Tag Archives: PEP

Equities Futures Higher But Investors Continue Cautious Trading

The market was revving its engine Monday morning, but a caution flag was still flying, keeping stocks from being off to the races. 

Momentum from Facebook.com, Inc. (NASDAQ: FB) stronger-than-expected earnings, reported after the market closed yesterday, helped equities futures, which were pointing to a higher open for all three of the main U.S. indices. Investors seemed to cheer as the tech giant beat expectations despite the data handling issue. Eyes will turn to the Seattle area later today as Amazon.com, Inc. (NASDAQ: AMZN) and Microsoft Corporation (NASDAQ: MSFT) report earnings after the bell.

Still, sentiment is mixed, with market moves perhaps getting overdone either way because of a tug of war between bulls and bears. Longer term investors may want to simply ignore some of the noise and focus on the fundamentals, which appear strong.

Earnings Roundup: Transportation and Food

General Motors Company (NYSE: GM) this morning continued the string of companies reporting better-than-expected earnings only to see their stock take a dip. Shares in premarket trading were down about 1 percent. Though GM beat analyst estimates on both the top and bottom line, largely on strong sales of crossover vehicles in North America and China, a fall in net income seems to be what led to the underwhelming response. GM's earnings come on the heels of Ford, which reported higher profit yesterday. 

A similar story was repeated this morning by American Airlines Group Inc. (NYSE: AAL), which posted stronger earnings than analysts were expecting. But its shares slid on a warning about higher fuel prices and other input costs. Also lower this morning were shares of Southwest Airlines (LUV), which reported earnings roughly in line with estimates. The Dallas-based airline, still reeling from a recent mid-air mishap, saw its shares lose over 4 percent in early trading.

Moving on to foodstuffs, PepsiCo, Inc. (NYSE: PEP) and Chipotle Mexican Grill, Inc. (NASDAQ: CMG) were among those reporting earnings. PEP earnings beat estimates, but its North America beverage division "continues to work through some challenges," CEO Indra Nooyi said in this morning's call. CMG, however, seemed to crush it, reporting earnings of $2.13 a share versus analyst estimate of $1.53. CMG shares rose over 14 percent in the pre-market.

Investors seem to be realizing the U.S. economy is on decent footing. Helping back that up this morning was news that U.S. jobless claims, which came in under expectations, were at their lowest level since 1969. 

Yield Watch

In news from across the pond, the European Central Bank left its benchmark interest rate unchanged, but it remains to be seen when the central bank will end its bond-buying program. Futures on the euro (/6E) remain in a tight range just above $1.22.

Trading this morning is essentially a carryover from yesterday, when stocks ended mixed as investors seemed to weigh conflicting sentiments.

On the one hand, the 10-year Treasury yield closed above 3 percent yesterday, likely reflecting concern about future inflation and causing worry about increased corporate borrowing costs. On the other hand, higher longer term rates can reflect more bullish expectations for economic growth in general. The yield on the 10-year Treasury was back below the 3 percent mark Thursday morning, but concerns about inflation seem to be lingering with crude oil near $70 per barrel and aluminum and steel prices also elevated.

Priced for Perfection?

Investors also seem to be intently watching earnings. But even though many of the companies that have reported so far have beaten expectations, the market hasn’t seen a large rally. Why, you ask? Well, as been noted before, it appears this market is “priced for perfection”. That generally means if companies knock investors’ socks off, maybe they get a little bump or stay flat. But if there’s anything negative to focus on, that’s where investors’ minds seem to be going. Part of the reason behind that sentiment is that stocks appear to be in a repricing mode.

tnx-spx-4-26-18.png
FIGURE 1: 3 percent YIELD AND THE S&P 500. The 10-Year Yield Index (TNX), which reflects 10-times the yield on 10-year US Treasuries, starts the day right at the 3 percent market, a shade lower than yesterday. The S&P 500 Index (SPX – purple line) moved lower yesterday as the 10-year yield moved up, but seemed to settle in by later in the day. Data source: Cboe Global Markets, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Stocks Vs. Bonds

The climb in treasury yields to four-year highs could pose a special challenge to stocks that long-term investors often buy and hold for yield. Dividend-paying sectors like telecom, utilities and staples all could face more pressure if yields keep ticking up. Staples are already down double-digits year-to-date. Stocks tend to be riskier than bonds (though no investment is risk free), and if bonds pay decent yields, there may be more pursuit of fixed income. This would tend to pull money into bonds that might have otherwise gone into stocks. Though the 10-year gets most of the headlines, it’s worth noting that the 1-year Treasury note currently yielded 2.247 percent going into Thursday, compared with just a 1.85 percent dividend yield for the S&P 500.

