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Air NZ shares still over-priced as growing uncertainties cloud earnings outlook: FNZC

Wednesday 8th November 2017

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(Fixes analyst's name in 2nd paragraph)

Air New Zealand shares are trading higher than what First NZ Capital reckons is fair value, and while the national carrier has a number of tailwinds, the research house sees some clouds on the horizon for the airline's earnings. 

FNZC analyst Andrew Steele lifted the stock's target price to $2.90 from $2.55, citing Air NZ's ability to deliver a return equal to the cost of its capital over the long-run, however he affirmed its 'underperform' rating to reflect the research house's view on where the trading price was relative to the company's fundamental value. The shares recently traded at $3.35, down 0.6 percent today. 

"In our view, with AIR trading at close to peak multiples relative to recent history; the elimination of a valuation discount to global peers; recent increases in the cost of fuel; at a time of increased NZ consumer uncertainty we are concerned that the current share price imputes a level of future returns upside, or alternatively, a level of risk which is not reasonable for an airline," Steele said in a note to clients. 

Auckland-based Air NZ's earnings fell less than expected in 2017 as the country's tourism boom and persistently cheap jet fuel helped fatten the carrier's margins, offsetting heightened competition in the market. 

FNZC's Steele increased his forecast for the airline's jet fuel costs over the next three years, tracking movements in crude oil prices, while acknowledging the impact of shale oil production could create a structural change driving down energy costs over the medium-term. 

Air NZ faced reduced competition in short-haul domestic, trans-Tasman and Pacific Islands routes which Steele anticipates will deliver better yields. However, increased competition on long-haul routes to Asia creates "material competitive pressure on load factors and yields" on a number of those flights. 

"While the industry appears to be capturing the lower jet fuel tailwind we could argue that such a short timeframe of capacity management is currently insufficient evidence of structural industry change allowing it to deliver greater than WACC (weighted average cost of capital) returns, in our view," Steele said. 

FNZC expects Air NZ to generate more passenger revenue over the coming three years than previously predicted, however more expensive jet fuel is set to squeeze margins. Steele lifted his forecast for the airline's annual profit 1.1 percent to $388 million in 2018, while cutting 12 percent and 4.9 percent from his outlook in the following years to $362 million and $415 million. The airline reported a profit of $379 million in 2017. 


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