Stocks to Watch · Wed 07 December 2016 02:30 PM

Why you’re better off if Qantas’s stock crashes, even if you already own it

QAN:ASX Qantas Airways

By Graham Witcomb

The golden rule in investing is that every stock is a claim on a future stream of cash flows. It follows, then, that the price you pay and the return you get are two sides of a seesaw. As the share price decreases relative to the future cash flows, your return on investment goes up.

Qantas Airways (ASX: QAN) has barely put a foot wrong recently, with underlying pre-tax profit up 57% to $1.5bn for the year to June. The result was driven by a recovery at the struggling Jetstar division, $400m of cost-cutting initiatives and a decline in the price of jet fuel. Still, with the share price up 25% since late June – and having tripled since 2014 – investors are paying up for a rosy outlook.

Given the seesaw analogy mentioned above, anyone wanting to buy Qantas today – not that we recommend it – should hope the share price falls so their purchase price is lower. However, long-term investors who already own the stock would also be better off if the share price were to fall. How does that work?

The magic of buybacks

Qantas completed a $500m share buyback last year and a second buyback of $360m is currently underway. The company still has around $134m of unused ammunition. If Qantas’s stock averages, say, $3.30 for the remainder of the buyback, the company will acquire roughly 41m shares for its $134m. There would then be around 1,792m shares outstanding.

If the price were to crash back to its 2014 low of $1.10, however, the company could repurchase 122m shares and investors would only have to split the pie 1,710m ways. Long-term shareholders would own around 5% more of the company than they otherwise would, without any additional investment themselves.

Whether Qantas should be buying back shares at all, though, is a different matter. The company is extremely capital intensive and produces low returns on capital ‘through the cycle’, despite the occasional year of decent profits. Over the past decade, Qantas has produced an average net profit of just $61m, yet required more than $3bn of shareholder equity to do so. We think the cash is better off in the hands of shareholders than being used to buy stock in a below average business at inflated prices.

If you’re a current shareholder, though, you presumably disagree with us on that front and believe in the company’s long-term potential. That’s your call to make.

Whatever the case, if you’re going to buy a stock, either directly or because the company is repurchasing shares, high prices lessen your future returns. Qantas, CSL (ASX: CSL), Telstra (ASX: TLS), Asaleo Care (ASX: AHY) and Navitas (ASX: NVT) are just a few companies currently buying back stock. When the next big dip comes along, it’s time to cheer.

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By Graham Witcomb

Graham Witcomb is an analyst at Intelligent Investor owned by InvestSMART Group. This article contains general investment advice only (under AFSL 282288).

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