It has been a very disappointing year for shareholders of Qantas Airways Limited (ASX: QAN) after the airline surprised markets by revising down its planned capacity growth because of weaker-than-expected demand from domestic travellers.
This has now led the share price to lose almost 18% so far in 2016, bringing it to a 52-week low in the process. But much like one of its jets, the Qantas Airways share price could now be on the runway getting ready to take-off.
Qantas Airways shares are changing hands at 6x estimated FY 2016 earnings. This may sound incredibly cheap, but traditionally airlines trade at much lower earnings multiples than the rest of the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
This is largely down to the fact that the industry is well known for being cyclical and extremely volatile. It is for this reason that everybody's favourite investor Warren Buffett won't go near airline shares.
Going back to the valuation again. Some investors prefer to look at a different multiple for judging airline shares. Many will favour a multiple that uses enterprise value divided by earnings before interest, tax, depreciation and amortisation – EV/EBITDA. This ratio is a financial metric that measures the return a company makes on its capital investments.
Using management's guidance, Qantas Airways is trading on an estimated FY 2016 EV/EBITDA multiple of 3.2. This is a reasonable discount to Virgin Australia Holdings Ltd (ASX: VAH) and the entire airline industry as a whole, which trade on an EV/EBITDA ratio of 5.8 and 4.7, respectively.
Qantas Airways does look on the cheap side using this multiple, so investors might well find value in its shares today. However, the main caveat here is that the company delivers what is expected of it for the full year.
That is easier said than done because it really has little control over demand. However, although demand has softened, there is a chance that things could be about to change. Data released this week shows consumer sentiment increased 8.5% and into positive territory at long last. This could be interpreted as a sign that consumers are willing to start to spend a little more freely again and travel. Any strengthening of demand will only be good news for Qantas's bottom line.
As tempting as an investment might be, unfortunately the unpredictability of the airline industry and oil prices makes this a risky investment in my opinion. I believe Qantas Airways has a very capable management team, but ultimately it has little control over consumer demand.
I believe a better option for those looking at exposure to the travel and tourism industry would be Flight Centre Travel Group Ltd (ASX: FLT). Recent declines in its share price has brought it down to an attractive entry-level price now for investors, as far as I am concerned. Alternatively, investors could stay out of the industry and take a look at these fantastic shares which I predict will produce strong returns this year.
