Why I’m not jumping on board Qantas Airways Limited stock just yet

In 2013, Warren Buffett quipped that “Investors have poured their money into airlines and airline manufacturers for 100 years with terrible results”. He went on to state that the airline industry “has been a death trap for investors”. Similarly Richard Branson has said that “If you want to be a millionaire, start with 1 billion dollars and launch a new airline”

Airlines such as Qantas Airways Limited (ASX: QAN) Virgin Australia Holdings Ltd (ASX: VAH), and Air New Zealand Limited (ASX: AIZ) have typically been thought of as capital intensive, high debt, low margin businesses whose fortunes are tied to fluctuations in oil prices.

Investor sentiment has, as a result, been bearish for a number of years, and this has been reflected in the share prices.

For example, Qantas shares currently trade at a price to earnings ratio of 9.4, and Air New Zealand at 8.6. Price to book is 2.6 for Qantas and 1.6 for Air New Zealand.

However, structural changes have begun to reverse investor sentiment. Indeed, Buffett’s Berkshire Hathaway surprised many investors when it took a stake in a number of major US airlines in 2017.

Consolidation in the number of airlines has led to less competition and greater pricing power. Furthermore, more sensible capital expenditures, lower oil prices, and higher percentages of seats sold have led to increasing stability in the airline industry. Buffett hopes that they have “got a bad century out of the way”.

So are airlines now profitable businesses available at a cheap price?

When it comes to Qantas, analysts have forecasted earnings growth, reasonably strong returns on equity, and lower oil prices for the next few years. As such, Qantas shares, although currently 20% off their 52-week high, are up almost 50% in that time. Investor sentiment has certainly turned.

But are they currently a good buy?

If the current tailwinds continue, there may be a reasonable margin of safety at the current share price, depending on your assumptions about growth and required return. However, if we’ve seen the majority of the changes in the industry already unfold the robust earnings increases may not continue. I’d like to wait and see how stable and substantial earnings increases will be over the next few years before jumping on board.

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Motley Fool contributor Stewart Vella has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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