The Qantas Airways Limited (ASX: QAN) share price may have flown 16% higher in the past six months, but the Webjet Limited (ASX: WEB) share price and Vocus Group Ltd (ASX: VOC) share price look more tempting.
What's wrong with Qantas Airways shares?
Warren Buffett, the world's most renowned and arguably best investor, famously joked that he had a toll free number which he could call if he ever considered buying an airline — because they are bad investments.
But even Buffett could not resist the temptation of cheap airline stocks. At the end of 2016, Buffett's Berkshire Hathaway amassed a $US 2.9 billion position in Delta Airlines.
Buffett obviously knows what he is doing. But I think ordinary people like us shouldn't attempt to buy airline stocks for two simple reasons: They have terrible economics and many risks.
Let me explain what I mean…
The 'economics' of a business relates to a company's ability to turn sales into profit. Let's say it costs $200 to fly from Melbourne to Sydney. Hypothetically, let's say the costs — think fuel, servicing, wages for pilots, charges for landing at the terminal, etc. — for the flight are $180. That means they made $20 before taxes for the flight. That's an operating margin of 10%. By my calculations, Qantas had an operating margin of 10% in the last half of its current financial year.
Contrast that with, say, a software business like Adacel Technologies Limited (ASX: ADA). They make software for air traffic controllers. Once they have developed the technology, they can sell licence after licence at really no extra cost to them. They had a net profit margin of 44% during their most recent half year.
Then there are the risks. Every company has risks. But when you have a skinny operating margin, it leaves little margin for error. If fuel prices continue to rise, for example, Qantas' fuel bill will 'fly' higher. It has no control over that.
If competition continues to increase, its revenue will squeeze the operating margin down from the top.
And if interest rates rise, the company's $4.6 billion of debt may start to cripple the profit margin. That risk could affect any debt-heavy business.
2 alternatives to Qantas
If I were looking for alternatives to Qantas, I'd turn my gaze to Webjet Limited (ASX: WEB) and Vocus Group Ltd (ASX: VOC). Webjet does online bookings (read: software) and appears to be growing at a healthy clip.
Vocus is the owner of Dodo, Primus, Eftel, Amcom, NextGen and more. Its financials are a bit of a mess at the minute but I think its shares appear pretty well priced.
I would put them on my watchlist before buying shares in Qantas.
