qantas 2015 12 16 - credit suisse

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16 December 2015

Asia Pacific/Australia Equity Research

Airlines

Qantas (QAN.AX / QAN AU) Rating OUTPERFORM Price (16-Dec,A$) 3.80 Target Price (A$) 5.50 Target price ESG risk (%) 0.0 Market cap (A$mn) 7,837.1 Yr avg. mthly trading (A$mn) 687.0 Projected return: Capital gain (%) 44.7 Dividend yield (net %) 13.2 Total return (%) 57.9 *Stock ratings are relative to the relevant country benchmark.

¹Target price is for 12 months.

Research Analysts

Paul Butler

61 2 8205 4309

[email protected]

Gretel Janu

61 2 8205 4028

[email protected]

INITIATION

Flash cash-flow flood

■ Erratum: This report is updated to correct the financial summaries on pages

1 and 2. There is no material change to our underlying estimates.

■ Initiate coverage of Qantas with $5.5 TP and OUTPERFORM rating: Free

cash flow generation (after all capex) could exceed $3bn over the next two

years (~40% of market cap), driven by lower fuel costs, management's

revenue and cost improvement initiative and a continuing period of capacity

restraint in the domestic market. Consensus is underestimating the benefit

from falling fuel prices for FY17, and our PBT estimate is 30% ahead of the

street. We forecast special dividends of 50cents for this year and next

($2.1bn total), but excess capital (based on 45% FFO/debt investment grade

threshold) could be over twice this level.

■ Expect FY16 PBT at $1.8bn & FY17 at $2.1bn, 30% ahead of consensus:

FY17 PBT consensus has not changed in the past 3 months, despite a >20%

fall in crude prices. We can't see it all being passed to customers. FY16 fuel

may be $110mn lower than last guidance and Qantas can hedge FY17

$160mn lower again, with further downside participation.

■ Domestic capacity restraint for at least next 18-24 months: Domestic

competitor Virgin Australia appears focused on repairing its weak balance

sheet (S&P B+), and the recent period of capacity restraint may continue.

Qantas may retain much of the benefit from fuel price and cost savings.

■ Fair value at $5.5 per share: We value Qantas shares based on 4.4x

EV/EBITDAR multiple. This implies a 0.68x EV/IC (gross capital) multiple that

is in line with the historical EV/IC vs CROIC trend line.

■ Risks to our view include weaker demand, higher competition, higher fuel

cost, labour disputes, regulatory risk, geopolitical risk and other shocks.

Share price performance

On 16-Dec-2015 the S&P ASX 200 Index closed at

5028.447

On 16-Dec-2015 the spot exchange rate was A$1.38/US$1

Performance 1M 3M 12M Absolute (%) 3.03 6.10 66.60 Relative (%) 5.82 3.88 72.71

Financial and valuation metrics

Year 6/15A 6/16E 6/17E 6/18E Revenue (A$ mn) 15,816 16,567 16,733 17,122 EBITDAR (A$ mn) 2,824 3,729 3,936 3,552 EBIT (A$ mn) 1,233 1,988 2,169 1,764 Underlying PBT (A$ mn) 975 1,838 2,070 1,721 EPS (Adj.) (A$) 0.25 0.60 0.70 0.58 Change from previous EPS (%) n.a. n.a. n.a. n.a. EPS growth (%) n.m 136.8 16.4 (17.3) Consensus EPS (A$) 0.33 0.57 0.60 0.60 EV/EBITDAR (x) 3.7 2.8 2.7 3.0 P/E (x) 15.0 6.3 5.4 6.6 Dividend (A$) 0.23 0.50 0.50 0.00 Dividend yield (%) 6.1 13.2 13.2 0.0 Price/Book (x) 2.4 1.9 1.7 1.6 Adj. Net debt/EBITDAR (x) 2.2 1.3 1.2 1.3

Source: Company data, Thomson Reuters, Credit Suisse estimates

16 December 2015

Qantas (QAN.AX / QAN AU) 2

Qantas (QAN.AX / QAN AU)

Price (16 Dec 2015): A$3.80; Rating: OUTPERFORM; Target Price: A$5.50

Income Statement 6/15A 6/16E 6/17E 6/18E

Revenue 15,816 16,567 16,733 17,122 RASK 11.1 11.1 11.0 11.1 % change 2.6 0.1 (0.8) 1.0 Fuel cost 3,937 3,489 3,331 3,798 EBITDAR 2,824 3,729 3,936 3,552 EBITDA 2,329 3,204 3,400 3,008 CASK 10.3 9.8 9.5 9.9 % change (9.1) (5.3) (2.4) 3.7 Depr. & Amort. (1,096) (1,217) (1,231) (1,244) EBIT 1,233 1,988 2,169 1,764 Associates - - - - Net interest exp. (258) (150) (99) (43) Other 0 0 0 0 Profit before tax 975 1,838 2,070 1,721 Income tax (229) (551) (621) (516) Profit after tax 746 1,287 1,449 1,205 Minorities (3) (10) (10) (15) Preferred dividends - - - - Associates & Other (187) 0 0 0 Normalised NPAT 556 1,277 1,439 1,190 Unusual item after tax 0 0 0 0 Net profit (Reported) 556 1,277 1,439 1,190

Balance Sheet 6/15A 6/16E 6/17E 6/18E

Cash & equivalents 2,908 2,908 2,908 2,908 Inventories 322 336 339 339 Receivables 959 1,000 1,010 1,037 Other current assets 860 860 860 860 Current assets 5,049 5,104 5,117 5,144 Property, plant & equip. 10,715 10,749 10,821 10,969 Intangibles 803 502 550 600 Other non-current assets 963 681 665 647 Non-current assets 12,481 11,933 12,035 12,215 Total assets 17,530 17,037 17,152 17,359 Payables 1,881 1,962 1,981 2,036 Interest bearing debt 5,562 3,995 3,621 3,455 Other liabilities 6,640 6,852 6,903 7,048 Total liabilities 14,083 12,808 12,506 12,539 Net assets 3,447 4,229 4,646 4,820 Ordinary equity 3,442 4,214 4,621 4,780 Minority interests 5 15 25 40 Preferred capital - - - - Total shareholder funds 3,447 4,229 4,646 4,820 Net Debt 2,654 1,087 713 547 Capitalised aircraft leases 3,748 3,940 4,024 4,083 Adj. Net Debt 6,306 4,930 4,642 4,534

Cash Flow 6/15A 6/16E 6/17E 6/18E

EBIT 1,233 1,988 2,169 1,764 Net Interest (196) (150) (99) (43) Depr & Amort 1,096 1,217 1,231 1,244 Tax Paid (2) (282) (621) (516) Change in Working capital 262 232 56 173 Other cash and non-cash items (345) 18 18 18 Operating cashflow 2,048 3,022 2,754 2,641 Capex (1,237) (1,260) (1,360) (1,500) Capex - expansionary - - - - Capex - Maintenance - - - - Acquisitions & Invest 129 100 150 200 Asset sale proceeds 28 350 0 0 Other - - - - Investing cashflow (944) (950) (1,350) (1,443) Dividends paid (4) (505) (1,031) (1,031) Equity raised 0 0 0 0 Net borrowings (2,276) (730) (446) (443) Other financing cash in/(outflows) 1,063 (837) 73 276 Financing cashflow (1,217) (2,072) (1,404) (1,198) Total cashflow (113) 0 (0) (0) Adjustments - - - - Movement in cash/equivalents (113) 0 (0) (0)

Earnings 6/15A 6/16E 6/17E 6/18E

Equiv. FPO (period avg) (mn)

2,196 2,129 2,062 2,062 EPS (CS adj.) (c) 25.3 60.0 69.8 57.7 EPS growth (%) 119.7 136.8 16.4 (17.3) DPS (c) 23.0 50.0 50.0 0.0 Dividend Payout (%) 90.8 83.4 71.7 0.0 Free CFPS (c) 36.9 82.8 67.6 55.3

Valuation 6/15A 6/16E 6/17E 6/18E

P/E (CS) (x) 15.0 6.3 5.4 6.6 PEG (x) 0.1 0.0 0.3 (0.4) EV/EBITDAR (x) 3.7 2.8 2.7 3.0 EV/EBITDA (x) 4.5 3.3 3.1 3.5 EV/EBIT (x) 8.5 5.3 4.8 5.9 Dividend Yield (%) 6.1 13.2 13.2 0.0 FCF Yield (%) 9.7 21.8 17.8 14.6 Price to book (x) 2.4 1.9 1.7 1.6

Returns 6/15A 6/16E 6/17E 6/18E

EBITDAR Margin (%) 17.9 22.5 23.5 20.7 Return on Equity (%) 16.2 30.3 31.1 24.9 Profit Margin (%) 3.5 7.7 8.6 6.9 Asset Turnover (x) 0.9 1.0 1.0 1.0 Equity Multiplier (x) 5.1 4.0 3.7 3.6 Return on Assets (%) 3.2 7.5 8.4 6.9 Return on Invested Cap. (%)

15.5 26.2 28.3 23.0

Gearing 6/15A 6/16E 6/17E 6/18E

ND/ND+E (%) 43.5 20.4 13.3 10.2 Net Debt to EBITDA (x) 1.1 0.3 0.2 0.2 Adj. Net Debt to EBITDAR (x)

2.2 1.3 1.2 1.3 Int Cover (EBITDA) (x) 9.0 21.4 34.3 70.4 Int Cover (EBIT) (x) 4.8 13.3 21.9 41.3 Capex to Sales (%) 7.8 7.6 8.1 8.8 Capex to Depr (%) 112.9 103.6 110.5 120.5

MSCI IVA Rating BBB

TP ESG Risk (%): 0.00 TP Risk Comment: Moderate risk in line with local sector peers. Main risks from fuel emissions and the labour workforce, which are its two largest operating costs. MSCI IVA Risk: Neutral MSCI IVA Risk Comment: There is moderate risk due to the poor social score driven from previous labour issues and disputes. The environmental score is fitting due to Qantas' high fuel consumption and emissions. Labour and fuel together account for ~58% of operating costs (ex ownership & associates).

Share price performance

On 16-Dec-2015 the S&P ASX 200 Index closed at 5028.447

On 16-Dec-2015 the spot exchange rate was A$1.38/US$1

Source: Credit Suisse Estimates

Stock Local Sector

Global Sector Country

Environment Social Governance

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16 December 2015


Qantas investment summary We initiate coverage of Qantas with an OUTPERFORM rating and target price of $5.5 per

share (~45% upside). Qantas has attractive investment characteristics due to its strong

position in the duopoly Australian domestic airline market (~62% market share) and its

dominant Loyalty program that provides 17% of group EBIT and over $2bn of "free"

financing.

The domestic market appears to be experiencing a respite from excessive competition and

this supports attractive RASK (unit revenue) growth. In the international market to/from

Australia, capacity is likely to grow at 7-8% over the next year. Qantas international RASK

has improved so far in FY16, but is likely to be weaker in the second half with increasing

capacity. However, lower fuel prices and management's continued delivery of its $2bn

transform initiative is likely to drive strong margin improvement. We forecast special

dividends of 50c per share for FY16 and FY17, providing a ~25% return of equity capital

over the next two years.

