MIAMI — In September of 2009, Japan Airlines was on the brink. Having just lost a record ¥131.22 billion ($1.45 billion) in the first half of Fiscal Year 2009, the airline was collapsing under the weight of its nearly $26 billion debt load. A bloated workforce and route network had placed the airline into dire financial straits, and the emerging global financial crisis threatened to put one of the world’s most historically influential airlines out of business for good.
The company shed 15,000 employees, 60 aircraft, and 45 routes, and briefly flirted with Delta Air Lines before entering into a strengthened joint venture partnership with American in a bid to right the ship.
After a two year bankruptcy restructuring in 2009-10 the company turned itself around through the aforementioned cuts, capital injection from the Japanese government, and roughly ¥500 billion worth of debt forgiveness, Japan Airlines jumped up to become the world’s most profitable airline in Fiscal Year 2011.
Since then, the carrier has delivered consistent profits despite a running series of headwinds, including a declining Yen, rising fuel prices, and a series of 787 debacles. Since its IPO last year, Japan Airlines’ stock has appreciated nearly 50% to ¥5,080. But I still believe Japan Airlines is undervalued. Here are five reasons why.
JAL is Undervalued Relative to its Competitors and Comparables.
Each of the major ratios and valuation comparisons relative to domestic rival All Nippon Airways and comparable full service carriers in mature markets like the United States and Europe point to JAL being significantly undervalued, with a minimum upside of at least 30-40%. Starting with Price to Forward Earnings, ANA is currently trading at around 48 times its projected Fiscal Year 2013 EPS (given alongside its most recent earnings result by management), while Japan Airlines is trading at around seven times the projected Fiscal Year 2013 EPS (also using management figures). Clearly Japan Airlines does not have upside of 485.7% as this comparison would indicate, but it is still clear it is extremely undervalued relative to ANA.
EV/EBITDA is my other favorite valuation ratio and here once again with a forward EV/EBITDA of roughly 3.0 vs. 4.95 for ANA, one can make a clear case for JAL being undervalued (with an implied 66% upside). However, even if you broaden the comparison to include other full service carriers in mature markets such as Delta Air Lines, United Airlines, or Lufthansa, JAL still appears to be relatively undervalued, with these airlines trading at P/E ratios between 11.5 and 30. To put all of the above in layman’s terms, Japan Airlines produces consistently strong profits, but its stock is not priced accordingly.
JAL is Undervalued Relative to its Intrinsic Value as a Business.
It’s no accident that JAL has been one of the world’s three or four most profitable airlines since emerging from bankruptcy: It has a well-designed and conservative business model and business plan focused on building up cash and equity, while continuing to return cash to its shareholders at a consistent rate. Its balance sheet is strong, and it has paid off nearly ¥70 billion in debt over the past two and a half fiscal years. Yes, some of this is thanks to the government bailout.
It has a sustainable competitive advantage thanks to built-in corporate contracts with its core customers plus strong brand identity in Japan. Even more, it has an effective duopoly with ANA in the full service sphere, with a hedge against LCC penetration in Jetstar Japan, slot restrictions against competitors at its three largest hubs (Tokyo Narita and Haneda, Osaka Itami), and access to cheap aircraft thanks to its defection to Airbus earlier this year.
From a technical perspective, even a downside DCF with a negative terminal growth rate implies a valuation of more than ¥8,000 per share, with the upside value reaching more than ¥11,000 per share. Ultimately this means that if you project how much cash the business will bring in over the next five years under the most pessimistic assumptions, the value derived from that is still more than 60% higher than the present value of the stock.
JAL is Positioned well to Benefit from the US Airways – American Merger.
While this is not an effect that will appear until the second half of next year, it’s still important to keep in mind. Currently, US Airways frequent flyers traveling to Japan tend to fly either All Nippon Airways or United Airlines. But with US Airways shifting to the oneworld alliance post-merger, those passengers will now shift to the American – JAL joint venture. The new spike in revenue will bring in billions of yen, from a projected share shift of 30 to 60 percentage points in the three major US Airways strongholds of Philadelphia, Charlotte, and Phoenix alone. And many of these US Airways passengers are high yielding ones. Additionally, ex US Airways hubs, especially Philadelphia and perhaps Phoenix, are strong candidates for 787 service from JAL, thereby enhancing its long haul network
The 787 will allow JAL to re-take Market Share in the Trans-Pacific Market.
One of the core stories of the past decade has been the erosion of Tokyo Narita as the primary trans-Pacific gateway in Asia. As Seoul rose thanks to Korean Air’s massive growth and nearby domestic hub Haneda saw its own big growth spurt, Narita has slowly declined in importance. But the 787 has been a game-changer. As seen by the addition of Boston and San Diego, JAL has been aggressive about attacking secondary US markets with the 787. Given its lead time with the 787, JAL can use its presence in secondary markets to recapture some of its lost trans-Pacific market share in the Narita hub – a strategy it has hinted at in the past.
Abenomics Should Bolster Demand for Japanese Air Travel.
The economics program of Japanese premier Shinzo Abe certainly has both its critics and cheerleaders, but one thing it has done is shake up the moribund Japanese economy and restore nominal growth (even if the real results are somewhat mixed). However, a key upcoming cog in the so-called Abenomics program could be a boon to JAL (and other Japanese carriers). The Abe government is putting pressure on Japanese corporations (who are reporting record profits) to increase the salaries of its employees, and the effort is likely to be successful. If salaries do rise (for the first time in several years), JAL and ANA could see a major surge in demand. Even if the wage increase does not universally materialize, the general forward momentum and economic growth driven by Abenomics bodes well for JAL’s future demand.
To summarize, stock analysis, as well as an analysis of the business itself, show that JAL is undervalued as a company based on its present results. Moving forward there are macroeconomic and airline-specific opportunities for profitable growth that should also increase JAL’s true value for the foreseeable future.