Air New Zealand – brightness on the horizon?

It is no secret that the airline industry has faced a turbulent time in recent years, with participants halted for long periods during the pandemic, and making large losses.

Monday, May 13th 2024, 10:30AM

by Devon Funds

By Greg Smith, Head of Retail at Devon Funds

The reopening post-Covid then saw supersonic passenger demand with airfares rising accordingly, and turbo-charging earnings. Volatile jet fuel costs on the back of wars and geopolitical tensions have made the journey more testing.

From the stock market’s perspective, the sector has descended around 30% over the past five years, while global equity markets have risen strongly – the S&P500 is up over 70% in this time. Air New Zealand has also lagged the NZX50, which will not have gone unnoticed by legions of retail investors (who increased their position via the $1.2b capital rise in 2022), and the government given its 51% stake. Air New Zealand’s share price is down nearly 20% year to date, with recent weakness driven by a downgrade to earnings forecasts.

Last month the airline reduced underlying earnings guidance for the year to 30 June 2024 by $40-$50 million, citing a softening of trading conditions both at home and abroad. In NZ, driving factors have been cost of living pressures along with subdued corporate and government demand. The kiwi economy is in recession and with airfares elevated, people are cutting back on travel. The airline’s ratio between revenues and available seat kilometres (RASK) on short haul routes is down ~7% year to date versus a year ago. The airline is now putting up prices which could help but may also be a hindrance.

On North American routes, the kiwi carrier is suffering from intense competition. Big US airlines have yet to return to China en masse, and have directed capacity this way. Long haul year to date RASK is down 16% on a year ago.

Outstanding Covid credits are an added complication. These have been extended until the end of 2026 and are not being used by passengers as quickly as expected. The assumed level of additional Covid-related credit “breakage” for the second half of the financial year has increased from $20 million to $50 million.

Then there are oil prices, which are highly relevant, with jet fuel being the single biggest cost item. Oil prices are unpredictable as Air New Zealand well knows. At the interim results just over two years ago the airline said it was positioned for falling oil prices – that same day Russia invaded Ukraine. Oil prices surged and did so again this year following rising geopolitical tension in the Middle East.

Little wonder then that the near-term profit outlook is challenged. Air New Zealand expects earnings before taxation for the 2024 financial year to be in the range of $190m to $230m. Stripping out Covid credits, the underlying profit range is $95-$135m. Given reported underlying profits of $140m in the first half, our national carrier is effectively losing money, with a second half loss of -$45m to -$5m.

Other challenges include rising costs, with part availability also a constraining factor and impacting capacity. Engine supplier Pratt Whitney is undergoing a major remedial maintenance program while issues are also being addressed on Rolls-Royce Trent 1000 engines. The latter has caused the suspension of Air NZ’s Chicago route.

Then there is an ongoing stoush with Auckland Airport over pricing increases. The Commerce Commission will pass initial judgment this month, but price increases will ultimately be passed on to passengers, potentially further denting demand.

With headwinds aplenty, is there any light on the horizon for Air New Zealand? Possibly.

On the plus side of the ledger, Air New Zealand has a dominant market position, however this should not be taken for granted. Recent figures showed that the airline is trailing Jetstar in terms of reliability. 77% of domestic flights were on time in March, down from 88% in January. International reliability has also been impacted by capacity issues.

While the airline is beholden to engine manufacturers, these issues should be resolved in the next 12-18 months. By this time, Covid-related credits will also largely be in the rear-view. Some middle ground may also be found on landing charges. Oil prices remain something of an unknown, but there is a push for a peace deal in the Middle East.

Intense international competition could improve as big US airlines look to reposition capacity to more profitable routes, with bigger scale opportunities. Domestically, a demand boost could be forthcoming as the economy improves, and cost-of-living pressures ease - the RBNZ could well provide some help here later in the year with cuts to interest rates.

Brand wise, our national airline, for all its issues, is coming from a position of strength. AirlineRatings.com has rated the airline the best for Economy and Premium Economy. Note was made of an airline that “punches well above its weight globally” and is lauded for its approach to innovation, and for being one of the few airlines to have an investment grade credit rating.

Air New Zealand has plenty of headwinds to navigate but is also led by one of the most respected business leaders globally in ex-Walmart CEO Greg Foran. Air NZ trades at a price earnings multiple of 13 times, more than double that of the global airline sector.

Disclosure: Devon does not hold shares in Air New Zealand

Devon Funds Management is an independent investment management business that specialises in building investment portfolios for its clients. Devon was established in March 2010 following the acquisition of the asset management business of Goldman Sachs JBWere NZ Limited. Devon operates a value-oriented investment style, with a strong focus on responsible investing. Devon manages six retail funds covering across the universe of New Zealand and Australian, equities and has three relatively new international strategies with a heavy ESG tilt. For more information please visit www.devonfunds.co.nz

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