what does the future hold for qantas?

Invast Insights

Week Commencing March 3, 2014

www.invast.com.au | 1800 468 278

This week we look at the following topics:

1.0 What does the future hold for Qantas?

2.0 Australian reporting season scorecard

3.0 US jobs report, this week’s key event

4.0 Recent webinar highlights and answers

Editor’s note: Due to the huge amount of corporate news out recently, this

week’s report is slightly more focused on stock related news. Next week’s report

will conversely have a strong focus on currency markets following key data

releases.


1.0 What does the future hold for Qantas?

Last week we wrote about the bottoming out of the Australian economy and

the potential upside in the Australian share market. We spoke about how at

the bottom of the cycle one of the best guides to where the market or

economy is going is what the front page of the newspaper reports. When you

see doom and gloom on the front pages, you know it’s time to buy. When you

see newspapers reporting on their front pages about how fantastic the

market is or how strong the economy is performing it is probably a good sign

to sell. This doesn’t always work out, timing can be tricky, but usually the front

page of a newspaper is the perfect contrarian indicator.

So with that in mind, we start this week’s report with a review on Qantas. This

isn’t necessarily one of the largest or most important businesses in Australia

but it is one which carries national pride and a fair bit of indirect investor

sentiment. We think Qantas’ disastrous earnings numbers and very

unfortunate decision to shed 5000 additional jobs is the worst piece of


economic news Australia will see for a while. From here on, we think things

will get better. Again, we explained last week why we think the stock market

and economy are edging higher.

There are four key issues at hand for Qantas:

• The financial numbers released last week. The underlying loss is within the

target band range of $250-300m so no real surprise here. We were

expecting an underlying loss of $280m, so it’s slightly better. For us the

composition is worse than expected, the leakage out of the international

business is really surprising and we think that Qantas will find it very hard

to articulate how it plans to stop this. Expansion into Asia is a long term

plan and it doesn’t seem like it is paying off anytime soon.

• The government removing the foreign restriction cap. No decision as of

the time of writing but looking very likely to be announced by the

Government within the next 24-48 hours.


• The job losses and where Qantas goes as a business from here. The 5000

worst case scenario number has been confirmed. We actually think this is

larger than expected because it relates to full time equivalents, which

means when taking into consideration part time workers, the full number

might be even worse. This is a massive blow to the domestic workforce,

most of the losses will be Australian based.

• The government guaranteeing Qantas debt. No decision as of the time of

writing. This is the key point that many investors will be looking for,

perhaps the most important in terms of valuation as an investment.

International fund managers will be watching this very closely, it will be

the main game post today’s announcement.

Bottom line: The government guaranteeing Qantas financially is the most

sensitive question now in terms of market valuation. We believe the

shareprice is unlikely to rise significantly until this is announced and any rally

might see sellers until this is quantified. Qantas Qantas is a reflection of where

the Australian economy is right now – probably near the bottom of the cycle.


Invast spoke to Bloomberg Television following the Qantas announcement.

Watch the full video here:

http://www.bloomberg.com/video/avoid-qantas-virgin-australia-stock-esho-v5sku~EIQfO39dOJKAdqoA.html



























All three major Sydney newspaper headlines on Friday reported the Qantas

news and many smart contrarian investors have seen this as a signal that we

are near the bottom. The stock market front runs the economy by around 6-12

months and so we think as the Australian economy improves before the end

of the year, the stock market will pre-empt this and continue rising. Not in a

straight line of course. We continue to hold the view that Qantas is still

trading at a discount to its replacement cost value, it hasn’t been valued on

earnings merit for a while now and understandably so – it’s losing money.

Qantas is shrinking as a business and its international success into Asia is still

many years away, if ever. We think there will be huge pressure now on Joyce

and the board to respond to the massive job cuts. The Government will be

closely watching, perhaps slower than what some are expected. We prefer to

Sell into any rally and buy back near the strong support level somewhere in

the $1 per share range.


2.0 Australian reporting season scorecard

With corporate reporting season winding down this week, we thought we

would touch base with some of our recommendations made in Invast Insights

published on 17 February 2014. In that report, we listed a number of key

stocks that were due to report their earnings and we included market

expectations for earnings together with our view on how to trade these

stocks. Below is an update on our initial view and our current view based on

the actual numbers coming out.

We got 14 of our calls correct and 7 of our calls incorrect, so our total strike

rate is somewhere around 67%. We aim to improve this over time but one of

the important things to note is that on the stocks which we didn’t get right,

the margin of error was not that great and so on balance clients could have

done very well trading our calls.