Expect PBT FY16 at $1.8bn and FY17 at $2.1bn

We expect Qantas to improve profit before tax by over $800mn in FY16 and a further

$240mn in FY17 (Figure 1). The key drivers are lower fuel price and management's $2bn

transform initiative to improve revenue and cost performance.

Underlying RASK (excluding the benefit of FX on foreign currency sales) is likely to be

down in FY16 due to large capacity increases on international routes and competitors

passing on a portion of the fuel cost savings to customers. However, the FX benefit on

foreign currency sales (25% of total revenue) is likely to offset this. In the domestic market,

RASK could be up slightly.

We forecast management to reach its cost and revenue improvement target (Transform

initiative) of $450mn for FY16 and forecast a further ~$380mn improvement in FY17.

Strong cash generation could significantly lower debt levels and result in lower financing

charges.

Figure 1: Qantas—underlying profit before tax ($mn)

Source: Company data, Credit Suisse estimates

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16 December 2015


Demand–capacity looking balanced for now

Domestic airline market

We forecast demand growth in the domestic market at ~3%. Airlines forward capacity

plans suggest capacity growth of 2-3% over the next year. This moderate capacity growth

could provide incremental RASK improvement.

The competitive environment appears relatively benign in the domestic Australian airline

market, this could be conducive for strong cash flow generation for a period to time, but we

don't expect these conditions to persist. Despite the domestic market's duopoly

characteristics, there has been surprisingly aggressive competition at many points during

the past two decades. We can't see structural changes that suggest any lasting changes

to this dynamic.

The catalysts for higher competition in the domestic market could include Virgin sufficiently

strengthening its balance sheet, rising fuel prices, a new entrant or governance that allows

or encourages irrational competitive behaviour.

International routes to/from Australia

International capacity growth has been flat for the past year, partly due to the weakness of

the Aussie dollar making it less attractive for foreign carriers. But, capacity increase over

the next year could be high at 7-8%. Qantas reports that international RASK has been up

for FY16 so far. This has benefited from foreign exchange of overseas ticket sales. In the

second half FX benefit will be lower and we forecast weaker RASK.

More to go on cost cutting targets

Qantas delivered $1.1bn of cost and revenue improvement from its business

transformation initiative over the past two years. It is targeting a cumulative benefit of $2bn

by FY17. Given management's record on delivering over half of the targeted improvement

so far, we are inclined to believe it is likely to achieve the target and could potentially

outperform it.

Figure 2: Qantas on track for $2bn cumulative cost and revenue benefits by FY17

Source: Company data

16 December 2015


Fuel – cumulative $1.2bn benefit for FY16 & FY17

Fuel cost is typically Qantas largest cost item and has been running at ~25% of revenue.

The recent continued fall in crude prices could enable Qantas to lock-in a further $110mn

fuel cost saving for FY16. At the AGM in October, management announced it was fully

hedged for FY16 with a likely cost of $3.6b. However, its hedging approach includes

optionality that gives 70% participation to further declines of fuel price. We estimate the

recent fall in crude could enable it to get below $3.49bn for FY16 (equivalent to Brent at

US$56/bb).

Qantas' hedging policy allows management to hedge fuel two years in advance and it

tends to hedge fuel in AUD or with corresponding AUDUSD hedges. It likely has significant

hedging in place for FY17 and 1H18. Management suggest that the proportion of exposure

it chooses to hedged for each forward period can deviate significantly from a straight line

approach (e.g. 100% next six months, 75% following six months, etc.). We think Qantas

could have hedged the majority of FY17 fuel exposure at a cost of ~$3.33bn (based on the

current forward curve, average at Brent ~US52/bb), while retaining optionality to further

price declines.

For FY18, we forecast fuel costs rising to $3.8bn, based on Jan Stuart's (CS global energy

economist) view for Brent to trade at US$65/bb in 2017 and US$70/bb in 2018 (Oil Sense,

2 Dec 15).

Qantas could have significantly lower hedging costs compared to Virgin due to its investment

grade credit rating (S&P BBB-) vs Virgin's junk rating (S&P B+). This makes it attractive for

Qantas to hedge fuel further out and retain downside optionality, while for Virgin and other

airlines with a poor credit rating, the hedging cost might make this less attractive.

Figure 3: 14% fuel price benefit in FY16 and 5% further benefit in FY17

Source: Company data, Credit Suisse

Fair value at $5.5 per share

We estimate fair value for Qantas shares at $5.5 per share based on a forward EBITDAR

multiple of 4.5x and an EV/IC (at cost) multiple of 0.7x. A 4.5x EBITDAR multiple is at the

lower end of the historical valuation range, while a 0.7x EV/IC multiple is at the higher end

of the range (Figure 5). However, we think the earnings power of Qantas is likely to be

higher than in the past due to the high cash generation from the Loyalty business that

supports ~25% of the capital base. This significantly lowers Qantas cost of financing.

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Brent forward curve Jet forwards + hedge & into wing cost Qantas & Virgin (prices paid for jet fuel)

https://plus.credit-suisse.com/r/h2lVVD

https://plus.credit-suisse.com/r/h2lVVD

16 December 2015


WACC at 8.1%

We estimate WACC for Qantas at 8.1%, based on cost of equity of 10.7%, cost of debt of

5.9% and target debt ratio of 40%. On a pre-tax basis, we estimate WACC at 8.8%. This is

significantly below the ~10% figure that management quotes.

To estimate cost of equity, we use a market risk premium of 7% and use the highest beta

we can calculate 1.1x vs ASX200 (20year, monthly, unadjusted). The beta over the past

few years has been much lower (~0.8), as the Qantas share price has been driven by

company-specific issues (falling fuel prices, management cost cuts and less aggressive

competition), while the ASX200 has been driven by other issues.

We estimate the cost of debt at 5.9%, based on a 300bp spread over the Aussie gov 10y

(2.9%). Qantas has medium-term notes (11-Jun-21 and 19-May-22) trading at 5.4% and

5.5% yield. This implies a spread over the relevant Aussie gov. yield of ~300bp.

Figure 4: Qantas—EV / IC (at cost) valuation Figure 5: EV / IC valuation

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Qantas shares attractive vs international peers

Qantas is on an attractive valuation compared to international airlines. It trades at 3.4x

EBITDAR over the next 12 month and following 12 month periods (Figure 7). This is

attractive compared to the global average for airlines of 4.8x and 4.5x and Japan Airlines

on 3.9x and 3.8x.

On an EV/IC basis, Qantas also looks attractive compared to international airlines (Figure 6).

FY16FY17

FY18

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16 December 2015


Figure 6: Qantas vs international airlines—EV /IC vs ROIC (12m forward)

Source: Credit Suisse

Qantas

Asian Pacific

European

North American

South American

Low cost airlines

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16 December 2015


Figure 7: Global airline valuation multiples

Source: Thomson Reuters Datastream, Credit Suisse

Sensitivity analysis

We present a sensitivity analysis for Qantas' exposure to fuel, foreign exchange and changes

in unit revenues and costs for each of the airline businesses (Figure 8). Qantas' earnings are

highly sensitivity to changes in fuel prices. While Qantas appears to have significant FX

exposure, in practice, this may be offset by beneficial changes in competitor behaviour.

