UBS Has Massively Upgraded The Outlook For Qantas Shares: Here's Why

QANTAS aircraft seen on display at the QANTAS Founders Museum in Longreach. Lisa Maree Williams/Getty Images

One of the big developments last week was Qantas management telling the company’s AGM that the airline had posted a profit for the first time in years during the first quarter of the financial year.

After announcing a multi-billion dollar cost-cutting program at the start of the year involving the eventual shedding of 5,000 jobs, the company says it is on track to deliver on its guidance of turning a small profit in the first half of the financial year.

UBS has changed its recommendation on Qantas to a buy from neutral and has made a big hike in its share price target from $1.50 to $2.

“Despite a poor past three years, we see Qantas in the early stages of a significant turnaround,” UBS says in a note to clients.

UBS is forecasting pre-tax profit to rise from a loss of $600 million in the 2014 financial year to a $350 million pre-tax profit this financial year, $810 million the following year and $900 million in 2017 financial year. Here’s some of the reasoning:

“Qantas has retraced two-thirds of its share price outperformance since the August result despite more evidence of positive earnings momentum. The A$ jet fuel price has dropped 10% and Qantas has confirmed the domestic market recovery is well under way with domestic yield turning positive in September, after two years of erosion.”

And here’s a chart showing UBS’s profit forecasts for the company:

Source: UBS

The $2 billion transformation program and favourable fuel price movements will aid Qantas in returning to underlying profitability in the 2015 financial year and in capturing an increased share of the domestic market earnings pool.

An earnings turnaround, restrained capital expenditure and $1 billion of accumulated tax losses will drive improved free cash flow of $500 million in 2015 and $1 billion in 2016.

Demand for the shares typically comes from foreign investors, UBS says, “but we believe the next leg of upside is likely to be driven more by domestic investors as the current earnings momentum becomes clearer.”

Basically, UBS sees Australian investors starting to find some appeal in the airline again, after years of the management being among the most hated in corporate Australia.

Qantas last week said it hit profit in the first quarter of this financial year with better yields on seats.

Qantas shares were trading at $1.487 today compared to the UBS target of $2.

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