AIR - Air NZ.

[Zaphod]

Again yay on the dividend! Huge check coming for me!

Well done Modadm, you were spot on with your analysis! Enjoy the cheque, you've certainly earned it!

I'm also pleased with the AIR result, but just a pitty that current events appear to muting the SP. But on the bright side, perhaps a good buying opportunity.

[Zaphod]

(And this is from someone who's against asset sales - of national infrastructure, that is.)

Labour have agued in the past that AIR is part of the national infrastructure. I wonder what a prospective Labour government would seek to do in relation to the AIR sale? I suspect they would have their hands full for one full term trying to implement their NZ Power proposal.

[bulltrap]

Labour have agued in the past that AIR is part of the national infrastructure. I wonder what a prospective Labour government would seek to do in relation to the AIR sale? I suspect they would have their hands full for one full term trying to implement their NZ Power proposal.

Political rhetoric perhaps, anyway it's a stretch to call an airline infrastructure. We've seen other airlines come and go over the years. Airports are infrastructure, airspace even, but not airlines.

Also worth a mention is that a large part of Air New Zealand's operations are outside of NZ borders.

[peat]

Countries always have one flag-carrier tho which is Air NZ here of course and its very hard to imagine it not being assisted should trouble arrive. Hence there is IMO a big diff between other airlines and Air NZ.
Airlines earnings are way too volatile for useful analysis or normal investmest. Hence SP does not assume earnings continue.

[bulltrap]

Countries always have one flag-carrier tho which is Air NZ here of course and its very hard to imagine it not being assisted should trouble arrive. Hence there is IMO a big diff between other airlines and Air NZ.
Airlines earnings are way too volatile for useful analysis or normal investmest. Hence SP does not assume earnings continue.

I was alive in 2001 but only semi-conscious (at varsity) so bear with me while I brush up on history...

http://www.wsws.org/en/articles/2001/11/nz-n03.html

Prime Minister Helen Clark argued that the move was essential to the national interest. A national carrier was needed, she said, to ensure a measure of control and certainty over such vital economic activities as tourism, overseas trade and domestic and international travel. The country’s other main airline, Qantas New Zealand, a privately-owned local franchise of the Australian carrier Qantas, collapsed in April with the loss of 1,100 jobs and debts of over $NZ20 million.
...
Finance Minister Michael Cullen made clear that the government did not intend to be the airline’s “long-term owner”. The government plans to maintain its control long enough to restore its profitability then sell it off to big business.

So reading into that, a bailout was necessary since Air New Zealand was the sole major carrier at the time in NZ, and it was uneconomical to operate an airline under the prevailing conditions. (Note that Qantas NZ, formerly Ansett NZ, went under before 9/11!) That I concede made Air New Zealand part of national infrastructure, but not so today, now that we have healthy competition and profits.

Regarding the current share price, a quick google suggests a benchmark forward P/E of 10 for the airline industry. The industry risk factor is built in to this figure. By this crudest of measures, Air New Zealand would be fair value at upwards of $1.65, and is currently trading at a 15% discount. OTOH, that assumes at least industry average long-term growth prospects, and maybe that's not justified. Chasing that growth via Australia was the downfall of AIR back in 2001 (not to mention a stumbling block for numerous other mature NZ companies) and so the current investment in Virgin makes me a little nervous.

[modandm]

Result

Quite happy with the result. The fact that they took $11m of one off losses relating to a cargo penalty payment and a VAH derivative position on the P&L instead of to equity means that earnings have actually been understated. In the past Air NZ has reported 'normalised profit' but if they had this would have beat guidance. Seems management don't want to blow the trumpet too hard.

One of the best insights was a comment that domestic yields were down 5% in FY13, but looking forward management see them improving slightly "there will be some improvement". That is fantastic news in light of the new A320's (5) and 4 more arriving in next 12 months. New a320's have a 15% cost advantage over 737's being retired. Domestic is 30% of revenue but I would guess 50-60% of profits because it is much higher margin. So improvement in domestic is vital, it has been a little weak with govt cutbacks and general corporate travel weaker but there must be signs of an improvement. Lets see if it comes through on the op stats.

Cathay alliance has seen an improvement already so the impact of this should be well realised in FY14. The long haul business should improve further. Trans-tasman remains solid but not great.

Otherwise comments were that bookings look every bit as good as last year and that all areas of the business are performing well. Sounds good to me.

Capital management

Very good cash flow generation, they didn't buy many planes! Nice dividend.