EV / IC*

Fwd 12m Fwd 24m Fwd 12m Fwd 24m Fwd 12m Fwd 24m Fwd 12m Fwd 24m Fwd 12m

Qantas* QAN.AX O AU 5,735 3.4 3.4 2.7 2.7 6.0 6.0 20.7 19.8 1.38

Virgin Australia VAH.AX AU 1,166 5.5 4.9 7.5 6.1

Australian airlines average 3.6 3.5 6.6 6.1 20.7 19.8

Air New Zealand AIR.NZ U NZ 2,208 3.6 3.9 6.4 7.5

Singapore Airlines SIAL.SI O SG 9,386 4.5 5.8 3.7 4.0 14.8 14.1 8.0 4.0 0.98

Japan Airlines 9201.T O JP 12,662 3.9 3.8 4.8 4.5 8.4 8.2 21.8 18.5 1.52

ANA Holdings 9202.T O JP 9,956 6.8 6.9 4.1 3.8 16.3 14.5 5.8 5.4 1.14

Cathay Pacific 0293.HK U HK 6,698 4.9 6.4 5.6 5.1 7.9 7.1 9.7 5.3 0.96

EVA Air 2618.TW O TW 2,218 5.0 4.9 5.0 4.8 9.1 11.3 8.1 7.3 1.12

China Airlines 2610.TW O TW 1,971 5.9 5.4 5.4 4.9 10.0 10.1 4.3 4.5 1.03

Korean Air 003490.KS N KR 1,754 6.8 6.5 6.6 6.3 8.0 6.7 4.3 3.9 1.10

Asiana Airlines 020560.KS O KR 797 7.4 7.3 6.9 6.7 15.0 10.3 4.7 4.5 0.97

Air China 0753.HK HK 15,393 6.5 5.9 7.4 6.4

China Eastern 0670.HK HK 13,283 7.3 6.6 5.8 5.2

CSN 1055.HK HK 12,156 6.6 5.7 6.8 5.8

Asian Pacific airlines average 5.4 5.6 5.2 5.0 8.7 8.0 8.4 6.7 1.08

IAG ICAG.L O GB 19,692 5.5 5.0 4.4 3.9 8.5 7.6 21.3 21.1 2.08

Deutsche Lufthansa LHAG.DE U DE 7,347 3.5 3.4 3.0 2.7 5.6 5.0 13.2 12.8 1.23

Air France-KLM AIRF.PA U FR 2,219 4.9 4.6 2.9 2.5 6.5 4.6 6.3 7.1 1.30

Turkish Airlines THYAO.IS O TR 3,550 6.4 5.5 6.0 5.3 6.3 7.0 5.2 5.0 0.92

European airlines average 4.9 4.5 3.7 3.3 6.6 5.8 11.5 11.5 1.27

Delta Air DAL.N O US 40,472 4.0 3.9 4.4 4.3 8.2 7.7 31.7 29.2 2.27

American Airlines AAL.OQ N US 26,726 5.1 5.8 5.1 5.5 6.7 6.7 14.3 0.4 1.27

United Continental UAL.N O US 21,642 3.3 2.9 3.6 3.5 6.9 6.6 25.5 26.8 1.40

Air Canada AC.TO CA 2,113 3.9 3.6 2.8 2.6

North American airlines average 4.0 3.9 4.2 4.3 5.2 4.9 23.8 18.8 1.55

LATAM Airlines LFL.N N US 2,881 1.5 1.2 7.0 6.4 56.5 19.5 5.8 6.2 0.82

Copa Holdings CPA.N N US 2,221 23.6 26.6 6.7 5.8 11.0 9.1 8.5 8.8 0.71

Gol Linhas Aéreas GOLL4.SA U BR 242 6.8 6.4 13.7 10.7 -1.9 -8.0 5.9 7.3 0.79

South American airlines average 3.4 2.9 8.2 7.1 18.3 12.4 6.7 6.7 0.77

Southwest Airlines LUV.N O US 28,206 4.9 4.6 5.2 5.2 10.7 10.1 39.8 43.3 2.82

Ryanair RYA.I O IE 21,845 8.3 6.7 9.1 8.0 14.8 13.4 32.0 31.9 4.27

EasyJet EZJ.L O GB 10,089 6.7 5.9 11.1 9.8 23.5 25.5

JetBlue Airways JBLU.OQ N US 7,344 4.4 3.4 4.6 4.1 10.2 9.4 22.8 25.5 1.34

Cebu Air Inc CEB.PS O PH 1,025 5.9 6.1 5.3 5.1 6.4 6.5 10.7 0.3 1.17

AirAsia Berhad AIRA.KL O MY 823 8.6 8.4 7.5 7.0 5.4 4.9 5.5 0.1 0.94

Tiger Airways TAHL.SI U SG 728 11.0 11.3 11.7 10.9 27.9 21.1 4.1 3.7 1.80

AirAsia X AIRX.KL O MY 174 5.5 5.5 7.8 8.2 -11.4 51.3 6.4 17.1 0.84

Low cost airlines average 6.3 5.7 6.6 6.2 9.6 9.9 18.1 18.4 1.40

Global airlines average 4.8 4.6 5.1 4.9 10.9 8.4 13.7 12.8 1.18

Note: * based on CS estimates, all others based on consensus

P / EStock

EV / EBITDAR* EV / EBITDA ROIC* (%)Ticker Listing

Market cap

(USDmn)

CS

rating

16 December 2015


Figure 8: Qantas—sensitivity analysis

Source: Credit Suisse estimates

Foreign exchange exposure

Qantas receives ~25% of revenues in foreign currency. The USD is roughly half of this

and other key revenue currencies are GBP, EUR, NZD, CNY, HKD and JPY. The fuel bill

(~21% of revenue) has USD exposure. Other USD costs including leases are equivalent to

another ~12 of revenue. This leaves net FX exposure on costs equivalent to ~8% of

revenue. This assumes that the non-USD foreign currencies move in step with the USD.

This sensitivity analysis appears to suggest that a weak AUD would result in lower

profitability for Qantas. However, the analysis does not take account of changes in

competitor behavior. The weak AUD over the past year has also coincided with foreign

competitor airlines rationalising capacity to the Australian market. This has enabled

Qantas to achieve higher pricing on international tickets sales in Australia. The weaker

AUD could also boost foreign tourist levels, and foreign tourists constitute ~10% of

passengers on domestic flights.

Management suggests that the weak AUD is a positive contributor to the recent strong

profitability improvement.

Top of consensus for FY17

Our PBT estimates for Qantas are above the top end of the consensus range for FY17, as

we expect management to have taken advantage of the recent fuel price decline to lock-in

lower fuel pricing. We also forecast management to reach its $2bn transformation target

by FY17.

In FY18, our revenue estimates fall to the lower end of consensus as we include the risk

that overcapacity issues return to the sector. We also use CS crude price estimates for

Comment

FY16 FY17 FY18 FY16 FY17 FY18

Fuel

CS - base case

Jet price (AUD/bb, incl into wing & hedge costs) 110 106 121 110 106 121

Crude price (USD/bb) 56 52 63 56 52 63

Crude USD10/bb lower 0% 2% 6% 0% 5% 13%

Crude USD10/bb higher 0% -2% -6% 0% -5% -12%




FX - AUDUSD

AUDUSD at 0.60 0% -3% -8% 0% -5% -16%

Base case - AUDUSD at 0.72 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

AUDUSD at 0.80 0% 2% 5% 0% 3% 11%

AUDUSD at 0.90 0% 4% 12% 0% 8% 24%

FX - non-USD foreign vs USD

USD 10% stronger -2% -4% -4% -4% -8% -8%

USD 10% weaker 2% 4% 4% 4% 8% 8%

Qantas domestic

RASK +1ppt 0.4% 1.5% 1.7% 0.8% 2.8% 3.5%

CASK (ex fuel & ownership) +1ppt -0.2% -0.9% -1.1% -0.5% -1.8% -2.2%

Qantas international

RASK +1ppt 0.4% 1.5% 1.7% 0.8% 2.8% 3.5%


Jetstar

RASK +1ppt 0.2% 1.0% 1.1% 0.5% 1.9% 2.3%


PBT (% chg)EBITDAR (% chg)

Assume FY16 fully hedged, FY17 67%

hedged & FY18 25% hedged. Also

assume 1/3rd pass through of changes in

fuel cost to customers.

Assume FY16 fully hedged, FY17 67%

hedged & FY18 25% hedged. Also

assume 1/3rd pass through of changes in

fuel cost related to FX.

Exposure to GBP, EUR, NZD, CNY,

HKD, JPY and others. ~10% of revenue

16 December 2015


FY18 that could drive a 15% increase in fuel cost, compared to FY17. These two factors

lower our PBT estimates for FY18 to within the consensus range.

We forecast a 50 cents per share special dividend for FY16 and FY17, as management is

likely to deliver on its promise to return excess capital. We have no dividend for FY18.

While there could be excess capital based on our estimates, we wish to highlight that

airlines are unlikely to be attractive sources of dividend income in the long term.

Figure 9: Credit Suisse vs consensus revenue Figure 10: Credit Suisse vs consensus EBITDA

Source: Company data, Thomson Reuters Datastream, Credit Suisse Source: Company data, Thomson Reuters Datastream, Credit Suisse

Figure 11: Credit Suisse vs consensus PBT Figure 12: Credit Suisse vs consensus dividends

Source: Thomson Reuters Datastream, Credit Suisse Source: Thomson Reuters Datastream, Credit Suisse

Key risks

Key downside risks to earnings forecasts, target price and investment rating include:

■ Increasing competition

■ Labour disruptions

■ Delays in aircraft turnaround and other operational risks

■ Fuel supply and costs

■ Fixed cost commitments

15,000

15,500

16,000

16,500

17,000

17,500

18,000

18,500

FY16 FY17 FY18

Rev

enue

($m

)

Cons (+/- 1 std deviation) Cons high / low CS

2,000

2,200

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2,600

2,800

3,000

3,200

3,400

3,600

FY16 FY17 FY18E

BIT

DA

($m

)


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FY16 FY17 FY18

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T (

$mn)


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FY16 FY17 FY18

DP

S (

$)


16 December 2015


■ Low barriers to entry

■ Availability of airport facilities

■ Financing costs and availability

■ Economic downturn

■ External significant events

Strong share price recovery, but more to go

Qantas share recovered strongly during the past year and significantly outperformed the

ASX200 (Figure 13).

16 D

ece

mb

er 2

015

Qan

tas (Q

AN

.AX

/ QA

N A

U)

12

Figure 13: Qantas' share price history


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1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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Qantas ASX200

Sep-98: +11% Introduced oneworld alliance.

Sep-01: +12% Ansett placed into administratration.Qantas the only large player in the domestic market.

May-01: +32% Launches domestic New Zealand Qantas services and begins partnership with Impulse.

Dec-14: +25% Announced beginnings of business turn around. Expected $300mn - $350mn profit in 1H15.

Dec-08: +13% Discussed potential merger with BA.

Jun-12: -27% Profit update, Qantas International EBIT loss of $450mn.

Mar-01: -22% Outlook guidance: discontinued domestic routes, low AUDUSD.

Dec-13: -10% Announced $2bn costreduction program, S&P downgrades to BBB-.

Sep-08: -7% Defers frequent flyer IPO.

Jun-08: -12% Cut domestic and international capacity due to global downturn.

Aug-07: -2% AcquiredDPEX Worldwide.

Jul-07: +2.5% Purchased 20 more aircrafts, increased fuel surcharges, finalised ownership in Jetstar Pacific.

Dec-03: +5% Introduces Jetstar

16 December 2015


Qantas profile Qantas operates within of five segments divisions—Qantas Domestic, Qantas

International, Jetstar Group, Qantas Freight and Qantas Loyalty.

Figure 14: Qantas – segmental revenue Figure 15: Qantas - underlying EBIT by segment


Qantas Domestic Airlines

Qantas Domestic is Australia's largest premium single integrated airline, providing

transportation through its brands Qantas, QantasLink and Network Aviation. It carried 21

million passengers in FY15 on over 4,500 flights per week in Australia targeting corporate,

business and premium leisure passengers. Qantas Link and Network Aviation service 56

metropolitan and regional passenger transport destinations across Australia and Port

Moresby in Papua New Guinea.

Qantas Domestic offers up to 2 classes to customers: Business Class and Economy.

Qantas International Airlines

Qantas International is a premium full service international airline providing transportation

between Australia and New Zealand, Asia, North and South America, Africa, the Middle East

and Europe under the Qantas brand. It carried 6 million passengers in FY15 on over 520

flights per week. Through code-sharing with other airlines, Qantas provides access to ~1,200

destinations in more than 150 countries, as well as more than 600 lounges globally.

Qantas International offers up to 4 classes to customers: First, Business, Premium

Economy and Economy.

Qantas Domestic

34%

Qantas International

32%

Jetstar Group20%

Qantas Loyalty8%

Qantas Freight6%

Qantas Domestic

34%

Qantas International

19%

Jetstar Group16%

Qantas Loyalty23%

Qantas Freight8%

16 December 2015


Figure 16: Domestic markets (% of ASKs) Figure 17: International markets (% of ASKs)


Jetstar Jetstar is Qantas Group's low-cost airline brand, operating primarily in the leisure markets,

offering domestic and international passengers a value-based product. Jetstar comprises

three divisions: Jetstar Domestic, Jetstar International (including New Zealand based

domestic operation) and Jetstar Asia. It also has minority holdings in Vietnam-based

Jetstar Pacific (30%) and in Jetstar Japan (33%). Its main market is domestic and

international traffic to and from Australia, but has also strengthened its intra-Asia network

through its relations with Jetstar Asia, Jetstar Japan and Jetstar Pacific.

Figure 18: Distribution of Jetstar's market

Passenger Distribution Passenger Revenue

Australian Domestic 59% 52%

International 41% 48%

Total 100% 100%


Qantas Freight Qantas is the leading provider of air freight services and airfreight cargo terminal operator.

Qantas Freight markets the freight capacity on Qantas and Jetstar passenger aircraft and

operates a fleet of 11 dedicated freighters to supplement capacity on 80 key domestic and

international routes. It has a network of 22 cargo terminals providing ground handling to

the Qantas Group and other customer airlines.

Qantas Freight is present in all international markets where the Qantas Group flies and

has dedicated freighter aircraft operating through Asia to the Americas, and to New

Zealand. It offers the Q-Go product to businesses offering a range of air freight services,

including airport-to-airport line haul and ground handling services.

