Shares in Qantas Airways Limited (ASX: QAN) soared around 50% over the course of 2015 as plunging oil prices helped the airline reduce its fuel bill and lift its earnings to an expected amount between $875 million to $925 million for the six months ending December 2015.

This result would be more than double the underlying profit delivered in the prior corresponding period and it’s not hard to make the bull case for Qantas shares in 2016 either.

Plunging fuel bill

The group currently has 95% of this year’s fuel bill hedged, but retains a 70% participation rate to lower fuel prices in the financial year with a full year fuel cost expected to be $3.61 billion.

Oil prices are now at 12-year lows with Morgan Stanley predicting that they could fall around another one third from here to trade not much above US$20.

These kinds of big oil price falls if they materialise suggest Qantas may be able to hedge its fuel requirements at even more attractive terms for FY17 and lift its profit margins substantially in the year ahead.

Improving credit rating

The airline’s credit rating was recently upgraded to the benchmark ‘investment grade’ by Standard and Poor’s in a move that is likely to lower short and long-term borrowing costs and improve its ability to restructure debt terms as necessary. This is significant as borrowing costs can vary wildly for companies depending on their credit ratings and Qantas is actively looking to pay down debt.

Additional cost savings

Qantas’s chief executive is determined to carry on with his $2 billion cost-slashing program named the Qantas Transformation Program. The group might not like to publicise it much but some 4,000 to 5,000 staff are expected to have been made redundant by the end of FY17, while others are expected to work harder in a brutal overhaul planned prior to the oil price crash.

Increased traffic

The group is seeing revenue growth across its domestic and international operations in part as a falling Australian dollar encourages more inbound international tourism, while Australians are more inclined to stay at home.

The competitive environment is also reported to be softening as rivals like Virgin Australia Holdings Ltd (ASX: VAH) ease up on a price discounting war previously waged in the domestic travel space. Budget operators like Virgin have a lower cost base than Qantas and thus are able to compete on fares more effectively, however, Qantas remains the dominant operator in the domestic space for now.


Nothing is more likely to lift a share price than the prospect of rising dividends with analysts’ forecasts for total dividends of 15 cents per share in FY16. The Thomson Reuters consensus analyst price target for shares in the business is $4.85 which would mean a 22% return plus dividends to investors at today’s valuation.

Foolish takeaway

Investors should note that the airline business remains cyclical in nature and the tailwinds that are supporting it today could quickly switch into headwinds in an altitude-losing effect on the airline’s share price.

The industry is also unpredictable in nature with government-sponsored international competitors, the potential for a shock travel slowdown due to an act of terror for example, or a return to fast-rising fuel costs.

However, the short-term outlook appears strong with the stock up 1.8% to $4.05 this morning, while many professional money managers are also suggesting this could be one of 2016’s top performing shares.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.