High capex ahead, but should be well covered and the balance sheet is very strong - expecting leverage in the middle of target range after huge capex shows just how strong it is. Strong case for continued growth in dividends in FY14 - I think 10c as a minimum. Therefore 5+10 = 15c worth in next 13 months... thank you very much.

VAH - sensible long term, annoying short term. VAH has a young fleet, and has had a busy year. With the Australian market now 2 players we should see an improvement in returns from this investment. Some are worried about this loan but actually I like it because AIR will be getting paid a better interest rate than if the cash was sitting in the bank in NZ. AIR has so much cash its embarrassing for management right now.

Govt stake - what will happen who knows. Would be stupid to sell now. Dream scenario Air NZ buys the govt stake back from the govt - this would be massively value enhancing. Why is this not talked about? I will be talking to management telling them to do this. This is what US company's AIG etc have done why can't Air NZ. Its a bit of a political football isn't it. Base case is the government try and place the stock with brokers but this seems like it would be hard to do. Would SIA like another bite at Air NZ, what about Cathay? A complex picture with no clear outcome. Any kind of resolution removes uncertainty and should result in the valuation rising. Currently the biggest reason cited for the shares not going up.

Valuation and model update

Key assumptions: 3% pax revenue growth, Jet fuel at $125 USD/barrel, NZD USD at 0.80 (a lot hedged at .826). Other costs I have put are best estimates based on guidance and historic trends. I have been more conservative than in the past intentionally, particularly on fuel costs. I also think 3% revenue growth is conservative, and this is the most sensitive input.

Result: FY14 EPS of 23c or a 36% increase on FY13. Should the PE remain constant (at a depressed level) and 15c come in dividends between now and next October we are looking at a total return of c.45% over 1 year.

Valuation

Bear case: Earnings disappoint due to higher fuel costs/lower FX and EPS is 17c - stock trades on 8x PE and VAH goes bust. Stock is worth $1.36, and pays a 6% dividend. 1 year return 6%

Base case: 10x P/E is reasonable given the strong competitive position, young fleet, etc. Use 23c EPS forecast therefore $2.30 is my valuation. Ascribe no value to the VAH stake. 1 year return 75%

Bull case: EPS 26cps, Govt stake issue clears, stock trades on 11x PE (in line with peers), VAH stake is recognised by market at 20c of value. Valuation $3.06. 1 year return 130%

Conclusion:

In my view the stock is a compelling opportunity, and although there are risks the low valuation means a good deal of safety. The business is performing well even if the share price isn't (this year). Patience will be rewarded, cheers.

[bulltrap]

Excellent result, kudos to the team.

Will someone please give the nearest Air New Zealand stewardess a congratulatory pat on the bottom and say it's from old bulltrap.

(Or steward, I'm not sexist.)

[Marilyn Munroe]

Modadm wrote; "Would SIA like another bite at Air NZ, what about Cathay? "

You have missed Etihad as a potential suitor for Cullen Airlines.

One vulnerability for Cullen Airlines is if a competitor operates an A380 on the Trans-Pacific routes, say QF or EA, MEL --> AKL --> LAX. The competitive threat this poses would be reduced if Cullen Airlines 787's enjoy good customer acceptance.

Boop boop de do

Marilyn

[CJ]

Govt stake - what will happen who knows. Would be stupid to sell now. Dream scenario Air NZ buys the govt stake back from the govt - this would be massively value enhancing. Why is this not talked about? I will be talking to management telling them to do this. This is what US company's AIG etc have done why can't Air NZ. Its a bit of a political football isn't it. Base case is the government try and place the stock with brokers but this seems like it would be hard to do. Would SIA like another bite at Air NZ, what about Cathay? A complex picture with no clear outcome. Any kind of resolution removes uncertainty and should result in the valuation rising. Currently the biggest reason cited for the shares not going up.

What do you mean by this? Buy back enough of the Govt shares and cancel them so they are only left with a 51% interest. Gives the government money I guess without needing to go to the public. Also gives the benefit of any discount required to existing shareholders which is a lot fairer than with an institutional bookbuild which is more likely.

Edit: I dont think AIRNZ could afford to buy back half of their shares!

[bulltrap]

Edit: I dont think AIRNZ could afford to buy back half of their shares!

Good point, I make it 43.4% to be exact. It'd basically take their entire cash reserve.

If they could buy the shares and not cancel them, that'd only cost half. But is a company allowed to eat its own tail like that?