Air NZ shares fall, analysts query capital return strategy

Air New Zealand's [NZX: AIR] share price has dropped 16 percent in the last three months and 5.7 percent since announcing a record $327 million net profit this week and indicating a significant earnings uplift for the 2016 financial year.

Deutsche Bank analyst Chris Byrne said in a research note that the negative reaction to the 2015 full-year result suggested the market was disappointed no special dividend was announced and remains concerned about the airline's ability to profitably fill capacity increases over the next year as economic activity weakens and competition increases.

Following this year's result, analysts covering the stock have bumped up their expected 2016 earnings based on jet fuel savings, 11 percent capacity growth, and a stronger contribution from its 26 percent stake in Virgin Australia. That's partly offset by concern about new competition including Jetstar on regional routes, Chinese airlines, and from Qantas alliance partner American Airlines on trans-Pacific flights.

The analysts have a dimmer profit outlook for the airline in the following two years when oil prices are expected to rise, the NZ dollar weaken, and increased competition hurt earnings.

Deutsche Bank is forecasting net profit of $531 million for 2016, $409 million for 2017, and $347 million for 2018. UBS's forecast for 2016 is slightly lower at $527.7 million but higher for 2017 and 2018 at $468.9 million and $434.4 million respectively. First NZ Capital is the most pessimistic of the three forecasting net profit of $519 million in 2016, dropping to $338 million in 2018 and $335 million in 2018.

First NZ Capital analyst Paul Turnbull said in a research note that the direction of jet fuel prices and currency will see significant excess returns in 2016, with the fuel price having most influence on the end result. "However, we also believe that the competitive dynamics of the airline industry will apply downward pressure to Air New Zealand's returns in the medium-term."

Target prices for the stock from the three firms range from $2.40 to $3.15 compared to the current $2.50 share price.

Opening two new routes in December to Buenos Aires and Houston could also have an impact on 2016 earnings. UBS analyst Marcus Curley said in a research note that while Air New Zealand said advance sales on both routes had been "going well", it was only appropriate to incorporate some initial long-haul pressure as the airline builds demand in the first six months.

He's putting less weight on additional Chinese competition with new year-round services from China Eastern from Auckland to Shanghai because of a survey showing a substantial increase in New Zealand's popularity as a tourism destination for mid-to-high income Chinese. Air New Zealand and Air China are still waiting on regulatory approval for their proposed alliance to coordinate operations in the New Zealand to China market.

Christchurch International Airport today announced the commencement of year-round direct services to be provided by Chinese government-owned China Southern Airlines, between Guangzhou and the South Island gateway, with New Zealand's increasingly popularity as a Chinese tourism destination cited for the development.

Turnbull said Jetstar's decision to enter regional routes in New Zealand likely represents the first step in the Qantas budget offshoot's return to capacity growth in the domestic market. Its entry will lift regional capacity by around 12 percent while Air New Zealand intends lifting domestic capacity by 8 percent in 2016.

Byrne has lifted his estimated dividend for the 2016 financial year by 25 percent to 20 cents per share which reflects an expected revenue decline in 2017.

"The dividend profile will depend on what happens to demand, fuel price and the New Zealand dollar over FY 2016. Air New Zealand may choose to pay a special dividend to recognise the confluence of factors contributing to 2016's result," he said.

(BusinessDesk)