Lower fuel prices and a successfully executed cost reduction program have seen the share price of Qantas Airways Limited (ASX: QAN) fly high in 2015. Investors have clearly been impressed with the major turnaround in Australia's largest airline with the share price increasing by nearly 150% over the last year.
Airlines are notoriously complicated and volatile businesses that many investors simply don't understand. The famous advice from Richard Branson should be a warning to all investors – If you want to be a millionaire, start with a billion dollars and launch a new airline.
While Qantas may have enjoyed some success recently, I don't believe it can be considered as a good long-term investment. Instead, it should be treated as a trading stock and here are seven reasons why:
1. According to Morningstar, Qantas' return on assets has been less than 5% for each of the last 10 years and was a paltry 3.97% in its last result. To put this in perspective, investors could have achieved better returns by simply investing their money in cash over that time.
2. There has been increasing competition in the sector with domestic rival Virgin Australia Holdings Ltd (ASX: VAH) attempting to increase its market share especially in the lucrative business traveller category. Although this seems to have moderated over the last year, downward pressure on fares remains.
3. Asian and Middle Eastern-based airlines have been taking market share from Qantas by adding extra capacity to the international travel market. These airlines operate from a much lower cost base than Qantas and are able to offer much cheaper fares. While Qantas has a superior safety record, government backed airlines like Etihad are making it difficult for Australian travellers to pay such a high premium to fly with Qantas.
4. The aviation industry is subject to a number of inherent risks. From terrorism to contagious diseases, wars to natural disasters, airlines can be impacted by factors outside of their control. Although many of these issues are usually short term in nature, the frequency of these events means it is almost impossible to accurately forecast earnings.
5. Operating an airline requires constant investment and involves high capital costs as fleets need to be continually upgraded and planes need to be maintained. This puts pressure on cash flows and reduces the ability of the company to pay dividends throughout the economic cycle. Although Qantas has taken steps to reduce its debt burden, it still needs to service over $5 billion in long-term debt.
6. Qantas operates from a very high cost base compared to other airlines due to the higher wages paid in Australia relative to other countries. There has been extensive publicity about the difficulty Qantas has had in dealing with union groups and this still remains a risk for investors.
7. A significant factor in Qantas' profitability is fuel prices. There is little coincidence that the recent improved financial performance has occurred when fuel prices are the lowest they have been in five years. This is a short-term tailwind and investors should take this into account when looking at Qantas as a long-term investment.
Foolish takeaway
One look at the long-term performance of Qantas should be a warning sign to all long-term investors. For most investors, including myself, airlines are just too complicated to confidently invest in. They are a high risk proposition best left to traders or those who understand the underlying business.
Looking for something that's guaranteed to perform better than Qantas over the next ten years?
