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Should I add Qantas shares to my portfolio?

In February this year, Qantas Airways Limited (ASX: QAN) released its half-yearly earnings report to investors.  This report showed that underlying earnings per share were down 16% when compared with the same period last year.  Given the recent track record of strong results from Qantas, this outcome would have been disappointing to most investors.   

Despite this result and only a small decline in the Qantas share price since the announcement, I believe that the case can still easily be made that QAN shares are priced below value.  The company likely agrees, having announced a share buyback scheme, which is now over 50% completed, the same day as the half yearly results were released.  If you are fan of Qantas and its underlying business, now might be the time to buy.

Is Qantas a business worth owning?

Return on equity is often cited as the best guide to economic performance.  Qantas has achieved strong double-digit results using this measure over the past four years.  This, however, is in stark contrast to the results achieved earlier in the decade which raises concerns over the ability of Qantas to sustain this type of performance. 

Qantas, being predominately involved in air transportation, is in a highly competitive industry.  This makes raising prices for its services hard.  When costs rise, which would occur simply with an increase in the price of oil, the business performance will deteriorate.  This has been demonstrated in the half-yearly results where fuel costs were flagged as a key reason for the reduction in profit.

The airline industry as a whole is also renowned for its high level of capital costs which means cash is continually tied up in sustaining the business.  This leaves less cash available for distribution to shareholders and is something that’s worth keeping in mind when investigating other ASX listed airlines such as Air New Zealand Limited (ASX: AIZ) or Virgin Australia Holdings Ltd (ASX: VAH)

One more item worth considering is the debt level of Qantas.  In general, less debt means less risk and therefore lower levels of debt are preferable.  According to the half-yearly results Qantas has net debt of $5.2b which they say is ‘at the bottom of the target range’.  Despite this sitting at the bottom of the range that Qantas has set itself, this is a high level of debt and this statement implies it won’t be decreasing in the short term.

Foolish Takeaway

When investing, it is important to consider the opportunity cost of your investments.  I believe at its current share price, a price quite possibly below intrinsic value, investing in Qantas shares would mean sacrificing better investment opportunities elsewhere.  In particular, in companies which have a greater likelihood of increasing their value over the long term. 

There is the possibility of a positive short-term correction in the market price for Qantas shares.  Investing now could, therefore, mean a quick profit, but at its current price, I don’t believe the upside is worth waiting around for.

I still believe Qantas will be around for a long time into the future.  Even so, without a true competitive advantage in a high-cost industry, I will be choosing to remain solely a customer of Qantas and not an owner — unless we see a dramatic drop off in the share price.

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Motley Fool contributor Mitchell Perry 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 Scott Phillips.

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