth quarter. That It was a good result given rising competition in suggests Qantas is capitalising on a pick-up in airline international aviation and one that creates confidence demand and benefiting from good capacity in Air New Zealand’s medium-term prospects. The management, cost control and plane yields. company said it is “optimistic” about overall market Thursday 31 August 2017 03 dynamics and expects to improve on 2017 earnings. Important: This content has been prepared without A higher dividend is perhaps the best sign of taking account of the objectives, financial situation or management’s confidence. needs of any particular individual. It does not constitute formal advice. Consider the Air New Zealand ticked plenty of boxes with its appropriateness of the information in regards to your operational performance. Costs were well managed, circumstances. and aircraft utilisation and yield were solid. Rising demand for outbound travel from New Zealand to Bali and Pacific Islands is another tailwind. Like Qantas, Air New Zealand has an excellent market position, prominent brand and improving customer experience. It also has rising return on invested capital (15.3%). Both tran-Tasman airlines have come through their transformation program better than the market expected. At NZ$3.55, Air New Zealand trades on a forecast FY18 PE of around 10 times, according to consensus analyst forecasts. Like Qantas, Air New Zealand is valued below the global airline PE average, despite its improving operational performance. The consensus price target of $3.55, based on the average of six broking firms, suggests Air New Zealand is fully valued at the current price.

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