The Qantas Airways Limited (ASX: QAN) share price is up an impressive 30% in 2024 to date. It appears to have largely recovered from the hits to its reputation with investors. However, Qantas shares are down over 5% in October after it emerged that Qatar Airways is making an investment in Virgin Australia to take up a 25% stake.
Qantas has enjoyed a strong competitive edge since the reopening of borders following COVID-19 disruptions. It has been able to charge higher airfares due to pent-up demand and reduced competition from Virgin Australia, which was struggling with voluntary administration woes during a large chunk of 2020.
However, the Australian airline sector seems poised to change again with Qatar Airways set to bolster Virgin Australia in a variety of ways. So, could this impact Qantas' future profitability prospects?
How will Virgin Australia compete?
Virgin Australia says this strategic relationship with Qatar will "drive increased competition in Australian aviation." It hopes to provide "even better value airfares and greater choice".
One part of the plan involves a "measured" entry into long-haul international flying by mid-2025, with "significant flow-on benefits for Australian travellers and the Australian economy." The proposed wet lease services will begin next year, when Virgin Australia will "assess the longer-term merits and viability of wide-body aircraft while providing Australians with greater local competition for their long-haul travel needs in the near term."
Virgin Australia also says it will gain access to "scale and synergy benefits, further strengthening Virgin Australia's financial resilience", and underpinning the company's growth.
What could this mean for Qantas shares?
Clearly, these developments suggest Qantas will face increased competition and, therefore, may not be able to charge as much as it has been on routes in which Virgin Australia will start competing more.
Lower revenue per flight would likely mean lower profit margins for the airline and, therefore, a potential hit to the bottom line.
The latest note from broker UBS, released after Qantas' FY24 result but before the Qatar/Virgin Australia news hit, had a buy rating on Qantas shares with a price target of $7.95.
In that note, UBS forecast Qantas' net profit to drop slightly to $1.44 billion in FY25 and then to $1.41 billion in FY26.
Notwithstanding this, overall the broker was positive about Qantas shares in the note because it believed the market was "still not pricing in the new normal earnings". While earnings were projected to fall slightly, the airline was still trading at a low future earnings multiple, which the broker thought was attractive. According to UBS at the time, Qantas shares were valued at under 8x FY25's estimated earnings
UBS explained:
Overall this was a positive result, leading to modest upgrades to our P&L and larger upgrades to our cash flow forecasts. We would not expect material changes to consensus forecasts. That in itself should be a source of relief for the market which, at <7x PE, is currently pricing Qantas on the implicit assumption that earnings need to fall further before being considered sustainable.
We think FY25 reflects the new normal of post Covid earnings with a better domestic market structure, a reset approach to the international network, and higher loyalty earnings. We see strong valuation support for QAN, and we believe we're still being relatively conservative on margins.
However, as mentioned, these comments were made without the broker factoring in any potential impacts from the Virgin/Qatar deal.
And, in my opinion, a stronger and more competitive Virgin Australia is not helpful for Qantas' future earnings.
Considering the impressive run/re-rating of the Qantas share price already this year, I don't believe it's likely to rise a lot more in the shorter term. The current earnings multiple is not high, but we should keep in mind what could happen beyond the next 12 months.
In the longer term – in FY26 and onwards amid potential new challenges coming from Virgin Australia – I think Qantas will need to grow earnings to justify investors paying more than today's price.
