Back from the red: Air NZ turnaround set to make corporate history

Air New Zealand’s forecast pre-tax profit could be the country’s biggest turnaround within a financial year, analysts at Forsyth Barr say.

‘‘From an anticipated small loss on the first day of the financial year to more than $580m on the last, [is] quite likely the biggest positive change in expected financial fortunes during an annual reporting period in New Zealand corporate history,’' say analysts Andy Bowley and Paul Koraua.

The airline will announce its annual result on August 24 amid still strong demand and high yields from its growing network as competitor airlines haven’t fully restored their capacity.

Air New Zealand last year suffered a $507m bottom-line loss but after-tax profit is forecast to be around $426m.

The strong recovery from near-record losses during the depths of the pandemic is consistent with that experienced internationally.

The latest quarterly reporting from US airlines highlights buoyant conditions in US domestic and international markets driven by strong leisure demand.

Bowley and Koraua say ordinarily consumer confidence should affect demand, but the current weak consumer environment in New Zealand hasn’t appeared to yet for Air New Zealand.

They attribute this to the big gap between underlying demand, which has grown since pre-Covid times, and available capacity.

The airline, 51 per cent owned by the Government, continues to benefit from a two-speed Covid recovery.

A strong demand recovery contrasts with a slower recovery in capacity, leading to record yields and strong airline profitability.

Yields will fall as capacity continues to return, but will remain well above pre-Covid levels given the impact of cost inflation in the intervening years.

Air New Zealand has a stanglehold on the domestic market. Photo / Estelle Sarney

‘‘As yields moderate and capacity increases, we expect Air NZ’s margins to contract and its return on capital to fall back within its target band. In the meantime financial year 2023 earnings guidance implies a pre-tax ROIC (return on invested capital) well above the top end of this range, with upgrade risk to financial year 2024.’'

The analysts say Air NZ’s shares have also traded within an unusually narrow band.

The range bound share price - which will today open on 78c - has the second lowest standard deviation of any stock in the NZX 50.

This is unusual for an airline accustomed to higher levels of volatility, particularly as it recovers from the biggest system shock since World War II.

The analysts note the share register underwent a major change in the pandemic with international institutional holders exiting and retail investors taking their place.

‘‘A reasonable proportion of the retail investor interest in Air NZ coincided with the emergence of online platforms allowing easier access to the share market for retail investors. Many of these investors are unadvised - unable to access professional investment advice - and therefore may pursue different behaviours than other investors.’'

While near-term earnings have enjoyed an upgrade cycle over the past 12 months, medium-term expectations appear anchored around the airline’s earnings capacity as dictated by return on capital aims - and history.

The company continues to target pre-tax ROIC of 10 per cent to 15 per cent.

Current earnings guidance suggests it will generate a return well in excess of the top end of this range, however, ROIC is expected to fall within this band over the next 12 to 18 months.

‘‘Deteriorating consumer economics may depress demand, yet the level of excess demand relative to constrained capacity will provide some financial cushioning for Air NZ over the near term.’'

But the demand picture has been complicated by Covid. Passenger demand for aviation is heavily influenced by consumer confidence in developed nations and the growing wealth effect in developing economies.

‘‘Given Air NZ’s reliance on NZ resident outbound traffic, it is more exposed to the former than the latter. Consumer confidence in New Zealand is currently at multi-decade lows, reflecting a cost of living crisis and deteriorating economic growth.’'

A significant gap continues to exist between longer-term trend demand and actual demand, which is restricted by capacity.

While analysts and the aviation industry continue to focus on measuring the aviation recovery against the pre-pandemic year, population and economic growth mean that these measures under-state the level of underlying demand.

Over the past three years, underlying demand could have grown by around 12 per cent relative to pre-Covid levels reflecting long-term trend growth of 4 per cent a year, which exaggerates the gap between trend demand and actual demand.

‘‘We suspect that this, coupled with lingering “revenge travel”, which should dissipate over time, helps to explain why deteriorating consumer confidence is not apparent in airline financial performance yet.’'

Grant Bradley has been working at the Herald since 1993.  He is the Business Herald’s deputy editor and covers aviation and tourism.