Figure 1: FY18 QAN operating segments’ performance

Source: Company

Figure 2: Profit Bridge – Underlying Profit Before Tax

Source: Company

FY18 key headline figures.
1. Return on Invested Capital at 22%;
2. Net free cash flow up +10% to $1.44bn;
3. Underlying EPS up +18% to 64c;
4. Total unit cost increase of +2.4% – excluding fuel;
5. Unit revenue up +3.9%;
6. Operating margin up +0.6pts to 10.5%;
7. Operating cash flow up +$709m to $3.41bn;
8. Net free cash flow up +$133m to $1.44bn; and
9. Net debt was at $4.9bn (below the bottom end of the target range).

QAN operating segments.
1. Domestic (Qantas Domestic & Jetstar Domestic) reported EBIT of $1.1bn, which was +25% higher on pcp. Margin growth was supported by efficiency gains and investment for higher premium services. Supported by healthy demand in all parts of the domestic markets, QAN’s corporate share remains robust, with SME share growing and leisure travel expanding.
2. International delivered a +7% increase in earnings to $399m and maintained margins despite strong competition and higher fuel prices. This was supported by a greater Load factor (how full flights are), which rose to 84% and a +4% increase in capacity. FY18 structural changes in Qantas international, such as the introduction of the 787 on new routes have started to deliver cost and revenue benefits, which will likely continue through FY19 and onwards. Qantas Freight continues to perform strongly with a strengthening international market and stable domestic market. JetStar International also posted strong profit from the expansion into key growth markets and consequent start-up of new routes.
3. Loyalty reported profits of $372m (up +1% from the prior year). However, margins eased due to mixed market conditions and promotions, but remained strong at 24.1%. The revenue growth is supported by new ventures into health insurance and financial services and growing Frequent Flyer program (+4.2% to reach 12.3m members).

Higher fuel costs potentially squeezing margins. Higher fuels costs will impact QAN’s margins however this is an industry wide issue. Management believes that fuel costs will rise another $690m in FY19 (on the back of the $200m increase in FY18). However, given the strength of forward bookings, hedging strategies (costs 87% hedged in 1H19), ongoing efficiency measures (which has driven a -1% reduction in fuel consumption and is expected to continue in FY19), management is confident that such costs will be substantially recovered.

Capital Management. Current net debt at $4.9bn (comfortably in the lower-end of management’s target range of $5.0 – 6.2bn) continues to provide QAN with significant financial flexibility. This is furthered by the recent extended tenor (to 8 years) and diversified funding, and strong short term liquidity, with cash of $1.7bn and undrawn facilities of $1bn.

FY19 Outlook…Management’s expectations for FY19 are:
1. Fuel bill to increase to ~3.92bn (up $690m) – management however is confident that the Group will “substantially recover higher fuel costs in FY19”;
2. Inflation impact on Group expenditure (including wage growth) to be ~$250m;
3. Net Capex to be $1.0bn – on track to complete a combined $3bn for FY18/19;
4. Transformation benefits to be ~$400m;
5. Total group capacity to increase by ~0-1% in 1H19, with Group International up by +1% and Group Domestic capacity flattish;
6. Net depreciation and non-cancellable aircraft operating leases to be ~$155m higher than FY18.

QAN’s relative valuation, both to global peers and the ASX200, remains undemanding to attractive. This is despite the potential for ongoing capital management initiatives. Further, QAN offers an attractive fully franked dividend yield of approximately 4%.

Figure 3: QAN comparable table

Source: Bloomberg

Figure 4: QAN Financial Summary

Source: BTIG, Company, Bloomberg