3.0 US jobs report, this week’s key event

The US jobs numbers out on Friday 7 March 2014 will be one of the most

crucial piece of data out this week. The market is expecting the rate of

unemployment to remain at 6.6%. It will be interesting to see where the final

number prints and if the previous month sees an upward revision. The ADP

employment survey which comes out on Wednesday 5 March is expecting a

reading of 175,000 compared to the prior month at 153,000. Below we attach

a chart showing the trend in US jobs from the Bureau of Labor Statistics

showing the trend in jobs.


On average the markets are expecting fairly good numbers are several

months of out performance. It will be interesting to see if these expectations

are matched given the huge weather disruptions to have plagued large parts

of the United States in recent months. Official figures are always adjusted for

one off items so we assume the market has made these adjustments.

4.0 Recent webinar highlights and answers

We held two very popular webinars last week as previously advised. The

webinars attracted a large turnout and we thank all those who attended and

participated. Most of those who attended managed to ask some very

insightful questions and we take this opportunity to share those questions

and our answers below for all to see. To watch the webinar, click on the link to

the left.


Question: Victor asked “Are the banks overvalued?”

Answer: We think the Australian banks are among the best in the world, we

don’t doubt their quality or their ability to generate large profits. Where we

think the vulnerabilities lie is in the margins which the Australian banks have

enjoyed over the past decade. We think the Australian banks will have to dig

deep and continue fighting aggressively on price which will see their net

interest margins fall over the next five to ten years. We have discussed this in

a previous issue of our Invast Insights newsletter.

Question: Michael asked “How do you manage the May/June tax loss period?”

Answer: Good question Michael, you need to keep in mind that tax loss

selling usually takes place in a sideways or downward trending market. When


stock prices go up, many investors don’t want to sell because they will have

tax gain liabilities with the tax office! Tax is just one thing to consider, when

the market turns and points higher usually this is one of the last thing people

are considering. When the market edges higher the fear or missing out and

the herd mentality means most investors are jumping onboard and buying

aggressively. This is what we focus on, we don’t spend too much time thinking

about tax loss selling. Also keep in mind, any short term tax loss selling in a

sideways or downward trending market is usually followed by buying in the

following months, so things even out.

Question: Daniel asked “Just inquiring about the sweet crude oil contract,

would there be a probability of it going higher?”

Answer: We quote two oil contracts on our Invast MT4 platform – Brent Crude

Oil and West Texas Light Crude Oil. We are generally bullish on energy this


this year and have made a strong case for this in our 2014 Forecast guide. We

went through and spoke about current demand and supply dynamics and

formed a view that energy prices are likely to outperform. We highlighted the

fact that a lot of the noise are the United States becoming a net energy

exporter is rhetoric and the facts are signalling that global oil supply is

struggling to keep up demand. We also wrote “The biggest loser of a deal

between the West and Iran on joint co-operation is also the world’s largest

producer of oil – Saudi Arabia. Saudi Arabia and its Gulf neighbours - Kuwait

and the United Arab Emirates - combined produce around one fifth of the

world’s oil. We think the geopolitical landscape will continue to shift in 2014

with Saudi Arabia facing serious strains. The system of government which has

held up Saudi Arabia’s ruling royal family continues to face serious strains and

rising energy prices will only fuel further unrest which could lead to political

and social turmoil – enough to set fear in the markets of a much larger scale

than we have seen so far during the Arab Spring“.


Question: Richard asked “Any clues for Iron ore and copper prices? Are they down because of China issues?” and Jacques asked “What do you think about gold?”

Answer: We have also touched on this extensively in our 2014 Forecast Guide. At Invast we tend to think of commodities in two buckets - first the industrial commodities that are used in the production of goods and services and secondly the currency commodities like gold and silver which are held for different reasons, usually a storage of wealth. Gold is mentioned separately in section 5 of the 2014 Forecast Guide report.

We will start with copper first. Most experienced traders and investors refer to copper as Dr Copper - reputed to have a Ph.D. in economics because of its ability to predict turning points in the global economy. Copper is very widespread in its industrial application. It finds itself in many different products from homes and factories, to electronics and power generation and transmission. There are various ways to generate electricity but not many ways to transport the electricity from the generators to households or businesses except copper and other similar substitutes.


