Qantas: How come nine analysts had ‘buy’ ratings?

Qantas Limited (ASX: QAN) yesterday announced a surprise profit downgrade – well a surprise to many, but not me. As I mentioned a few weeks ago, “Airlines are notoriously bad investments – In aggregate airlines globally lose billions most years.”  The share price subsequently dropped 18.7% to close at $1.155.

What was most surprising to me was that nine out of 13 analysts had a ‘buy’ or ‘strong buy’ rating on the stock before the announcement. How did they get it so wrong? I have several possible explanations for that.

Broker analysts have an inherent conflict of interest, that is evident in so many of them rating Qantas a buy. Whether a stock is worthy of investment or not, analysts don’t like being the odd-ones out, so you find that not one analyst rated Qantas as a ‘sell’. Despite this profit warning, I suspect that you’ll find not many analysts will change their rating. They will argue that it’s now even cheaper, and therefore a must buy stock.

It’s a tough job when analysts talk to fund managers and need to justify their rating, which is made even harder if they take a contrarian approach. Imagine talking to a fund manager and trying to convince him or her that the other eight analysts are wrong, and that you are right.

As I’ve stated many times before, analysts can be alienated and even sacked for putting a ‘sell’ rating on a stock. Companies don’t like that much, and they tend to avoid the analysts company, when and if they want an investment bank to act on their behalf to raise funds. So putting a ‘sell’ rating on a company, could mean the analyst’s firm loses business.

Analysts tend to have a short term focus, because their clients, mainly fund managers, are focused on quarterly performance rather than longer term performance. Hence their 12 month ratings are not really meant for 12 months, but closer to 3 or 6 months.

Analysts models are overly complex Excel spreadsheets with thousands of calculations and inputs. The more complex the model, the more the analyst feels that they have covered everything that might affect the performance of the company. My view is that they are unnecessarily complex, and the complexity obscures the ratios and performance of a company that really matter to investors, such as Return on Equity, Return on Assets, Return on Capital, profit margin and debt. Just looking at those 4 financial ratios and the total amount of debt the company has – should be enough to determine whether the company is investment grade or not. Qantas, by the way, fails on all 5 counts in my model. The fact its an airline should automatically place a sell or avoid rating on it, without any need for a model.

Who to blame?

The newspapers are full of analysis on how this could happen, and who is responsible. The fact is that no-one is directly responsible. No matter how well management run the company, the fact that its an airline means its a bad business to begin with, with loads of external factors that can impact its profits, and sooner or later the company is going to come a cropper, despite the best efforts of management. As Warren Buffett has stated “When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

Summary

This illustrates that analyst stock ratings aren’t worth much at all, and that airlines are just bad businesses. If your super fund has money invested in Qantas, you might want to ask them exactly why.

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One Response to Qantas: How come nine analysts had ‘buy’ ratings?

  1. Ken says:

    Have to agree 100% with your assessment, both of QAN and analysts.

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