Tell ’em they’re dreaming

Well, that was one of the memorable lines from Darryl Kerrigan in the 1997 comedy film ‘The Castle’ starring Michael Caton. If you watched the film, you may recall one of Darryl’s sons ‘Steve Kerrigan’ who was in love with buying items advertised for sale in the Trading Post. Overhead projector $150, Pulpit $800, Ergonomic chairs – four of them $180 and don’t forget “jousting sticks”.

To paraphrase a couple of lines from the movie….
Steve Kerrigan: “Dad, a guy’s selling a pair of jousting sticks”
Darryl Kerrigan: “How much does he want for them?”
Steve Kerrigan: “Dad, $450”
Darryl Kerrigan: “For Jousting sticks? Tell ‘em he’s dreaming”

When I look at any of the airline stocks in the Australian market and their corresponding share price, I have a similar thought running through my head “Tell em’ they’re dreaming”.

Using Qantas as an example, their shares are currently trading at $1.59 (27 Jan 2012). After the recent media coverage and turmoil Qantas have been facing, I have estimated my intrinsic value for Qantas. My estimate of Qantas’s value at June 2011 is $0.40 moving to $0.45 in June 2012 and $0.49 in June 2013.
With my belief that in the long run, the share price will follow value, I see that it is a tough road ahead not just for Qantas but for shareholders in any of Australia’s airline businesses.

Owning and operating an airline is one of the toughest businesses to be involved in. Airlines face headwinds from many directions. Operational costs that are difficult to control, uncertain fuel costs, currency risks, the enormous cost of buying new planes, ongoing maintenance and servicing and general economic factors of the time. Compounding all of these headwinds for Qantas is the recent quarrelling with their employees and their employee’s unions just making their life more difficult to succeed.

With the Qantas share price around $2.90 in October 2010, a lot of investor’s may have bought into Qantas recently, justifying their purchase that Qantas shares are now ‘half price’. But taking your buying cues from price can be a trap. Just because the shares are half the price of what they were not so long ago does not necessarily mean they are good value.

Qantas have an excellent CEO in Alan Joyce. He gets a lot of media attention and handles himself very well. My view is that over the years, he has made and continues to make good decisions that are in the best interest of the business. However, a good manager can only do so much. Even though Qantas is about the most profitable airline worldwide partly due to the efforts of Mr Joyce, the economics of businesses operating in the aviation industry are more powerful than the person who is the chief pilot (CEO) in a business.

To confirm this point, Richard Branson who runs Virgin once talked about the question he is asked more often than any other question. He is very often asked “How do you become a millionaire?” His answer nowadays is “First become a billionaire and then buy an airline”.

Airlines provide an amazing public service to our community and I applaud all those who are involved in owning and operating them. Collectively, airlines give so much to our community, however the cost to do so is greater than the profit they receive.

As a long-term investor, with the market offering airline shares at current prices, I choose to respond to the market, “Tell ‘em they’re dreaming”.

This article is published by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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