More on Yield and Stocks

That said, stocks may be able to continue higher even if bond yields also keep rising — at least for a while. After all, there’s nothing really magical about the 3 percent mark. Although it is psychologically important, it really shouldn’t come as a surprise that yields are moving higher, as the Fed has been telegraphing that to the market for a while now. Investors just seem to be in the mood to sell, and that could provide a buying opportunity for contrarian investors. But there is a limit. If the yield on the 10-year Treasury rapidly rises from where it is now to, say, 3.25 percent, then some investors might start rethinking their portfolio mix.

Lifeblood of the Economy

Trains and trucks are like the blood flowing through the circulatory system of the economy. And the latest checkup results look pretty good. Rail company Norfolk Southern Corp. (NYSE: NSC) reported stronger than expected earnings Wednesday. One interesting metric it reported was that overall volumes rose 3 percent as growth in its intermodal category offset declines in merchandise and coal volumes. Trucking companies have also been doing well as demand for their services is high. Trains and trucks transport the building blocks of America’s economy, which means if the companies that operate them are doing well, the economy probably is too.

Information from TDA is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade.

Qantas Airways Limited: A Good Company, Not A Great Price

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Qantas Airways (OTCPK:QUBSF) has struggled in the past, particularly in 2014 when the company recorded a $2.8 billion loss. Since then, the company has announced aggressive cost-cutting plans and is now 3 years into this revival. I believe Qantas is a good company and will continue to be a leader in the Australian airline industry; however, I don’t think the price of the stock offers a good enough margin of safety to make the leap and invest.

Industry Overview

The domestic airline industry in Australia is a duopoly with Qantas and Virgin Australia (combined market share of over 90%), each owning a low fare airline subsidiary Jetstar and Tigerair Australia, respectively. Over the past 5 years, the industry has seen steady declines in revenue, this is predominately due to the price war that Qantas and Virgin engaged in (which has since ended). However, many firms have been able to cut cost through layoffs, wage freezes, maintenance changes, and enjoying lower prices for jet fuel. This has resulted in higher margins and increased profits despite declining revenues.

Over the next 5 years, the industry can expect slow growth as domestic tourism is expected to increase as well as international trips to Australia. Margins may also continue to increase as planes, such as the Boeing 787 Dreamline become more fuel efficient. This growth is very minimal, estimated at 1.9% annual until 2023 (IBIS World).

Source: IBIS World

Comparing financial ratios with Qantas and other companies in the industry makes Qantas look appealing. Here I compared it to some of the other very large airlines in the United States and Singapore. All of these US airlines have something in common too, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) took a position in all 4.

(Source: IBIS World)

Source: Created by myself using data from Bloomberg

(Source: Created by myself using data from Bloomberg)

Investment Thesis

The reasons to invest in Qantas are rather simple, they have a massive market share of 64.8%, their historic brand has become iconic in Australia, and recent share buybacks and dividends show managements focus on shareholder returns.

Market Share

Their large market share is a huge advantage, since their next largest competitor, Virgin Australia, only has 27.2%, well less than half that of Qantas. Despite being so large, Qantas has been able to grow faster than the industry in several metrics. 1) Qantas increased its Revenue Passenger Miles at 2.68% annualized since 2010, compared to the industry at 2.12%. Qantas grew Available Seat Miles 2.7% annualized since 2008, compared to the industry at 2.13%. They have also managed to grow their fleet of planes substantially at 3.27% annually since 2007, adding 85 planes totaling to 309. Even with such a large market share, their earnings have been anything but steady, suffering losses in 2014, but turning around in the past 3 years.