Figure 19: Main Freight Markets

Route Percentage of RFTKs

America 35%

North East Asia 29%

United Kingdom/Europe 13%

South East Asia 15%

Other 8%

Total 100%


East West30%

Triangle (Sydney,

Mlebourne, Brisbane)

20%

Regionals17%

Other33%

America39%

Asia29%

Europe20%

Other12%

16 December 2015


Financial profile

Airline and passenger revenue make up the largest proportion of total revenue accounting

for ~86%, with freight revenue accounting for ~6% of total revenue. Fuel accounts for the

largest proportion of cost base at ~25% closely followed by labour costs (~23%) and

airport charges (~20%). Benefits from the lower fuel price reduced fuel costs 12% YoY,

with costs as a percentage of revenue falling from 29% in FY14 to 25% in FY15. The

Qantas Transformation program with a focus on reducing costs, including non-fuel

expenditure benefits of $576mn have been vital to driving a positive NPAT result.

Figure 20: Qantas profit and loss profile


86%6%

8% 23%

20%

0% 0% 15%

25%

7%

3% 2%1% 4%

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16 December 2015


Australian domestic airline market The Australian domestic airline market is a duopoly with Qantas (Qantas domestic &

Jetstar) and Virgin Australia (Virgin & Tiger) competing with a full-service and a low-cost

airline each (Figure 21). Qantas has the leading market share at ~62%. We expect

demand growth at a rate ~3% through FY16, below the historical average of ~5%. Airline

capacity growth appears to be slightly below this range for now, suggesting RASK could

improve (Figure 22). Qantas has reported a RASK increase for FY16 so far. We forecast

Qantas domestic RASK up 1.5% for 1H16 and then 1% in 2H16.

In the short term, key changes in the domestic market include:

■ Declining demand on routes with exposure to mineral resource related travel

■ Growth of demand for domestic holiday travel, driven by a weak Aussie dollar that is

encouraging Australian residents to holiday within Australia and more foreign tourists

adding domestic flight legs to their holiday.

In the medium to long term, key changes in the domestic market could include:

■ A further shift from travel on full-service airlines toward a higher proportion of travel on

low-cost airlines.

■ Also we would expect Virgin Australia to attempt to increase its market share toward

closer parity with Qantas, but Qantas is likely to defend its high market share and

future capacity wars are likely. For now, Virgin appears focused on using cash flow for

balance sheet repair rather than growth.

Figure 21: Domestic airline market shares Figure 22: Domestic capacity growth plans

Source: Company data, Credit Suisse Source: Company data, Credit Suisse

Domestic airline demand below average

We estimate demand growth for domestic airline travel is below average and expect real

demand growth of ~3% over the next year, compared to normalised long run demand

closer to 5%. The charts below show real domestic airline revenue growth compared to

various macro indicators. Revenue has been running at 5% during the past year. Macro

indicators are relatively positive, with consensus GDP estimates at 2.6% for 2016 and

rising to 3% for 2017. Business confidence is positive (Figure 25). Consumer confidence is

flat, and the recent fall in the ASX200 could be a concern, given the historical reasonable

historical correlation with domestic airline revenues.

Qantas domestic

40%

Jetstar22%

Virgin domestic32%

Tigerair6%

-5%

0%

5%

10%

15%

J A S O N D J F* M A M J J A S O

2015 2016

Cap

acity

gro

wth

(AS

Ks)

Domestic total Full service Low cost

16 December 2015


Tourists to Australia typically include 2-3 domestic flight legs in their itinerary. This

contributes ~10% of the passengers on domestic flights. Strong tourist growth to Australia

could boost demand for domestic airlines.

Traffic updates from Qantas indicate domestic RASK increasing. We forecast continued

improvement in 2H16, but this is dependent on low capacity additions.

Figure 23: Revenue growth vs GDP growth Figure 24: Revenue vs Consumer confidence

Source: Thomson Reuters Datastream, BITRE, Credit Suisse Source: Thomson Reuters Datastream, BITRE, Credit Suisse

Figure 25: Revenue growth vs Business confidence Figure 26: Revenue growth vs ASX200

Source: Thomson Reuters Datastream, BITRE, Credit Suisse Source: Thomson Reuters Datastream, BITRE, Credit Suisse

Domestic capacity growth at 2-3%

Based on forward capacity plans, we expect domestic airline capacity growth of 2-3%.

This is broadly in line with our estimate of demand growth and could support some RASK

growth (Figure 27).

The low-cost carriers (Jetstar & Tiger) could increase capacity 6% over the next year and

this could be weighted to the next six months. The full-service airlines (Qantas domestic

and Virgin domestic) are likely to have low-capacity additions.

-6.0%

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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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Revenue growth Consumer confidence

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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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Revenue growth Business confidence

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2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

AS

X 2

00

Dom

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airl

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rev

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Revenue growth ASX200 (RHS)

16 December 2015


Figure 27: Domestic capacity forecasts


Market share on domestic routes

Qantas (Qantas domestic + Jetstar) has majority capacity share at virtually every airport in

Australia (Figure 28). The difference in capacity share is largest between the low cost

carriers (Jetstar & Tiger). The difference for the full-service brands is less pronounced.

Services from regional airports are a small part of the market, but Qantas has a

significantly higher share than Virgin. There is likely to be low competition at many of these

airports and profitability could be significantly above average levels.

Figure 28: Domestic airline capacity share by airport (FY16)

Source: Diio-Mi, Credit Suisse estimates

On the mining routes, both Qantas and Virgin are cutting capacity, Qantas by 9% of FY15

capacity and Virgin by 5%. Qantas will gain ~2% share on the Melbourne–Canberra route

as Virgin plans to decrease capacity.

On the Sydney–Cairns route, both low-cost carriers are increasing capacity at the expense of

full service capacity. Jetstar is increasing services between Melbourne and Launceston in the

leisure market in FY16, gaining a total of 4% market share from both Qantas and Virgin.

1H14 2H14 1H15 2H15 1H16 2H16 Cancellation rate

Qantas Domestic 0.0% 0.0% -0.1% -12.6% -2.0% 0.1% 1.7%

Jetstar Domestic -7.6% -0.1% 7.0% 5.6% 3.7% 6.0% 1.6%

Qantas Domestic Group 1.4% 3.5% -0.7% -2.4% 0.1% 1.2%

Virgin Domestic 3.9% -0.6% 1.0% 3.7% 1.6% 2.2% 1.8%

Tigerair 21.3% 31.9% 16.9% 7.0% 8.6% 17.7% 1.2%

Virgin Domestic Group 5.7% 3.9% 3.6% -3.2% 2.7% 4.0%

Total Domestic 4.2% 4.6% -1.6% -0.9% 1.9% 2.3%

0.0

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Syd

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airp

orts

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iona

l airp

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ts (

mn)

Qantas domestic Jetstar Virgin Australia domestic Tigerair

16 December 2015


Figure 29: Domestic airline capacity share by route (FY16)


The trend across the domestic airline market is Jetstar increasing capacity on the

leisure/tourist routes as Qantas decreases capacity. Qantas, on the other hand, is

increasing capacity on the routes that have demand from the business traveler. The

strategy is less clear for Virgin.

Figure 30: Scheduled capacity changes for each route for FY16 (% of total route capacity)


0.0

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rout

es

Cap

acity

cha

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(% o

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cap

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)


16 December 2015


LCC vs full service

Low cost carriers have a ~30% market share of the Australian domestic airline market.

Market shares for LCC in Europe and North America are closer to 35% and increasing.

We expect that Qantas' Jetstar and Virgin's Tiger airlines are likely to be the main source

of capacity growth in the Australian domestic market.

Figure 31: Full-service vs low-cost market share


History of Australian domestic airline market

The Australian domestic airline market has historically seen aggressive competitive

behavior, despite its largely duopoly characteristics. The competitive environment appears

benign at present, but we do not expect this to last indefinitely. More aggressive

competition from Virgin or from a new entrant is likely at some stage.

Figure 32: Australian domestic airline market share history


0%

20%

40%

60%

80%

100%

Australia Asia South-East Asia Europe North America South America

Mar

ket s

hare

Full service carriers Low cost carriers

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1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Mar

ket s

hare

Qantas Ansett - 2001 Eastwest - 1993 Jetstar Compass - 1993 Virgin Australia Tigerair Impulse - 2004 Other

Qantas

Ansett

Virgin Australia

Jetstar

ImpulseCompass Tigerair

16 December 2015


Australia – International airline market Australia has highest international airline capacity on routes to Asia, the Middle East and

then North America (Figure 33). Qantas capacity share, along with JV partner American

Airlines is highest on routes to North America. Routes to South East Asia are most

fragmented. However, Qantas reports strong demand in Asia and despite its lower

capacity share this could provide attractive growth.

We estimate market capacity increases of 7-8% for FY16, with Qantas international

increasing capacity slightly below this level (Figure 34). We expect Qantas international

RASK up ~2% in 1H16, largely due to FX benefits on foreign sales. In 2H16, RASK could

be down ~2% as the FX benefit fades and capacity increases

Figure 33: Australia-International airline markets Figure 34: Aust-Intl capacity growth (FY16)


Expect strong inbound growth, but weak outbound

The Australian airline market could see strong growth due to rising foreign tourist

numbers, partly due to the attraction of the weak Aussie dollar. From the mid-80s to early

2000's when the AUDUSD was weak (<0.8), short term visitors to Australia contributed

over 50% of international passengers. The strength of the Aussie dollar in recent years

saw that proportion fall to 40%, but now with the currency weakening there is a recovery of

short term visitors to Australia (Figure 35).

This could benefit airlines with strong distribution in Asia and North America. Qantas is

likely to benefit from its JVs with American Airlines and China Eastern.

0

20

40

60

80

100

South EastAsia

North Asia MiddleEast

NorthAmerica

NZ &Pacific

Africa SouthAmerica

Cap

acity

(A

SK

bn)

Qantas Qantas JVs Virgin Virgin JVs Others

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

South EastAsia

Middle East NorthAmerica

North Asia NZ & Pacific Total

Cap

acity

gro

wth

Qantas International Jetstar Virgin International Total market growth

16 December 2015


Figure 35: High tourist growth from weak AUD Figure 36: International departures—trip purpose


Chinese visitors – strongest source of growth

Tourism Australia reports that there were over 840,000 Chinese visitor arrivals in 2014,

and we expect this number to have increased to over 1 million Chinese visitors in 2015.

Australia ranks ahead of any other country for the Chinese traveller, in terms of aspiration,

awareness and intention, yet falls to 10th in actual visitation.

International route markets

Australia – North America: too much capacity growth

On routes to North America, Qantas combined with Jetstar and JV partner American

Airlines operate ~55% of capacity. Virgin and JV partner Delta have ~20% share. We

expect high capacity growth (~9%) over the next year with American Airlines re-entering

the market this month. The take-up of this capacity is dependent on leisure sales in North

America incentivised by a weak Aussie dollar. This could take some time and RASK is

likely to be weak.

