With the Air New Zealand Limited (ASX: AIZ) share price down 12% in 2019 so far, I think it’s a good time to buy shares of the airline.
Background on Air New Zealand
Air New Zealand provides domestic and international travel to and from New Zealand along with cargo and engineering services. It has a market capitalisation of $2.94 billion.
Why I think it’s a buy
Air New Zealand has a price-to-earnings (P/E) ratio of 8.08x against the ASX 200, which has a P/E ratio of 17.81x at the time of writing. This cheap valuation could be associated with the risks of operating an airline along with debt levels; however, Air New Zealand has proven to be a very profitable business. While earnings have been down by around a third in 2019, this does not change the fact that the group has a low valuation.
The group has a grossed-up dividend yield of 6.7%. This is a healthy return against the current cash rate of just 1%. So far in 2019, its management have held the dividend steady. Given that the group had a payout ratio of 63% in 2018, there should be room to maintain dividends even in the face of lower earnings, provided that they do not drop a great deal more.
Air New Zealand has a price-to-book ratio of 1.47. This is against the ASX 200, which has a price-to-book ratio of 2.12. This suggests that the group is valued conservatively when considering its accounting value. Additionally, in the last 5 years the group have generally achieved a return on equity between 10% and 20%.
Another positive sign for this company is its cash flow, which has historically been much higher than earnings. This suggests that real earnings may be higher than what accounting values represent, as airlines face a high amount of depreciation and Air New Zealand is no exception. This non-cash write down of assets will reduce net profit while real cash generated by the business may be much higher than it appears.
One risk that should be mentioned is the company’s debt-to-equity ratio. This is high at 125.6% and suggests that the company is heavily geared. While this will contribute to earnings, it needs to be considered as a risk that could throw the company off track if earnings are lost. Provided that the group remains profitable, this debt can be managed.
Air New Zealand trades on a low valuation and has a healthy dividend yield. While the company does come with some risk due its debt level, it has proven to be a very profitable business. I think it’s a buy.
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Motley Fool contributor Chris Chitty 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.