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Is Qantas set to take off?

Qantas (ASX: QAN) shareholders have had a rollercoaster 18 months. After plumbing a multi-year low of $0.96 in June  2012, the shares rapidly recovered to reach $1.90 in April this year, but quickly gave up most of the gains to trade back at $1.18 in early October.

Today, the shares are sitting at $1.50, having gained 20% in the last month as a result of a favourable election victory by Tony Abbott, and number of positive broker reports about the future earnings potential of the airline.

A Coalition victory in the election earlier this month will lead to lower fuel costs once the carbon tax is removed, and a more favourable business environment. Improved business confidence and spending should lead to more businesspeople travelling interstate and, consequently, greater demand for Qantas’ services.

Recent broker comments have noted that the airline will benefit from the removal of the carbon tax, the recent agreement with Emirates, a lower cost base following negotiations with unions, and reduced competition in the highly profitable trans-Pacific route.

The brokers have forecast a rise in earnings per share from under 6 cents per share this year, to 11 cents in 2014-15 and 22 cents in 2015-16. This would indicate that the company is undervalued on a forward price to earnings ratio of around 13. Certainly Qantas CEO Alan Joyce thinks so, having initiated a share buyback instead of reinstating dividend payment with some of the company’s $100 million in cash.

Qantas is one of only a handful of companies to have successfully fought unions in Australia. This will result in lower staff costs and the retirement of the comparatively inefficient 767 fleet will reduce the overall cost base of the airline. Mr Joyce believes the company will get within 5% of Virgin Australia’s (ASX: VAH) costs while maintaining a quality premium in ticket pricing. Overall this should equate to greater margins and stronger pricing power in the future.

Qantas’ dominant position was evidenced last financial year when it was forced to lower airfares to compete with Virgin. This sent Virgin to a loss for the year while Qantas maintained profitability. Further tailwinds for the company include increased revenue from the link with Emirates and the expansion into Asia with the Jetstar brand, although these two will be a drag on profitability in the short term until the services are established. The company also stands to benefit from US-based United Airlines reducing capacity on the trans-Pacific route.

Foolish takeaway

Qantas represents a medium-to-long term, higher risk investment. Shareholders should expect some volatility as the company is influenced by government regulation and international competition, however it stands to benefit from a rise in consumer confidence and the policies of the newly elected Coalition government. If it can perform as well as some brokers believe, investors should be well rewarded in the medium term.

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Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned.

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