American alliances – American Airlines vs Delta Airlines

Qantas announced a significant expansion of the joint business agreement with American

Airlines in June 2015, which will include a revenue sharing agreement on domestic

American Airlines and Qantas flights based on ASKs. The deeper alliance provides

platform for further growth, closer commercial ties and more seamless customer

experiences between North America and Australia/New Zealand. As part of the

agreement, American Airlines will commence LAX-SYD services with three-class B777-

300ER, and Qantas will re-introduce flights to 6 flights per week to San Francisco and

increase flights on a daily schedule to Dallas.

During 2015, the Virgin Australia and Delta Air Lines trans-Pacific joint venture received final

reauthorisation for a further five years until September 2020. The alliance currently offers

Australian travelers access to around 240 destinations across North and Central America.

0

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1977 1983 1989 1995 2001 2007 2013

Sho

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% o

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asse

nger

s)

% of short term visitors AUDUSD (RHS, reversed)

Holidays57%

Visiting friends & relations

24%

Business / employment

16%

Other3%

16 December 2015


Figure 37: Airline market share to North America Figure 38: High capacity growth to North America

Source: Company data, Diio-Mi, Credit Suisse estimates Source: Company data, Diio-Mi, Credit Suisse estimates

Australia: South East Asia – low capacity growth

Capacity growth on routes between Australia and South East Asia is likely to be limited

over the next year due to Malaysian Airlines cutting capacity (Figure 40). AirAsiaX, Jetstar

and Qantas intend to increase capacity on the route by 0.5-1% of total route capacity

each. Virgin appears to be reducing capacity. RASK could be stable, but we would not

expect an improvement. This market is highly fragmented with the top eight airlines

providing less than 80% of capacity.

Figure 39: Airline market share to SE Asia Figure 40: SE Asia—flat capacity growth (next 12m)


Flights to Bali (Indonesia) moving down market

Both Qantas and Virgin are replacing full service airline offerings with low cost (Jetstar &

Tiger) on routes from Australia to Bali in Indonesia.

Jetstar is also increasing flights to Bali from many of Australia's major cities including

Melbourne, Perth, Sydney and Townsville. In total, Jetstar will fly an additional 66 flights

will fly to and from Bali within the next 12 months.

0

5

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FY11 FY12 FY13 FY14 FY15 FY16

Cap

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SK

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Qantas American Airlines Virgin Australia

Delta Airlines United Airlines Air Canada

-2%

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16 December 2015


Australia – North Asia: 20% capacity growth

There could be 20% capacity growth on routes from Australia to North Asia over the next

year. Most of this capacity increase appears to be targeted at potential visitors to Australia

from China and Japan. Qantas added services to Tokyo and will increase capacity to

Hong Kong in March. This is a ~20% increase of Qantas capacity to North Asia and a 3-

4% increase as a proportion of total market capacity. Qantas is reporting strong demand

and international RASK (including FX benefits) has improved in the past couple months,

likely due to this strong demand.

Qantas – China Eastern Airlines

Qantas and China Eastern Airways have a joint coordination agreement with a reciprocal

block space codeshare on services to and from Australia and China. Qantas codeshares

between Melbourne–Shanghai, Singapore–Shanghai, Sydney–Nanjing and Sydney–

Beijing via Nanjing. In this block space agreement, Qantas buys a proportion of seats on a

codeshare flight and are liable to fill the seats. They negotiate the proportion of seats they

purchase each quarter. Qantas also passenger code shares on 11 points within China.

Figure 41: Airline market share to North Asia Figure 42: High capacity growth to North Asia


Australia – Mid East / Europe: 10% capacity growth

Capacity share on routes from Australia to the Middle East is concentrated with three

operators/partnerships (Qantas/Emirates 60% share, Virgin/Etihad 38% & Qatar 16%).

However, most passenger traffic from Australia to the Middle East transits through to

Europe or elsewhere. There is strong competition from airlines operating through Asia to

these ultimate destinations.

There could be a 10% capacity increase on routes from Australia to the Middle East over the

next year, driven by Etihad and Qatar adding capacity. RASK could be weak, in our view.

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16 December 2015


Figure 43: Airline market share to Middle East Figure 44: Mid-East/Europe - high growth (next 12m)


Australia – New Zealand & South Pacific

The airline market between Australia and New Zealand is essentially a duopoly between

Virgin/Air New Zealand (51% share) and Qantas/Jetstar/Emirates (41% share). Market

capacity could increase 5-6% over the next year. Demand growth is likely to be below this

level and we expect pressure on RASK.

Figure 45: Airline market share to NZ & S Pacific Figure 46: High capacity growth to NZ & S Pacific


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16 December 2015


Transformation – $2bn cost & rev. saving Qantas delivered $1.1bn of cost and revenue improvement from its business

transformation initiative over the past two years. Last year, the $894mn improvement

realized was due to labour redundancies, less efficient aircraft retirements, fuel efficiency

gains, purchasing rationalisation and other initiatives (Figure 47).

Qantas is targeting a cumulative benefit of $2bn by FY17. Given management's record on

delivering over half of the targeted improvement so far, we are inclined to believe it is likely

to achieve the target and could potentially outperform it.

Management targets a $450mn further improvement for FY16, but expects this to be partly

offset by cost inflation of up to $250mn. We forecast it to reach the cost saving target for

FY16 and we expect a further ~$380 improvement to be delivered in FY17.

Figure 47: Qantas realized $894mn cost and revenue benefits in FY15


16 December 2015


Qantas Loyalty Loyalty is Qantas' frequent flier program. It’s a strong program that provides a number of

key benefits to the wider group:

■ Creates customer stickiness, like a frequent flier program is supposed to do.

■ Contributes ~17% of group EBIT from external revenue with few fixed assets

■ Provides financing with negative working capital of $2-3bn

■ Potentially provides a source of growth with less exposure to aviation

Partners (banks, retailers, etc.) buy Qantas frequent flyer points from Loyalty to issue to their

customers that are also Loyalty members. The partner benefits by attracting and retaining

customer spend on its products and services, as well as improving its understanding of

member behaviour. Members earn Qantas Points to redeem them for awards through the

program. Qantas Loyalty’s portfolio of brands and businesses span many distinct but

interrelated business segments supporting the Core Coalition Loyalty Program.

We estimate that the banks with their credit card programs account for up to 55% of

Loyalty revenue with Qantas' airline and other airlines contributing 35%. Woolworths could

provide ~5%, while another ~400+ partners account for the remaining 5% of revenue.

Qantas suggests that the 66% of external billings generate all of Loyalty EBIT.

Figure 48: Qantas Loyalty revenue breakdown


Membership growth likely to slow

Qantas claims ~11mn members of its loyalty program, but we think this is inflated by

duplicate and inactive memberships. The number of active members could be closer to

8mn. Even this number is a third of the Australian population and historical mid to high

single digit membership growth could slow.

Stable revenue generator

Despite being the second smallest division for revenue generation, it is the second highest

EBIT contributor to the group. It is the most stable revenue stream for Qantas unaffected

by the cyclicality of the airline business.

Qantas Loyalty has 8 brands, of which QFF is the largest and constitutes 90% of

revenues. The other brands account for the remaining 10% which are currently growing

16 December 2015


30% YoY. However, Qantas has already started to lose major partnerships and have

restricted ability to get new partnerships.

Figure 49: Qantas Loyalty brands


■ Qantas Frequent Flyer: Qantas Frequent Flyer is the most known Qantas Loyalty

brand launching in 1987. Its aim is to:

■ Acquire: Launched in March 2014, Acquire is similar to the Frequent Flyer program

but is aimed at SMEs rather than individuals. Members can earn Acquire points on a

range of business expenses and these are equivalent to Qantas points and are able to

be converted.

Figure 50: Acquirer's partners


■ Qantas Cash: MasterCard prepaid payment facility, where one can load up to 11

currencies with fixed exchange rates.

■ Qantas Store: Launched in 2008, allows members to redeem points across 3000

products across 8 categories.

■ Qantas epiQure: Members have the opportunity to purchase an extensive collection of

Australia's most valued and recognised wine brands. In FY15, Qantas epiQure

member base grew by 57% YoY and wine sales grew 43%,

■ Qantas Golf Club: allows members to redeem points on golf courses. The partnership

with the golf clubs is designed to benefit both golfers and the clubs.

■ Accumulate: Designed and delivered engagement and loyalty solutions, using an optimal

blend of recognition rewards and incentives to help clients influence employee behaviour.

16 December 2015


■ Red Planet: An integrated media, analytics and research services company, directly

targeting customers, aimed at increasing marketing efficiencies. Red Planet was

launched in 2014 and was profitable in the first year.

■ Taylor Fry: Independent consultancy firm providing analytical and actuarial advice to

the government. Qantas acquired a 51% controlling stake in Taylor Fry in 2015.

Potential upside with Qantas Assure

Qantas' partnership with nib and the announcement of Qantas Assure poses Qantas with the

opportunity to gain more stable revenue. They are targeting a 2-3% market share of the

Australian private health insurance market on a revenue basis in its first five years, which is

currently $19bn, which could provide a revenue stream of $38mn a year for Qantas.

Downside risk with the bank interchange fees

We see that the RBA's recent proposals to change the bank interchange fees will have

significant negative implications for both Qantas' frequent flyer programs. The RBA is not

proposing to replace the current system of weighted-average interchange benchmarks

with hard caps. The weighted-average benchmark for credit cards will remain at 0.50cents.

However, the weighted-average benchmarks will be supplemented by caps on any

individual interchange fee within a scheme's schedule. It is proposed that no credit card

interchange fee will be able to exceed 0.80 percent and no debit interchange fee will be

able to exceed 15 cents if levied as a fixed amount or 0.20 percent if levied as a

percentage amount.

We view that a cut to these interchange fees could lead to card issuers reducing rewards

to the loyalty members. The interchange fee is a very large component of the income that

is paid to the frequent flyer scheme and the points payments will be the easier costs to

reduce (compared to raising fees or interest rates for customers) when interchange

revenue falls for the banks.

Loss of revenue from Woolworths mitigated

Woolworths had intended to cancel its partnership with Qantas Loyalty, but a backlash for

its customers has forced a U-turn. We estimate Woolworths provides ~5% of Loyalty

revenue. The new partnership will not be as extensive or rewarding, but Qantas is likely to

retain most of the revenue.

Woolworths was the only Qantas Loyalty partner as a major supermarket and the loss of

this partnership could have impacted significantly on revenue for Qantas Loyalty. The

Woolworths partnership was beneficial in bringing along additional members, with the

frequent flyer membership base growing by up to 2.5mn in the first few years of the

partnership. We believe that losing this channel of rewards will cause disengagement by

many members who will have a subsequently reduced ability to earn points.

