Don't be fooled (lower case 'f') by analyst expectations of our national carrier to post a net profit of $1 billion this financial year.
Yes, Qantas Airways Limited (ASX: QAN) is expected to report an underlying net profit of $1 billion in the 2015 financial year, thanks in part to the lower oil prices, according to investment bank UBS.
But airlines have a number of quirks in their accounting that mean reported profit bears little resemblance to actual 'profits'. More on that below.
UBS expects Qantas to deliver a record pre-tax profit of $1.7 billion in 2016 financial year, allowing the airline to conduct capital management through share buybacks. But one year can be a long time in an airline's life, so don't count your chickens just yet.
The broker says transformation gains and a lag in passing on fuel savings to customers will help the airline deliver those numbers, aided by ratings agencies lifting their negative outlook and potentially giving the airline its coveted investment grade credit rating next financial year. A higher credit rating usually means lower interest rates on its debt and a smaller interest bill – helping to boost profit.
Qantas has declined to pass on lower oil prices through lower fuel surcharges to all customers, only on some routes for frequent flyer redemptions. The airline plans to remove the fuel surcharge on commercial fares over time, including it in the base fare. That has raised the ire of the Australian Competition and Consumer Commission (ACCC).
The airline has also benefitted from the end of a fierce air war with competitor Virgin Australia Holdings Ltd (ASX: VAH), allowing both airlines to compete normally in the domestic market. Profit is also being boosted by around $200 million less of depreciation charges each year, thanks to last year's massive $2.8 billion write-down.
On the profit accounting issue I mentioned above, Qantas depreciates the planes it buys from the original cost – much like any other business. But the problem for Qantas – and indeed all airlines – is that planes in 5 to 10 years' time are much more expensive, forcing the airline to either raise more debt or equity. Just one Airbus A380 cost US$414 million in 2014, and Qantas has committed to spending US$17 billion over the next 10 years on new aircraft.
Despite the positives and UBS's $4 price target, airlines remain bad investments and Foolish (capital 'F') investors would be wise to avoid Qantas.
