Huge ongoing costs and a lack of control over input prices are just two reasons why I’m unlikely to ever own Qantas Airways Limited (ASX: QAN) shares.
About Qantas Airways
The ‘flying kangaroo’ is an iconic symbol synonymous with Qantas and our country’s love of travel and adventure. Founded in 1920, Qantas is the third-oldest commercial airline in the world and today it is easily Australia’s largest airline, servicing dozens of destinations on a daily basis both domestically and internationally.
Why I Wouldn’t Own Qantas Shares
Every business faces ‘headwinds’ at times. The size and severity will often depend on the industry within which the company operates.
However, there are very few businesses that must combat the horrible economics faced by companies operating within the commercial airline sector. Below, I look at 3 reasons why airlines typically make for horrible investments.
1. Capital Intensive
The best companies to invest in are those that once set-up do not require a heap of ongoing capital expenditure to run. As you can imagine, constantly maintaining and replacing a fleet of aeroplanes costs a huge amount of money. Through good times and bad Qantas must continually spend large sums of money to ensure the ongoing safety and comfortable passage of their clients.
You need to be careful when reviewing the financial results as expenses can go understated for a number of years due to the accounting treatment of assets. Ultimately aeroplanes will need to be replaced and each time this happens it will be at significant cost to a company like Qantas. The following Rask Finance video explains, step-by-step, how you might value an ASX company like Qantas using a Discounted Cash Flow (DCF) analysis:
2. Lack Of Control Over Input Prices
One of the largest costs for an airline is fuel. The price of oil is notoriously volatile and nigh on impossible to predict despite the best efforts of economists and market analysts.
In the space of a little more than six months between July 2008 and February 2009, the price of oil went from a high of US$147 a barrel to a low of under US$40 a barrel. Wild price fluctuations are all too common, driven by geopolitical events and a complex web of supply and demand dynamics. Lower oil prices in recent years have been a key driver in Qantas returning to profit following an astronomical net loss of $2.84 billion in the 2014 financial year.
Future profits will continue to be heavily impacted by the oil price, which will remain outside the control of management and unpredictable to investors.
3. Fierce Competition
A number of airlines operate out of Australia but the main competitor to Qantas is Virgin Australia Holdings Ltd (ASX: VAH).
The two airlines went toe-to-toe in a protracted seat capacity war in recent years with customers being the only winners. The International Air Travel Association highlighted the fiercely competitive nature of the industry when it noted that ticket prices in 2017 were two-thirds lower than in 1995. It’s of little surprise that over the past decade Australia’s two biggest airlines have operated without making a single dollar in net profit despite a huge influx of additional capital provided by ever hopeful shareholders.
The Final Word
Qantas has been one of the strongest performers on the ASX during the past five years, rising nearly 400%. This fact may appear to be at odds with the observations I have made above but all it really highlights is that the share price performance of a business can diverge significantly from the long term economics of said business. Over time, Qantas will experience occasional periods of strong share price appreciation when conditions are favourable, however, these periods are likely to be surrounded by prolonged periods of weak share price performance.
For those who fancy their chances at actively trading the stock there may be money to be made. But in the long run investors are more likely to go on failing to make an adequate return largely due to the factors I mentioned above.
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Disclosure: At the time of publishing, Luke has no financial interest in any companies mentioned.