Who are the key consumers of physical copper? The simple answer is China

matters. There are various estimates out there but most tend to agree that at

the moment, China is consuming around 40% of total global copper

production. This might sound large on face value but on a per capita basis,

China is consuming around 5.4kg per capita compared to North America

which is around twice that. So even though China is the largest single swing

factor, it is by no means using as much as other developed economies when

compared to its population size. It may never do so, but we just want to paint

the picture that China is important to where the copper price goes from here.

Being the largest factory in the world, China's copper consumption goes into

its own domestic use but also in making products which it exports to the rest

of the world. As the global economy comes out of a recession, consumers in

the United States, Europe, Japan and other emerging economies are likely to

buy more Chinese products which will impact copper demand.


India is also important and depending on which estimates you believe is currently consuming around 0.5kg of copper per capita despite having a population of comparable size to China. India's power needs are likely to continue growing over the next decade and it will need to invest in its electricity network in order to keep up with demand, meaning more supply for copper. In 2014 we expect copper stockpiles to continue falling which should support the copper price towards US$3.60-65/lb. Copper producers continue to face production difficulties and the low prices seen in 2013 have forced many producers to cut back production, in turn having an impact on supplies as measured by the London Metals Exchange (LME). Copper is the most attractive industrial commodity to be trading over the next two years. The steep price declines in 2013 and associated production shortages should support the copper price for at least the next two-three years particularly as the United States commences housing and infrastructure investment after decades of neglect.

In terms of iron ore, we maintain a view that prices will stabilise at around US$120 per tonne over the next few years. There will be some price distortion as China goes through its growth issues but recent reports from BHP, Rio


Tinto, Fortescue Metals, Atlas Iron and Mount Gibson Iron ALL suggest that

demand for iron ore shipments remains strong and their cash balances

continue to grow. Most of the bears or sceptics out there focus on the rate of

Chinese investment infrastructure with the odd attention seeker pointing to

“ghost cities” where apparently nobody lives. This is a common excuse for

being negative on China and negative on mining companies including iron

ore stocks. At Invast we actually think that China will continue to invest

aggressively in the years ahead, albeit very differently to the way it did in

2008-2010. One area which we think will underpin investment is the Chinese

rail system and associated infrastructure.

There were some problems with the way investment was put into place very

quickly between 2008-2010. We are not naïve enough to think that there

weren’t any overcapacity issues. But in our view, China has learnt from these

lessons and is ready to invest aggressively in large-scale investment which has

the potential to provide solid financial returns and most importantly, social

benefits to appease any political backlash. One of the best areas of

investment is rail infrastructure for the following reasons:


• China already has one of the highest logistics costs in the world when

measured relative to GDP. The investment into rail infrastructure has

lagged other forms of transport on a relative basis over the past two

decades even though it has grown in absolute terms. According to a

report published by Armstrong & Associates, CSCMP & CLSA, logistics

costs as a proportion of GDP two years ago in China stood at 18.1%

compared to 8.5% in the USA and 8.3% in Germany respectively. We may

think the Chinese have invested enough in recent years through large

infrastructure programs but there is still huge scope for improvement in

the railroad system.

• Speak to anybody who has recently visited a major city in China and they

will tell you that one of the major problems is congestion. There are more

than 150 cities in China with a population greater than one million citizens

and this number will continue to grow as rural residents migrate into

major centres for jobs and education. We estimate that around 15% of

these cities have an adequate urban rail transit system and most of these

are only relatively new which means there is huge scope for expansion.


• Rail investment is not just something which we have drawn up ourselves

because we felt like it, instead it actually features prominently in Beijing’s

long term reform plans. One of the first major reform measures adopted

by the new Chinese leadership was to reform the Ministry of Railway into

a planning/regulatory arm and a operating arm now called the China

Railway Corporation.

We plan to go into more detail on Chinese rail infrastructure in future reports,

but for the time being the above goes some way to explain why steel

manufacturing capacity continues to grow in China and iron ore continues to

be consumed by steel mills as fast as it is being produced in Australia and

Brazil.

To be a part of these webinars, visit our website to check out the schedules

and registration.

http://www.invast.com.au/resources/webinars.aspx














7.0 Disclaimer

Please note that you are receiving this report complimentary from Invast Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time to time purchase securities which are included in this or future reports. The authors of this report may or may not be holding a position in the securities mentioned. Please note that the information contained in this report and Invast's website is of a general nature only, and does not take into account your personal circumstances, financial situation or needs. You are strongly recommended to seek professional advice before opening an account with us.

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what does the future hold for qantas?

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