Breaking formation: Why one major investment bank thinks Qantas can’t outrun poor service

World News

One of the major investment banks has broken formation with the financial pack and questioned whether this year’s earnings bounce for Qantas will be as robust as investors are expecting while highlighting the airline’s poor record around on-time performance and flight cancellations.

Citi analyst Samuel Seow posits the thesis that, as a premium airline, Qantas needs to address its underlying service problems – an exercise that comes with the financial cost of hiring more staff and at a cost to revenue.

Qantas has provided some colour around the pieces of the earnings puzzle. It has told the market it has cut domestic capacity by 10 per cent and has slowed the ramp-up in international capacity – both of which apply pressure to revenue. The missing piece is how much of this has been recouped through higher airfares.

On some routes, airfares have doubled – particularly on international business class tickets. But even domestic fares are pitched at the spicy end.

That said, even the higher airfares cannot completely offset the revenue impact of taking 10 per cent capacity out of the market.

And that’s Qantas’ dilemma. It is constrained by a lack of staff from increasing capacity. It is also paying relatively high prices for fuel, which is a disincentive for increasing the number of planes it is running.

For Qantas to maximise profits it needs to increase capacity, which it cannot do without having more staff (both crew and ground staff) or risking service and on-time performance levels.

Qantas must improve on-time performance.

The endless disastrous airline travel stories crowding social media cannot remain a feature for Qantas. It is better to not schedule a flight than to cancel it or lose customer luggage.

“If industry constraints have caused on-time performance issues, logically, we expect a flatter capacity profile in 1H23 (the current half-year period) as more realistic, which is less than what guidance and the market is indicating,” Citi said in the note to investors.

On Citi’s estimates, Australia’s flight cancellation rate was 5.8 per cent in June and 38 per cent of flights were delayed. But Qantas was above average at 8.1 per cent and had 46 per cent of flights delayed.

To be fair, the turmoil is not confined to Australia, it’s an international scourge. That said, Citi notes that in June, only 2.2 per cent of flights by US carriers were cancelled, and the delay rate was about 22 per cent.

Seow has taken a knife to his previous estimates on Qantas’ underlying pre-tax profit for financial year 2023 – cutting it from $740 million to $514 million. On the back of this, he has lowered Citi’s target share price for Qantas by more than 20 per cent to $4.28 and placed a sell recommendation on the stock. In doing so, Seow managed to knock a bit of the gloss from Qantas’ share price. It fell by 0.3 per cent against the broader market that was up.

This represents a significant divergence from the broker pack – only one other analyst has a sell on Qantas and the majority have a buy recommendation. The consensus for Qantas’ 2023 earnings sits at about $837 million.

In three weeks, Qantas will report its 2022 financial year results and its chief executive (hopefully) will provide some clarity on how the airline is faring financially since the start of the 2023 financial year in July. We will then get a better picture of whether Seow is sitting too far out on a limb or whether the rest of the pack has been unduly optimistic.

Citi is broadly supportive of the positive longer-term trends for Qantas and sees a strong profit bounce in the 2024 financial year – higher than the airline made in the last full year before COVID-19 annihilated its performance.

But Seow is clearly questioning the length of the COVID tail’s impacts on Qantas’ profit performance.

“In summary Qantas charges a premium for tickets, so we expect performance will be a key priority. However, doing so economically appears to be difficult.”

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