Analysts and investors might be getting all worked up over nothing, with Qantas Airways Limited (ASX: QAN) expected to post a profit of more than $1 billion in around 3 weeks' time.
We've long argued that airline reported profits are fiction, and the proof is in Qantas' $2.8 billion loss last financial year. The airline was forced to write down the value of its international fleet of planes by $2.6 billion and take a further $394 million in fleet restructuring costs.
Essentially that one-off write-down means that the depreciation on its planes, since they were purchased, wasn't high enough. As an example, a plane costing $200 million might be depreciated over 20 years, with the plane worth a maximum of 10% of its value at the end of that period.
Qantas depreciates its aircraft and engines over between 2.5 and 20 years on a straight-line basis. But even after 10 years technological advances might mean those planes are virtually worthless – which is why Qantas was forced to take the huge writedown on its planes. After 10 years, the planes might still be on the company's books valued at around half their cost.
Qantas' one-off write-down effectively brings forward the remaining 10 years of depreciation into one year – and here's the important bit – boosting profits through reduced depreciation in future years of around $200 million each year. The other problem is the cost of the planes.
When you consider that new Boeing 787s start at a list price of US$224.6 million each, while an Airbus A380 starts at US$428 million, Qantas is looking at nearly A$900 million for just two aircraft. Of course, airlines get discounts for pre-ordering and larger orders, with Emirates estimated to have received a 37% discount for its A380s ordered in 2011. They may also have to pay extra for different configurations, fuel, and seating capacity but the actual price airlines pay for their planes is a closely guarded secret and rarely published – somewhat similar to the Recommended Retail Price (RRP).
Boeing 787-9's have a list price of US$264.6 million in 2015 or A$362 million each – and Qantas has options to order 50 –or more than A$18 billion (using list prices) at today's prices. Even if the airline receives a 37% discount, it is still looking at a total cost of A$11.4 billion just for Boeing 787-9s. Qantas has other aircraft on order too, both smaller and including the larger and more expensive Airbus A380 – indeed the company says that it expects to order $18 billion (at list prices) worth of aircraft over the next 10 years.
The problem Qantas has is that if it follows the same depreciation schedule it has in the past, profits will be overstated (because the depreciation charge should be higher) and somewhere down the track, shareholders can look forward to another huge writedown – and the likely negative impact on the share price.
The solution would be for Qantas to write off its planes at a faster rate – say over 10 years, or rather than buy the planes outright, lease them. The problem with leasing, though, is that over a long period, it can be more expensive to lease than buy aircraft outright. When you consider some planes like the venerable Boeing 747 can still be flying 40 years or more since they first took to the air, buying rather than leasing made sense.
But offsetting the disadvantage of leasing is the benefit of being able to renew your planes on a more regular basis – which can save hundreds of millions or even billions in operating costs as planes become more efficient.
Running an airline isn't for the fainthearted. The decision between buying and renting and the associated depreciation schedule isn't easy, and then you have to compete against 40 or more other airlines that fly into Australia, two-thirds of which are owned by government-owned or supported – who don't have to answer to shareholders.
Foolish takeaway
Don't be deceived by the profit that Qantas reports. As I've noted above, it can be wildly inflated or deflated depending on non-cash write-downs and depreciation schedules. Also, remember that while the falling oil price is good news for the company, the falling Australian dollar is definitely not good news, making fuel and aircraft much more expensive.