Qantas Loyalty comps

There are three listed comps for Qantas Loyalty; Aimia (spun off from Air Canada), Smiles

(from GOL) and Multiplus (TAM airlines). Other airlines that have comparable frequent

flyer programs to Qantas include Cathay Pacific (Asia Miles), British Airways (Avios), Air

France (Flying Blue), Lufthansa (Miles & More) and Japan Airlines (JAL Mileage.

However, these are internalised FFP with less transparency in their reporting.

Aimia (AIM.TO)

Aimia is a global leader in loyalty management, through its subsidiaries, operating in

Canada, the US & APAC and EMEA. The Canadian operations is most comparable with

Qantas Loyalty as ~85% of revenue is from Aeroplan, the frequent flyer program of Air

Canada, and the remaining ~15% of revenue is proprietary loyalty, which includes the

partnerships with financial services groups TD Bank Group (TD) and Canadian Imperial

Bank of Commerce (CIBC).

16 December 2015


After Aimia's IPO when it was just the Canadian business having spun-off from Air

Canada, EBIT margin was ~20%. As Aimia added more coalition packages, margin has

fallen to <10%. This suggests that as Qantas Loyalty continues to spin out other

businesses away from the Qantas Frequent Flyer Program and more towards a data

analytics company, it may also experience a decline in margin.

Smiles (SMLE3.SA)

Smiles started as a single loyalty program, but has evolved into its current, coalition

model, which features several unique characteristics that allow for the accrual and

redemption of Miles from GOL flights and its international partner airlines, as well as

Brazil's main commercial banks, including co-branded cards issued by Bradesco and

Banco do Brasil, and a wide network of retail partners. It has ten active international

partnerships including Delta Air, Etihad Qatar Airways, Air Canada and Aerolineas

Argentinas. Smiles Program reached 11.0mn clients by the end of 3Q15, growing by 8.5%

YoY. In contrast to Aimia, Smiles has an EBIT margin of 35% but trades on a comparable

EBIT multiple.

Multiplus (MPLU3.SA)

Launched in 1993 as a frequent flyer program for TAM airlines, Multiplus was later partially

floated in April 2010. It is highly comparable to Qantas Loyalty in its structure, with 400

partners, able to accumulate points on major Brazilian bank credit cards, points can be

redeemed by retail partners and oneworld alliance airlines. In 2014, its program reached

13.8mn members.

Figure 51: Qantas Loyalty comps consensus EBIT margin and multiples

Company 2012 2013 2014 2015 2016e

EBIT Margin Aimia 16% 5% 11% 6% 8%

Smiles 31% 34% 34% 35%

Multiplus 16% 17% 20% 22% 24%

Qantas Loyalty 20% 22% 22% 23% 23%

EBIT Multiple Aimia 7.7x 34.2x 9.8x 14.1x 8.9x

Smiles 14.4x 20.8x 11.1x 8.2x

Multiplus 27.5x 17.6x 14.8x 8.9x 8.0x

EBITDA

Multiple Aimia 7.0x 24.3x 8.2x 8.8x 7.8x

Smiles 14.3x 20.5x 11.0x 8.2x

Multiplus 26.8x 17.1x 14.1x 7.6x 7.2x

Source: Company data, Thomson Reuters Datastream, Credit Suisse estimates

16 December 2015


Qantas – Shareholder base Qantas' shareholder base is composed of mainly institutional investors in Australia.

Institutional investors hold approximately 55% in blended funds (~34%), growth funds

(~13%) or ETFs (~12%).

Under IPO conditions and the Qantas Sale Act 1992, foreign persons are restricted from

holding a greater than 49% stake in the company. In July 2014, the Australian

Government made changes to the Qantas Sale act, removing the limitations that any one

foreign person is restricted from holding a greater than 25% stake and that foreign airlines

are restricted from holding a greater than 35% stake in the issued share capital. The

geographic ownership where Australians hold 48% of the stock, US-based investors

holding 14% and investors in Switzerland holding 14% is reflective of these laws.

Figure 52: Top 10 Qantas shareholders

Shareholder % interest

CBA 9.44%

UBS Group 7.63%

Westpac Banking Corp 6.23%

Franklin Resources 5.14%

Colonial First State 4.73%

Capital Group companies 3.63%

MLC Investments 1.95%

Alliance Bernstein 1.29%

AMP Life 1.14%

American Century Companies 0.88%

Total 42.06%

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates

16 December 2015


Qantas – ESG We see management of ESG risk to be reasonable with no material controversies. Like

other airlines globally, Qantas faces risks in the environmental front from future carbon

regulations in Australia due to its high carbon emissions footprint and being exposed to

high and volatile oil prices. Fuel hedging offers only short term protection and capital

intensive fleet renewal remains the key to reducing fuel costs. Whilst the airlines industry

faces large and unionised workforce generally, we view Qantas as exhibiting poorer labour

relations due to its history of higher profile, more frequent, and severe disputes. Corporate

governance is sound with reasonable incentive structures, breadth of Board experience,

and disclosure high compared to peers.

Environmental

Carbon emissions

Qantas's emissions footprint is from burning of aircraft fuel, and the airline industry globally

is one of the largest contributors to carbon emissions. It is exposed to risks of increased

costs related to global carbon pricing efforts or regulatory caps. However, as operations

are based in Australia and Australia having suspended carbon pricing, Qantas may be

better positioned against foreign peers with exposure to markets with carbon pricing, such

as Europe.

Qantas demonstrates average actions to reduce its carbon intensity. Whilst it commits to

the International Air Transport Association's (IATA) industry targets for reducing

emissions, its commitments does not appear as proactive as several industry peers that

have also committed to targets more stringent than IATA targets. However, emissions

level per dollar of revenue is slightly better than domestic peer Virgin. We prefer that

Qantas set a strong carbon reduction target, report its progress towards objectives, and

include environmental improvements as a management performance hurdle.

Figure 53: CO2 emission


Jet fuel

Fuel costs are Qantas's largest expense and while hedging is often undertaken across the

industry, it is expensive and offer only shorter term protection from energy price volatility.

Investing in fleet renewal programs and energy efficient technologies remains the key to

reducing fuel costs.

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16 December 2015


Renewable biofuel provides an opportunity for airlines including Qantas to reduce

emissions, reduce dependence on oil imports, and provide some diversification from the

volatility of oil prices. Qantas is participating in industry efforts to support development and

commercialisation of biofuel through university and private sector research. However, such

projects are at very early stages and remain a far term prospect.

Social

Labour relations and workplace safety

We view Qantas as facing higher risk of operational disruptions due to labour unrest or

reduced productivity compared to peers. Qantas has a large and highly unionised

workforce with a propensity to undertake industrial action. Whilst labour relation issues are

faced by the service-based airline industry globally, Qantas's history of labour disputes

have been high profile and severe and suggests continuing poor labour relations, including

most notably the lockout of staff and grounding of the entire fleet in 2011. The more recent

large scale restructuring in early 2014 resulting in up to 5,000 job cuts triggered further

unrest necessitating external mediation. Qantas faces increasing challenges in dealing

with an aging, more experienced and less flexible workforce compared to low cost carriers.

Figure 54: Workplace safety


Diversity

Women comprise ~41% of the total workforce and ~32% of senior management positions,

suggesting that women still dominate lower level positions. These proportions are

essentially unchanged over the past three years to 2014. Unlike ASX companies, Qantas

does not have explicit targets or programs for engagement of female, minorities,

Indigenous or disabled persons in its workforce or detailed reporting of progress over time.

Passenger safety

Whilst air travel has become one of the safest modes of transport, passenger safety and

reputation have again become key public focus following the high profile losses of

Malaysia Airlines disasters. Any suggested deviations from high safety standards and

associated maintenance upkeep, even if it does not result in any losses, could severely

punish Qantas's reputation, one that required decades to build.

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16 December 2015


Governance

Board structure

We view the Board and all Committees as comprising of a majority of independent

directors and drawing on a breadth of financial, airlines industry, and large cap

governance experience. The Committees appear to be appropriately organised to provide

oversight and draw on the background experience of each member. The Chair's tenure is

nearing 10 years, which may preclude him from being considered as independent, but with

a wide spread of tenure among the remaining members; it appears that Qantas has a

continual focus on Board renewal. Some members also exhibit above average external

workloads compared to other Boards of ASX 100 companies.

Figure 55: Board skills analysis

Member Position Gender Tenure (yrs) Acct / Finance Legal Aviation ASX100 Exp. Indep.

Leigh Clifford Chair & Non-Executive Director M 8.3 Y Y

Maxine Brenner Non-Executive Director F 2.2 Y Y Y Y

Richard Goodmanson Non-Executive Director M 7.4 Y Y * Y

Jacqueline Hey Non-Executive Director F 2.2 Y Y Y

William Meaney Non-Executive Director M 3.8 Y Y * Y

Paul Rayner Non-Executive Director M 7.4 Y Y Y

Todd Sampson Non-Executive Director M 0.7 Y Y

Barbara Ward Non-Executive Director F 7.4 Y Y Y Y

Alan Joyce CEO M 7.3 Y N

Average tenure 5.2

*Equivalent offshore experience


Figure 56: Membership of board committees and external workload

Member Audit Remun. Nomin. Safety Other current

Chairmanships

Other current

Directorships

Other current

Memberships

Leigh Clifford Chair 1 1 4

Maxine Brenner Y Y 3 2

Richard Goodmanson Y Chair 2

Jacqueline Hey Y 3 3

William Meaney Y Y 1 3

Paul Rayner Chair Y 1 1 1

Todd Sampson Y 1

Barbara Ward Chair Y Y 3 1

Alan Joyce Y 2


Remuneration

We view a reasonable proportion of remuneration to be at-risk and tied to high quality

growth. The remuneration structure from FY15 is more focused on the longer term

compared to FY14. This change is aimed at rewarding achievement of Qantas's three-

year restructuring plan which is targeting $2bn in cost reductions. We calculate that the

FY15 LTI award will have a market value of $4.09mn, 41% higher than the FY14 LTI grant.

The STI opportunity has correspondingly been reduced for FY15 so that there is no

increase in target pay.

Qantas provides high disclosure on performance hurdles, linkages to strategy,

performance outcomes against each measure, particularly as compared to domestic peer

16 December 2015


Virgin Australia. Although the maximum possible STI for FY14 increased 40%, we view the

hurdles to be relatively rigorous and objective with the Board exercising its discretion not

to award the STI in two of the previous three years in light of the financial performance

despite attainment of operational and restructuring milestones.

