Qantas hits turbulence with "accounting and strategic trickery" and an ageing fleet

The last six months have been tumultuous for Qantas Airways (ASX: QAN). Former CEO Alan Joyce departed amid controversy around Qatar being denied an opportunity to fly routes in Australia and the alleged sale of tickets on flights that were already cancelled. 

Trust in the national carrier has plummeted, something acknowledged by new CEO Vanessa Hudson, who is aware that rebuilding that trust will be crucial to Qantas' fortunes moving forward. 

So, how are they doing so far? 

Based purely on the latest numbers, which beat consensus expectations, one might be forgiven for thinking Qantas is faring 'OK'. But the share price reaction post the results yesterday tell a different story, as does Roger Montgomery, from Montgomery Investment Management, who is unequivocal in his thoughts on the company; 

"After years of accounting and strategic trickery, the true cost of running the airline is only just beginning to be revealed".

In the following, Montgomery doesn't hold back, laying out the case for why he wouldn't want to own the stock and why he and his team don't see it as "quality".

As an added bonus, he names a handful of stocks he believes do fall into the Quality bucket and outlines his bullish thesis for markets out to 2026. 

 Key first-half results

• H1 underlying PBT $1.25 billion vs expectations of $1.17 billion
• NPAT $869 million vs $852 million
• Revenue $11.13 billion vs $10.89 billion
• EBITDA $2.20 billion vs $2.22 billion

Outlook:

For more information and market data on Qantas, head to Market Index.

Note: This interview took place on Friday, 23 February 2024.

1. In one sentence, what was the key takeaway from this result?

After years of accounting and strategic trickery, the true cost of running the airline is only just beginning to be revealed.

2. Were there any major surprises in this result that you think investors should be aware of?

This isn't a high quality business. 

Investors should focus on quality, just as we do in the funds that we manage and distribute. For example, in the Montgomery Small Companies Fund, businesses like Megaport, Macquarie Technology is high quality. In The Montgomery Fund, we've got Macquarie Group, Cochlear, and CSL. And then over at Polen Capital, the managers of our Global Small Cap Fund, are businesses like Topicus and Fevertree. And in large caps, they have Amazon, Alphabet, and Adobe.

When I look across all of our managers, who all put quality first, none of them own Qantas. 

Most importantly, Qantas will be a very, very different business over the next 10 years compared to the last 15 years. 

And here's a really important insight: over the last 15 years to 2023, presided over, remember, by a single CEO, and using statutory after-tax profits as they were contemporaneously reported by the airline, total net profits over that 15 years amounted to a loss of $116 million.

In other words, no money was made on a net basis over the last 15 years. 

And here's the interesting thing: the business spent $2.2 billion buying back shares and it spent another $1.7 billion on dividends. So the question is, if it made a loss, how did it fund almost $4 billion in dividends and buybacks? 

Well, the answer to that is partly with borrowings, which rose by just over $1 billion in those 15 years. And then that leaves a shortfall of about $2.8 billion, which happens to match the $2.7 billion the government handed Qantas in COVID support.

So remember, those economics... and this is the other thing: those economics aren't allowing for the airline's fleet of aircraft to age. In other words, if the airline had purchased aircraft such that its fleet hadn't aged, the numbers would've been a lot worse.

3. Would you buy, hold, or sell this stock on the back of this result?

Rating: SELL

I wouldn't want to own the stock over the next period, when the fleet needs to be largely upgraded. And that's really important.

4. What’s your outlook on this stock and the sector over the year ahead? Are there any risks investors should be aware of?

The average age of a plane in Qantas's fleet is 15 years, which is the highest of any major international airline in Australia. So, if you look at Cathay, Emirates, and Qatar, the average age of a plane is 10 years. And Qantas's average age back in 2006 was eight years, and just before the pandemic, it was 11. So the profits that it's reported recently have been - one way of saying it is - artificially boosted by the fact that they haven't been keeping their fleet up to date.

5. From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or cautious?

Rating: 2

I reckon we sit at about two, believe it or not. I'm pretty optimistic. 

I think small caps are relatively cheap compared to the last 25 years globally. If the backdrop remains that we have disinflation continuing and positive economic growth, that's going to be supportive for innovative growth companies with pricing power as it was last year.

And I currently believe we're going to see the market rally all the way into 2026. There'll be bumps along the way. Growth for many companies is at double digits, which is good. So if you can find growth that's at double digits with PE ratios that are lower than they were in 2019, I think that sets you up for some really good returns. And finally, I will say that, because I think interest rates are going to stay relatively higher than they have been recently, we're going to see private credit emerge as a much larger asset class for investors' portfolios.

Don't miss an ASX announcement this reporting season, set up and receive announcements directly to your inbox on Market Index: Create Alert Now