Japan Airlines (OTCPK: JAPSY) recently released its FY2023 financial results, which revealed robust revenue growth, especially in the international passenger segment. Despite facing difficulties in the cargo business, the low-cost carrier (LCC) arm demonstrated significant revenue growth. The FY2024 guidance suggests potential for revenue growth and EBIT margin expansion, making Japan Airlines’ stock a buy with a 31% upside.
FY2023 Financial Performance
Japan Airlines’ total revenues grew by 20.1% year-on-year and 19.2% compared to FY2019. This growth was driven by a 2% increase in capacity compared to FY2019 and 16.6% year-on-year. Full Service Carrier revenues grew by 17.5% compared to FY2019, with international passenger revenues increasing by 17.2% due to a capacity recovery of over 85% compared to pre-pandemic levels. Domestic passenger revenues were slightly lower, with a recovery of over 96% of capacity, indicating higher unit revenues in both international and domestic segments.
Challenges in Cargo and LCC Growth
The cargo business experienced a revenue decline of 40.7% year-on-year due to increased freight capacity and softer demand. However, cargo revenues remained 45.5% higher than in FY2019. The LCC operations, particularly Zipair, saw year-on-year revenue growth of nearly 120%, with Zipair achieving 140.9% revenue growth on a 70.7% capacity expansion. Spring Japan also reported revenue growth of 61.1% on a 69.3% capacity increase.
Geographic Segment Performance
International operations showed strong growth, while domestic operations exhibited softer growth. Full Service passenger revenues increased by 28% compared to FY19 and 49.1% sequentially, with capacity growing by 12.2% and 24.4%. Notably, capacity in Europe and Asia/Oceania decreased by 14-15%, but revenues increased by around a third. In contrast, China and Hawaiian operations experienced significant declines in capacity and revenues. Long-haul America operations were a highlight, with an 8.1% increase in capacity and nearly 60% revenue growth.
Cost Analysis and EBIT Margin
Ex-fuel costs increased by 11.3%, exceeding the 8.7% inflation rate, while capacity expansion resulted in a 52 bps higher increase than expected. Fuel costs also rose significantly. Despite these challenges, EBIT margins improved due to strong international unit revenues from passenger traffic and cargo. However, concerns remain about the sustainability of this strength.
FY2024 Guidance and Market Reactions
Japan Airlines’ FY2024 guidance forecasts nearly 17% revenue growth and a 15.1% increase in costs, indicating potential EBIT margin expansion. However, international and domestic revenue growth projections exceed capacity growth, raising questions about the sustainability of demand.
Investment Thesis and Valuation
Despite the stock’s 20% decline while the S&P 500 gained 15%, Japan Airlines remains a buy with a 31% upside. The reasons for maintaining this rating include:
- Stronger-than-expected FY2023 EBITDA: This results in an 8% higher total EBITDA for 2023-2027, despite a 30% reduction in free cash flow generation due to fleet renewal needs.
- Valuation: Japan Airlines trades below its median EV/EBITDA valuation, which is already discounted compared to peers.
- Increased Relative Upside: The stock price decrease, combined with stable EBITDA estimates, creates an attractive reward for investors.
Conclusion
Japan Airlines offers an intriguing investment opportunity with a significant upside. However, it is not without risks, including slower-than-expected demand recovery, market weaknesses, and volatility inherent in the airline industry. For investors willing to navigate these challenges, Japan Airlines’ stock presents a promising investment case, given its undervaluation and potential for revenue growth and margin expansion.
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