Figure 57: Structure of FY14 remuneration for CEO

Type CEO weight FY14 remuneration % awarded

Fixed 23% $2.1mn salary and superannuation; no annual increases since FY13 100%

STI 58% 67% as cash and 33% as shares restricted for 2 years 0%

LTI 19% Share rights granted at end of testing period 0%


Figure 58: STI hurdles

Objective Measure CEO weight

Financial Underlying Profit Before Tax 50%

Operating cash flow to net debt 10%

Non-financial People and operational safety 10%

Domestic business and transformational agenda

Unit cost

Punctuality

Net Promoter Score

Domestic network and frequency advantage

Milestones around transformation initiatives

10%

Qantas International and Qantas Loyalty

Unit cost

Net Promoter Score

Strengthening network and alliances

Qantas Frequent Flyer membership numbers

Qantas Loyalty new revenue initiatives

10%

Jetstar in Asia

Unit cost

Underlying EBIT

Net Promoter Score

Key business milestones

10%


Figure 59: LTI hurdles

Objective Weight Testing period Measure % vest

TSR relative to ASX 100 peers 50% 3 yrs to 1 Jul 2017 Below 50th percentile 0%

50 - 75th percentile 50 - 99% pro rata

75th percentile or higher 100%

TSR relative to specified global

listed airlines

50% 3 yrs to 1 Jul 2017 Below 50th percentile 0%

50 - 75th percentile 50 - 99% pro rata

75th percentile or higher 100%


Our ESG analyst Sandra McCullagh has conducted a detailed review of Qantas's

remuneration structure.

MSCI ESG Rating

MSCI ESG Research awarded Qantas a rating of "BB" (26 Aug 2014) and places it within

the 55–85th percentile relative to airline operators globally. Qantas is negatively impacted

by its history of poor labour relations and industrial disputes; we agree with the view and

the higher weight to this metric in light of the service-nature of the industry. We believe the

"product safety and quality" metric should be extended to consideration of flight safety and

https://plus.credit-suisse.com/r/xpvlkb

16 December 2015


maintenance upkeep, but this would not negatively impact Qantas's score. The high

weights to carbon emission and energy efficiency are appropriate for an airline operator.

Figure 60: MSCI rating BB

Source: MSCI, Credit Suisse estimates

Valuation impact

Rather than applying a discount for ESG risks on its own, we factor in certain ESG-related

issues such as labour costs within our financials modelling, which form the basis of our

valuation and thus target price. We do not model for contingent liabilities such as

reputational risks on safety concerns in the community or lack of employee diversity where

we consider the occurrence to be remote or quantification not reasonably separable from

operating conditions holistically.

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Environment Social Governance

Stock Country Global Sector Local Sector

16 December 2015


Qantas – Risks Key downside risks to earnings forecasts and thus target price include:

■ Strong competitors: Qantas's international competitors can be much larger with

significantly greater financial resources. The airline industry is particularly susceptible

to price discounting to cover the high fixed cost base, and Qantas has reduced fares

and increased capacity on routes to compete. In the event that Qantas were to reduce

and maintain fares to levels at which it could not sustain profitable operations, Qantas

could withstand sustained losses for longer than competitors.

■ Labour relations: Whilst the airlines industry faces large, skilled and highly unionised

workforce generally, Qantas has a history of higher profile, more frequent, and severe

disputes relative to peers, including most notably the lockout of staff and grounding of

the entire fleet in 2011. This creates higher risk of operational disruptions on labour

unrest or reduced productivity with potential to inconvenience passengers, damage

reputations and impact forward bookings.

■ Delays in aircraft turnaround: Like other airlines, Qantas relies on maintaining high

aircraft utilisation rates to lower unit costs, including through reducing turnaround

times at airports. Utilisation may be reduced by delays from air traffic, the unavailability

of crews, fuelling and ground handling delays, maintenance and technical issues,

customer processing and bag handling, or security. Risks of delay could increase as it

includes new flight destinations and increase flight frequency on existing routes.

■ Fuel supply and costs: Fuel costs constitute the largest portion of operating

expenses. Oil prices have been subject to high volatility driven by supply and demand,

geopolitics and economic conditions. Significant, particularly unexpected, increases in

fuel costs or fuel shortages can materially affect Virgin adversely. Whilst Qantas has a

fuel hedging program, this can only partially protect against long-term increases and

volatility due to its limits in volume and duration.

■ Fixed cost commitments: The airline industry is characterised by high fixed costs

and low profit margins. Long term fixed obligations relating to aircraft operating lease

rentals, labour costs and financing commitments could impede further ability to obtain

additional financing to support expansion plans or limit its flexibility in reacting to

changes in its business and industry. Expenses of each flight also do not vary

significantly with passenger volume and relatively small changes in the number of

passengers, passenger mix or pricing can disproportionately affect performance.

■ Low barriers to entry: There are few ownership or regulatory limitations on

purchasing or commencing operations in Australia, and Qantas faces competition from

entry of larger, stronger foreign entities with potentially lower cost base. Liberalisation

of air travel lifts restrictions on flight and passenger numbers and allows for collection

of passengers en route.

■ Availability of airport facilities: Adverse changes in the availability and cost of

customer-friendly terminal space, landing slots, aircraft parking and hangers could

affect Qantas's appeal to customers and profit. The main Australian airports are

privately owned and have the flexibility to increase charges. Qantas is dependent on

ability to lease or access facilities on reasonable terms to support growth.

■ Economic downturn: A substantial portion of air travel, for both business and leisure,

is discretionary and sensitive to general economic downturn.

■ External significant events: Geopolitical shocks, terrorist attacks, military actions,

outbreak of contagious diseases and weather disruptions can lower industry wide

demand for air travel.

16 December 2015


Qantas – PEERs

Figure 61: Qantas Peers

Source: Credit Suisse

16 December 2015


Qantas – HOLT® Applying key Credit Suisse Research estimates through the Credit Suisse HOLT framework results in A$4.57 valuation for Qantas. The HOLT valuation uses 10 years of key Credit Suisse estimates to drive CFROI® forecasts, before a fade of CFROI towards the long-run average CFROI (~6%). The Credit Suisse forecasts results in a very marginal CFROI accretion over the 5 year forecast period driven predominately by improved asset efficiency. To access a scenario using Credit Suisse estimates for Qantas through HOLT Lens, go to: https://holtlens.credit-suisse.com/dal/TXVSoTCHsvuTp9H

Figure 62: HOLT valuation


If you have any questions regarding the HOLT methodology or the scenarios contained

within, please contact the Australian HOLT team:

Scott Chessum (+613 9280 1662 / [email protected]) or

Peter Jabour (+613 9280 1702 / [email protected])

https://holtlens.credit-suisse.com/dal/TXVSoTCHsvuTp9H

mailto:[email protected]

mailto:[email protected]