Source: Macquarie Research, February 2018

(Source: Macquarie Research, February 2018)

The Brand: A Competitive Advantage?

One of the well-recognized competitive advantages is the power of a brand. Qantas has a deep history in Australia and is seen by 96% of Australians as iconic. They have been rated Worlds Safest Airline for 4 years running, as well as Best Catering, Best Lounges and Best Domestic Service for 2017. They are also listed as one of the top 10 companies to work for in Australia despite issues with labor several years ago. Furthermore, the dual brand strategy of Qantas and Jetstar allows for price discrimination to take place between wealthier and business-oriented passengers and more economical, tourists type passengers. No doubt, the Qantas brand is extremely strong in Australia and may offer a competitive advantage that would be difficult for a competitor to steal away from them. However, this is far from the branding of say a company like Coca-Cola (NYSE:KO), where customers often refuse to switch to a rival, PepsiCo (NYSE:PEP). It would be very easy for a passenger to choose a flight with competitor Virgin Australia if the price is better, timing is better, or the route is better (no layover). So, while the brand is strong, I dont think it necessarily keeps customers for the future. However, the Qantas Loyalty (frequent flyer) portion of the business is growing extremely fast, at 10% compounded annually since 2012 and is expected to sustain a growth rate of 7-10%. Members of these programs would face implicit switching cost to another airline because they wouldnt get their rewards or be able to use them.

Shareholder Returns

Along with the cost-cutting initiative taken 3 years ago, Qantas management has worked hard to increase shareholder returns. This has been achieved by aggressively buying back $1.2 billion of shares over the past 3 years. They have also announced they will purchase an additional $387 million of shares, representing 3.5% of the current shares outstanding. Share buyback has been paired with dividends of $0.14 for the past 2 years, making the payout ratio only 26.27%. Management has said this trend will continue, hoping to buy back shares in the upcoming years and increase their payout of dividends.

Source: Macquarie Research, February 2018

(Source: Macquarie Research, February 2018)

Valuations

To value the company, I completed 3 separate valuation models and took a weighted average.

Free Cash Flow to Firm

I calculated a WACC of 6.28% (Bloomberg say 6.2%) and grew the FCF at 3% over the next 3 years and then 2% thereafter. The growth rates are low and reasonable because the industry growth will be low as well. This gave me a generous value of $6.88 per share.

Dividend Discount Model

Using the same discount rate and growth rates as above, I increased their payout ratio to 40%, giving me a $0.22 dividend, which is still less than the $0.25 dividend they used to pay out, so I think its perfectly reasonable. This gave me a value of $5.22 per share. I confess a DDM is not the best, knowing that the dividend has been anything but consistent in the past, yet I expect it to increase in the future and wanted to model that in the value.

Multiples Model

Lastly, using a P/E multiple, I averaged the past 3 years’ P/E ratio to get 8.83. I averaged 8.33 with the current P/E of 11.44 and used the estimated EPS of $0.62 and came up with a value of $6.28.

Source: Made myself using data from Qantas 2017 Annual Report

(Source: Made myself using data from Qantas 2017 Annual Report)

Combining all models and weighting the DDM less (because the dividends are not consistent), I got a fair value of $6.31, proving only a 4.96% upside from the current price.

Its important to note the recent price appreciation of the stock since the past 12 months has yielded gains of 60.34% and even YTD gains of 19.25%. The stock is also well above the 100- and 200-day moving averages.

Source: Bloomberg Terminal

(Source: Bloomberg Terminal)

Conclusion

In summary, I think Qantas is a good business that will earn profits for years to come. However, the valuation is not compelling, and the recent price appreciation may mean that the train has left the station. Since growth is slow, and the industry is cyclical, I would recommend buying at around $5.00-$5.25 per share so as to have a larger margin of safety. There is a considerable risk buying an airline as the industry is sensitive to fuel cost, labor cost, and fierce competition. The 2-3% growth in the future is not enough reward to take on the risk unless you can buy at a discount.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is written solely for informational use. I am not offering investment advice as I have not considered myself as your fiduciary.

Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.