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Is it time to buy Qantas?

With Air New Zealand (ASX: AIZ) receiving approval last week to increase its stake in Virgin Australia  (ASX: VAH) by 6% to 25.9%, it’s worth considering whether now is the time to invest in Australia’s airlines.

There are four shareholders currently controlling nearly 70% of Virgin’s listed equity — Air New Zealand (currently 19.9%), Singapore Airlines (19.9%), Etihad Airways (13.4%) and Richard Branson (12.47%). Etihad and Singapore airlines are continuing to increase their stakes as they attempt to gain a foothold in the lucrative local market, which also links to each of their regional hubs.

The interest in Virgin follows a recent deal between Qantas (ASX: QAN) and Etihad that will see many Qantas flights pass through Etihad’s base in Dubai. Despite the recent tailwinds of a Coalition victory, improved domestic economic conditions and steady oil prices, neither Qantas nor Virgin have seen noticeable share price appreciation this year. So far Qantas has produced a loss of 2% in 2013, and Virgin a mediocre rise of 2%.

Qantas and Virgin control Australia’s four largest domestic airline brands, full service carriers Qantas and Virgin, and budget brands Jetstar (Qantas controlled) and TigerAir (Virgin controlled). Brokers are generally in agreement that Qantas represents a better investment than Virgin, however few believe either are an outright ‘buy’.

Qantas has more near-term upside with the potential for earnings per share to rise by nearly four times in the next three financial years as the retirement of inefficient aircraft, lower cost base and the link with Emirates boosts customer numbers.

The lower cost base is of particular importance in the industry. Of note by brokers was the win by Qantas against the unions representing its workers. The hardline negotiations are believed to have brought Qantas’ cost base down to be closer to Virgin’s, allowing Qantas to more aggressively compete on price.

This was evidenced during the 2012-13 financial year when Virgin attempted to increase market share by lowering fare prices and increasing capacity. Qantas responded aggressively by taking the same action, pushing Virgin to a shock loss for the year while Qantas maintained profitability.

Qantas is also expanding its Jetstar arm into Asia and has a stronger rewards scheme, which is key to customer loyalty. Both companies will likely benefit from the Coalition government, so much so that some analysts have estimated Qantas will be $100 million better off once the carbon tax is repealed. Virgin appears to be up against it.

Foolish takeaway

Australia’s airline stocks are not for the faint-hearted. Both have fluctuated by over 20% between highs and lows in 2013, and this is expected to continue in the future. Investors are likely to be rewarded over the longer term, however, Qantas appears to have greater upside and pricing power than Virgin.

Both are trading near levels of 12 months ago despite the domestic and international business environment appearing to strengthen. Investors willing to accept short-term price fluctuations may consider purchasing Qantas shares for an exposure to the domestic economy.

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

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