16 December 2015


Route maps

Figure 63: Qantas Domestic route map


16 December 2015


Figure 64: Qantas International network


16 December 2015


Qantas financial forecasts

Figure 65: Qantas P&L


Year end Jun ($mn) FY14 FY15 1H16 2H16 FY16 FY17 FY18 FY19

Qantas domestic 5,284 5,291 2,716 2,639 5,355 5,355 5,462 5,517

Qantas international 4,658 4,878 2,657 2,544 5,201 5,148 5,252 5,304

Jetstar 3,073 3,283 1,837 1,725 3,562 3,705 3,817 3,893

Qantas freight 1,074 1,059 551 518 1,070 1,080 1,091 1,102

Loyalty 1,192 1,244 660 658 1,318 1,384 1,439 1,497

Corp / other 71 61 69 -8 61 61 61 61

Total revenue 15,352 15,816 8,490 8,077 16,567 16,733 17,122 17,374

growth % 3% 5% 4% 5% 1% 2% 1%

Passenger RASK (cents/ASK) 9.3 9.6 9.7 9.3 9.5 9.4 9.5 9.4

Total RASK (cents/ASK) 10.8 11.1 11.4 10.9 11.1 11.0 11.1 11.2

Labour cost 3,770 3,604 1,799 1,754 3,554 3,560 3,698 3,840

growth % -4.4% -2.2% -0.6% -1.4% 0.2% 3.9% 3.9%

AOV 3,303 3,206 1,642 1,679 3,321 3,349 3,462 3,578

growth % -2.9% 2.8% 4.4% 3.6% 0.8% 3.4% 3.4%

Selling, overhead & other 2,635 2,362 1,268 1,185 2,453 2,461 2,456 2,452

growth % -10.4% 3.8% 3.9% 3.8% 0.3% -0.2% -0.2%

Fuel cost 4,461 3,937 1,760 1,729 3,489 3,331 3,798 4,000

growth % -11.7% -19.6% -1.0% -11.4% -4.5% 14.0% 5.3%

Qantas domestic 804 1,171 701 726 1,427 1,479 1,374 1,276

Qantas international 188 706 589 490 1,080 1,105 928 803

Jetstar 310 625 380 463 843 932 829 758

Qantas freight 60 156 92 104 196 219 205 202

Loyalty 293 323 180 170 350 367 382 397

Corp / other -153 -157 -83 -83 -166 -166 -166 -166

EBITDAR (underlying) 1,502 2,824 1,859 1,870 3,729 3,936 3,552 3,270

margin % 10% 18% 22% 23% 23% 24% 21% 19%

Depreciation 1,351 1,014 559 566 1,126 1,139 1,151 1,164

Amortisation 71 82 45 46 91 92 93 94

CASK (ex fuel & ownership) 6.9 6.4 6.3 6.2 6.3 6.2 6.3 6.3

CASK (ex ownership) 10.0 9.2 8.7 8.6 8.6 8.4 8.7 8.9

CASK 11.4 10.3 9.8 9.7 9.8 9.5 9.9 10.1

EBIT (underlying) -440 1,233 990 998 1,988 2,169 1,764 1,459

margin % -2.9% 7.8% 11.7% 12.4% 12.0% 13.0% 10.3% 8.4%

Statuatory EBIT -3,772 1,048 990 998 1,988 2,169 1,764 1,459

margin % -24.6% 6.6% 11.7% 12.4% 12.0% 13.0% 10.3% 8.4%

Statuatory PBT -3,976 789 898 940 1,838 2,070 1,721 1,468

Underlying PBT -646 975 898 940 1,838 2,070 1,721 1,468

Net Finance Costs -204 -259 -91 -58 -150 -99 -43 8

Income tax (expense)/benefit 1,133 -229 -270 -270 -551 -621 -516 -440

Tax rate 28% 29% 30% 30% 30% 30% 30% 30%

Statuatory NPAT -2,843 560 629 658 1,287 1,449 1,205 1,027

Basic EPS (cents) -128.5 25.4 29.3 30.7 60.0 69.8 57.7 49.1

growth % -120% 217% 90% 96% 16% -17% -15%

Diluted EPS (cents) -128.5 25.4 29.3 30.7 60.0 69.8 57.7 49.1

DPS (cents) 0.0 23.0 0.0 50.0 50.0 50.0 0.0 0.0

16 December 2015


Figure 66: Qantas balance sheet


Year end Jun ($mn) FY14 FY15 1H16 FY16 FY17 FY18 FY19

Cash & cash equivalents 3,001 2,908 2,892 2,908 2,908 2,908 2,908

Receivables 1,196 959 1,141 1,000 1,010 1,037 1,064

Other financial assets 172 613 613 613 613 613 613

Inventories 317 322 322 336 339 339 339

Assets classified as held for sale 134 136 136 136 136 136 136

Other 112 111 111 111 111 111 111

Current assets 4,932 5,049 5,215 5,104 5,117 5,144 5,171

Receivables 158 134 120 140 141 141 141

Other financial assets 34 49 49 49 49 49 49

PP&E 10,500 10,715 10,736 10,749 10,821 10,969 10,805

Intangible Assets 741 803 478 502 550 600 651

Deferred tax assets 548 333 63 63 63 63 63

Other 405 447 438 429 411 393 375

Non-current assets 12,386 12,481 11,884 11,933 12,035 12,215 12,085

Total assets 17,318 17,530 17,099 17,037 17,152 17,359 17,256

Payables 1,851 1,881 2,099 1,962 1,981 2,036 2,066

Revenue received in advance 3,406 3,584 3,495 3,738 3,775 3,880 3,937

Interest-bearing liabilities 1,210 771 730 730 446 443 733

Other financial liabilities 182 416 416 416 416 416 416

Provisions 876 818 818 818 818 818 818

Current liabilities 7,525 7,470 7,557 7,663 7,436 7,593 7,970

Revenue received in advance 1,183 1,359 1,333 1,417 1,431 1,471 1,493

Interest-bearing liabilities 5,273 4,791 4,175 3,265 3,175 3,012 1,483

Other financial liabilities 66 68 68 68 68 68 68

Provisions 405 395 395 395 395 395 395

Non-current liabilities 6,927 6,613 5,971 5,145 5,070 4,946 3,438

Total liabilities 14,452 14,083 13,528 12,808 12,506 12,539 11,409

Issued capital 4,630 4,630 4,630 4,630 4,630 4,630 4,630

Treasury shares -16 -7 -7 -7 -7 -7 -7

Reserves -81 -66 -66 -66 -66 -66 -66

Retained Earnings -1,671 -1,115 -996 -343 64 223 1,235

Qantas shareholders 2,862 3,442 3,561 4,214 4,621 4,780 5,792

Non-controlling interests 4 5 10 15 25 40 55

Total equity 2,866 3,447 3,571 4,229 4,646 4,820 5,847

Net debt 3,455 2,558 1,917 991 617 451 -788

Capitalised operating lease libaility 3,888 3,748 3,972 3,940 4,024 4,083 4,143

Capitalising multiple 7.5 7.6 7.5 7.5 7.5 7.5 7.5

Adjusted net debt 7,343 6,306 5,889 4,930 4,642 4,534 3,354

Net debt / EBITDA 3.5x 1.1x 0.3x 0.2x 0.1x -0.3x

Adj net debt / EBITDAR 4.9x 2.2x 1.3x 1.2x 1.3x 1.0x

FFO / adj net debt 17% 45% 70% 71% 67% 84%

Average shares (mn) 2,212 2,196 2,129 2,062 2,062 2,062

16 December 2015


Figure 67: Qantas cash flow statement & valuation


Year end Jun ($mn) FY14 FY15 1H16 2H16 FY16 FY17 FY18 FY19

Cash from operations 1,247 2,241 1,537 1,916 3,454 3,474 3,200 2,817

Interest received 74 85 42 42 84 84 84 84

Interest paid -254 -281 -133 -100 -233 -183 -127 -75

Dividends received 4 5 0 0 0 0 0 0

Income taxes paid -2 -2 0 -282 -282 -621 -516 -440

Net cash from operations 1,069 2,048 1,446 1,576 3,022 2,754 2,641 2,385

PPE -1,072 -1,237 -630 -630 -1,260 -1,360 -1,500 -1,200

Intangibles -89 -122 -70 -70 -140 -140 -143 -146

Interest paid and capitalised -34 -17 0 0 0 0 0 0

Disposals 211 222 400 50 450 150 200 200

Other -85 210 0 0 0 0 0 0

Net cash from investing activities -1,069 -944 -300 -650 -950 -1,350 -1,443 -1,146

Share issues / (buy-backs & treasury) -63 0 0 0 0 0 0 0

Change in net debt -310 -1,480 -657 -910 -1,567 -373 -167 -1,239

Dividends paid to non-controlling interests -1 -4 0 0 0 0 0 0

Dividends paid to Qantas shareholders 0 0 -505 0 -505 -1,031 -1,031 0

Other 547 267 0 0 0 0 0 0

Net cash from financing activities 173 -1,217 -1,162 -910 -2,072 -1,404 -1,198 -1,239

Net increase in cash 173 -113 -16 16 0 0 0 0

Cash & equivalents - beginning of year 2,829 3,001 2,908 2,892 2,908 2,910 2,912 2,914

Exchange rate adjustments -1 21 0 0 2 2 2 2

Cash & equivalents - end of year 3,001 2,908 2,892 2,908 2,910 2,912 2,914 2,916

FCF (Maint capex) -246 1,129 891 1,015 1,906 1,674 1,596 1,327

FCF (G&M capex) 15 866 796 926 1,722 1,404 1,198 1,239

Operating CF per share (cents) 48.3 93.3 67.9 74.0 141.9 133.6 128.0 115.6

FCF per share (Maint capex) (cents) -11.1 51.4 41.9 47.6 89.5 81.1 77.4 64.3

FCF per share (G&M capex) (cents) 0.7 39.4 37.4 43.5 80.9 68.1 58.1 60.1

Returns & valuation

ROIC (pre-tax) -1.5% 12.7% 19.9% 21.5% 17.8% 15.2%

ROIC (post-tax) -1.1% 9.0% 14.0% 15.1% 12.5% 10.7%

CROIC 6.3% 11.9% 15.4% 15.6% 13.8% 12.5%

PE 9.0x 6.5x 5.5x 6.7x 7.9x 10.1x

EV/Sales 0.7x 0.8x 0.8x 0.7x 0.7x 0.6x

EV/EBITDAR 4.2x 3.7x 3.2x 3.5x 3.6x 3.7x

EV/EBIT 6.5x 5.0x 4.1x 4.8x 5.4x 6.2x

EV/IC (at cost) 0.42x 0.50x 0.57x 0.51x 0.49x 0.46x

Price/Book 1.6x 2.2x 1.8x 1.7x 1.5x 1.3x

16 December 2015


Companies Mentioned (Price as of 16-Dec-2015) ANA Holdings (9202.T, ¥346) Aimia (AIM.TO, C$9.18) Air Canada (AC.TO, C$10.36) Air China (0753.HK, HK$6.08) Air France-KLM (AIRF.PA, €6.477) Air New Zealand (AIR.NZ, NZ$2.87) AirAsia Berhad (AIRA.KL, RM1.29) AirAsia X (AIRX.KL, RM0.185) American Airlines Group Inc. (AAL.OQ, $42.595) Asiana Airlines (020560.KS, W4,420) Cathay Pacific (0293.HK, HK$12.92) Cebu Air Inc (CEB.PS, P81.5) China Airlines (2610.TW, NT$11.1) China Eastern Airlines (0670.HK, HK$4.2) China Southern Airlines (1055.HK, HK$5.34) Copa Holdings (CPA.N, $48.0) Delta Air Lines, Inc. (DAL.N, $51.15) Deutsche Lufthansa (LHAG.DE, €13.78) EVA Air (2618.TW, NT$17.05) EasyJet (EZJ.L, 1696.0p) Gol Linhas Aéreas (GOLL4.SA, R$3.24) International Airlines Group (ICAG.L, 583.5p) Japan Airlines (9201.T, ¥4,149) JetBlue Airways Corporation (JBLU.OQ, $23.2) Korean Air (003490.KS, W27,350) LATAM Airlines (LFL.N, $5.01) Multiplus (MPLU3.SA, R$38.4) Qantas (QAN.AX, A$3.8, OUTPERFORM, TP A$5.5) Ryanair (RYA.I, €14.675) Singapore Airlines (SIAL.SI, S$10.8) Smiles (SMLE3.SA, R$38.0) Southwest Airlines Co. (LUV.N, $44.22) Tiger Airways (TAHL.SI, S$0.405) Turkish Airlines (THYAO.IS, TL7.23) United Continental Holdings, Inc. (UAL.N, $57.9) Virgin Australia (VAH.AX, A$0.46) Woolworths (WOW.AX, A$23.26)

Disclosure Appendix

Important Global Disclosures I, Paul Butler, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Qantas (QAN.AX)

QAN.AX Closing Price Target Price

Date (A$) (A$) Rating

21-Feb-13 1.66 1.85 O

16-Jul-13 1.39 1.42 N

15-Aug-13 1.25 1.30

29-Aug-13 1.40 1.35 U

18-Oct-13 1.43 1.22

09-Jan-14 1.12 1.21 N

27-Feb-14 1.16 0.97 U

* Asterisk signifies initiation or assumption of coverage.

O U T PERFO RM

N EU T RA L

U N D ERPERFO RM

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities

As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s tota l return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiv eness of a stock’s total return potential within

16 December 2015


an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 1 2-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.

Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

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Global Ratings Distribution

Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 58% (33% banking clients) Neutral/Hold* 29% (31% banking clients) Underperform/Sell* 12% (25% banking clients) Restricted 1% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors.

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Target Price and Rating Valuation Methodology and Risks: (12 months) for Qantas (QAN.AX)

Method: Our target price for Qantas of $5.5 per share is based on a 12 month forward EV/EBITDAR multiple of 4.4x and an EV / IC multiple (gross capital) of 0.68x. This is inline with the historical trendline when compared to ROIC. There is ~40% upside to our target price and this high upside sufficiently offsets the high risk characteristics of Qantas' airline business, and justifies an OUTPERFORM rating on the shares, in our view. We expect large special dividends from Qantas over the next couple years, and this is a key catalyst for the share price. However, we would not expect a stable regular dividend stream in the longterm.

Risk: The risks to our target price and rating include: lower demand for airline travel both within Australia and in international markets, higher competition levels, increases in fuel price, higher regulatory burdens, higher financing costs and less availability of financing, labour disputes, geopolitical risk and other shocks.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names

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16 December 2015


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Related financial services or products are only made available to Professional Clients or Market Counterparties, as defined by the DFSA, and are not intended for any other persons. Credit Suisse AG (DIFC Branch) is located on Level 9 East, The Gate Building, DIFC, Dubai, United Arab Emirates. This research may not conform to Canadian disclosure requirements. In jurisdictions where CS is not already registered or licensed to trade in securities, transactions will only be effected in accordance with applicable securities legislation, which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. Non-U.S. customers wishing to effect a transaction should contact a CS entity in their local jurisdiction unless governing law permits otherwise. 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This research may relate to investments or services of a person outside of the UK or to other matters which are not authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority or in respect of which the protections of the Prudential Regulation Authority and Financial Conduct Authority for private customers and/or the UK compensation scheme may not be available, and further details as to where this may be the case are available upon request in respect of this report. CS may provide various services to US municipal entities or obligated persons ("municipalities"), including suggesting individual transactions or trades and entering into such transactions. Any services CS provides to municipalities are not viewed as "advice" within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 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Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can be eroded due to changes in redemption amounts. Care is required when investing in such instruments. When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to pay the purchase price only.

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