Qantas Airway – Hop in on the Flying Kangaroo’s bond yielding above 5%

Founded in 1920, Qantas Airways or popularly nicknamed “The Flying Kangaroo” is Australia’s flag carrier and is one of the world’s oldest airline. It primarily serves the Australian continent and is the largest airline by fleet size in Australia. The company’s main business segments include Qantas Domestic, Qantas International, Qantas Loyalty and their low-cost carrier Jetstar. In Australia, the Qantas Group (comprising Qantas and Jetstar) has an impressive market share of around 60% of domestic flights and carried an impressive 61.8% of passengers in December 2023.

Strong post-covid recovery

The COVID-19 pandemic had severely disrupted the aviation industry and left Qantas close to bankruptcy. However, thanks to government subsidies amounting to AUD 2.7 billion and asset sales, Qantas has managed to emerge out of the pandemic to post a record profit in FY23

Table 1: Qantas Group profitability (AUD million)

The post-covid travel demand remains strong as seen in their record revenue of AUD 16.9 billion in FY23 and continuing the trend in 1H24 to record a 20% year-on-year (YoY) increase in revenue in 1H24. The group has emerged from the pandemic with improved operating efficiency, recording operating margins of 14% as compared to a pre-pandemic 5-year average of around 9%. This is due to higher fares from increased demand and lower cost. In 1H24, despite higher revenue, operating profit declined by 12.8% caused by a 2.1% lower load factor as Available Seat Kilometers (ASK) outpaces Revenue Passenger Kilometers (RPK) and lower fares.

Nevertheless, we believe earnings to continue to remain stable, largely supported by Qantas significant market share in domestic flight routes with the Sydney-Melbourne route maintaining as the top 5 busiest route in the world in 2023. Their Qantas Loyalty segment continues to deliver strong performance with a 24% YoY increase in revenue contributed by strong growth in financial services products and travel bookings.

Chart 1: Operating profit of Qantas’ business segments (AUD million)

Making efforts to repair their reputation

In contrast to their post-covid recovery, Qantas Group reputation in the eyes of Australians has yet to recover after instances of operational issues causing delays and cancellation, selling tickets for flights it never intended to fly and setting deadline for travel credits from cancelled flights during the pandemic. Doing so have brought consequences to the group with their Net Promoter Score (NPS) – a measure of customer’s likelihood to recommend the brand – has dipped to very low levels. The group had to also pay a penalty of AUD 100 million as a penalty to compensate passengers for selling tickets on flights that they had already decided to cancel.

The events had led to a change in management, leading to the appointment of a new CEO and major changes in the boardroom. The changes were made in hopes that it will support the restoration of trust in the company. Since then, they have made considerable efforts in improving their reputation by upgrading their on-board catering, increased call centre staffing and their frequent flyer program to allow for easier points redemption. They have also backed down on their expiry terms for the Covid-19 travel credit by allowing refunds and redemption indefinitely.

While it may be a long road ahead for the new management in repairing the group’s tarnished reputation, their efforts have paid off with the airline’s NPS climbing steadily as operational reliability and the new changes fall in place. Overall, their fight to repair their tarnished reputation will bring added cost to the company, but we believe the company is well in position to foot the bill in exchange for an improved reputation and long-term brand loyalty, both of which will benefit them in the long run.

Decent credit profile supported by strong earnings and liquidity

Table 2: Qantas selected credit metrics

Qantas’ credit metrics improved post-covid supported by their earnings post-covid which allowed them to reduce their debt levels. Total debt declined slightly to AUD 6.1 billion as some cash were used to repay maturing debt. As such, net debt increased in 1H24 as cash levels dropped to repay outstanding debt and for capital expenditures. Net debt/EBITDA levels remain comfortable at 1.9x with management providing guidance to maintain the ratio at a range of 2.0x – 2.5x with a target net debt level at a range of AUD 4 billion to AUD 5 billion. Capex on the other hand is expected to increase in the coming years in line with future delivery of aircrafts with a guidance for FY24 at AUD 3.2 billion and FY24 at AUD 3.9 billion which we believe will largely be funded by future profits.

We believe that Qantas’ strong earnings will bolster their liquidity while their well spread-out debt maturity will reduce pressure on refinancing. As of December 2023, their debt maturity profile has an average debt maturity of AUD 0.3 billion for the next 5 years up to FY28. Their liquidity is also further supported by their unencumbered fleet and other assets of more than AUD 6.3 billion and an additional AUD 1.4 billion committed undrawn facilities.

Chart 2: Debt maturity profile

Outlook

The outlook for Qantas airways is stable, underpinned by the recovery in the aviation industry and the group’s growing capacity which is targeted to reach pre-covid levels in FY24. Furthermore, we believe their significant 60% market share in the domestic market will continue to support earnings as Australia is highly dependent on flights for intercity travel.

The group has also remained committed in improving their operations with ongoing plans for fleet renewal to improve efficiencies and customer satisfaction. Currently, Jetstar has received 11 new A321LR and is expected to grow to 15 by the end of FY24. This will be able to provide a reduction in savings by reducing fuel burn per seat of. On the other hand, extra operational buffer to improve overall operational performance for customers is expected to slightly increase cost but will help improve customer satisfaction by reducing delays.

Their loyalty segment continues to show good growth, registering more than 1 million new members in 1H24 and continued to maintain their ~35% market share on credit card spends with strong growth in bookings under the program. We believe the loyalty segment will continue to show good performance as new card acquisitions of 144k up 23% vs 1H23 will contribute positively to earnings growth while the revamp of their frequent flyer program will add value to their program and attract new members.

Related risk

Qantas faces the typical risk inherent in the aviation industry which include, but are not limited to economic uncertainty weighing down on travel demand, changes in government regulations, fuel prices and foreign exchange rates, accidents, natural disasters and an epidemic.

Aside from these risks which we believe most investors in the aviation industry would be aware of, Qantas also faces risk of an increase competition in the Australian aviation industry. Currently, 3 airlines dominate the market in Australia of which Qantas and Virgin airlines take up around 90% of domestic market share. They have been voices of concern over the protectionism and monopoly of Qantas in the market and The Australian Competition and Consumer Commission (ACCC) may introduce policies to introduce competition in the market. This may negatively affect Qantas market share and potential earnings if competition stiffens.

Conclusion

Qantas Group has shown a promising comeback post-covid, with improvements in operations and an credit metrics. The group’s cash flow is fairly strong with a well spread-out debt maturity profile easing pressure off large repayment for the coming years.

As such, we find both options an attractive consideration for investors, however, we prefer QANAU 4.750% 12Oct2026 Corp (AUD) for its shorter duration as we don’t find the extra 32bps spread on the 2028 bonds to be worth the added duration. This is also considering their debt maturity is higher in FY28 and FY29. Furthermore, investors may prefer the higher coupon in the 2026 bonds.

Nevertheless, investors who are willing to take on the added duration to lock in yields up to 2028 can consider QANAU 3.150% 27Sep2028 Corp (AUD).

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report holds a NIL position in the abovementioned securities.