Meh … is what I felt after going through Rex’s results for FY16.
The FY2016 loss of $9.5 million (mainly due to impairments) wasn’t too surprising given what shareholders were told at the half year. However, the underlying net profit of $3 million was disappointing as they have gone backwards from the half year (which reported an underlying net profit of $3.3 million). The key developments in FY2016 were i) winning the WA routes, ii) the cessation of Pel-Air’s defence towing contract which led to the above impairment and iii) Vietnam Airlines cadet training program tie up with AAPA, all of which were already flagged at the half year.
These were some of the positives takeaways:
- 2nd half RPT revenue grew by 16.7% despite i) the WA routes only started on 28 February 2016 and contributing four months of revenue to the 2nd half of the year and ii) RPT on the existing network fell by 0.74%. This means that although the WA routes on a full year basis will increase passenger numbers by circa 9%, its impact on revenue will be larger (due to its fares being higher than the average fares in the traditional network). Rex should experience full year FY17 revenue growth in the teens just from the WA routes.
- Fuel hedge in place which will lower fuel pcp cost from July 16 – Mar 17 by $4.7 million.
- Strong cash flow generation (operating cash flow $28.4 million) enabled management to reduce debt by $5.1 million at the same time increasing cash by $3.5 million. So overall net debt has decreased by $8.6 million.
Now the negatives:
- Annual expenses growth of 4.7% (excl impairments) exceeded revenue growth of 2.2%. Additional mobilisation and set up costs were incurred due to setting up the new WA routes.
- Passenger numbers are still falling in the regional areas of NSW, VIC and SA markets.
- No dividend for FY16 means that the share price is likely to continue to trade around current levels.
No doubt, this is a business where margins are so slim that the difference between one more or less passenger on a flight could be the difference between profit or loss. Cost is a key factor to the sustainability of the airline and the unionised nature of the workforce effectively ensures that wage cost (the biggest cost item) will increase annually. The annual cost increases are a structural problem for Rex.
Let me illustrate, from FY14 – FY16, Rex has nearly doubled the number of routes that it services and its net profits have actually gone from $7.7 million (FY14) to $3 million (normalised FY16). More routes, lower fuel cost and less profit?
Besides rising cost, one undisputed reason is that passenger numbers have fallen, in fact they have fallen by nearly 50% from 2008 (in spite of winning the new routes in Qld), a staggering decline. Management have always blamed weak regional economies, downturn in the mining sector etc as factors which have pulled down passenger numbers. I don’t disagree but I would add that management’s response to rising cost by increasing the fares is turning customers away. The chart below shows the passenger numbers and average fare over an eight year period.
So what to do? The obvious answer is to slash cost but given management frugality, it would be pretty hard to achieve without shrinking Rex’s operations. And I believe this is exactly what management should do. I believe Rex should re-assess its entire network and only service those routes where it can earn an adequate return on its capital.
Rex is unlike say Airasia who can benefit from network synergies as their route network expands. Airasia’s KL to Sydney and Shanghai to KL routes also attract passengers going from Sydney to Shanghai and vice versa. Rex enjoys very little network synergies as its customers are either headed to a capital city or going to a regional city from a capital city. There is very little inter-regional city traffic. Therefore, I would argue that there is little benefit of Rex having a large network (other than say sharing of central costs).
Routes that are culled as part of this process may even end up being subsidised by government (given regional politics) which would then make it profitable for Rex to continue the service.
Nonetheless, I’m still holding on to my shares as with the shares trading at 0.45x net tangible book value, the market has very low expectations. At this price it is like a free bet, (low downside but huge upside) but unfortunately the odds for upside isn’t looking great at the moment.