Japan Airlines: Why I Remain Bullish (OTCMKTS:JAPSY)

Japan Airlines released its FY2023 financial results in May 2024. Analyzing the financial results and forward guidance is always interesting, and I believe that given the Japan Airlines (OTCPK:JAPSY) (OTCPK:JPNRF) stock performance, assessing the results is even more important. In February, I upgraded Japan Airlines stock from hold to buy, but that buy rating has not worked out at all. The stock lost nearly 20% while the S&P 500 gained nearly 15%. Those are not returns to be proud of and warrant a review of the rating.

Japan Airlines Earnings Point At Some Challenging Developments

Total revenues grew 20.1% year-on-year and 19.2% compared to FY2019, with capacity being 2% higher compared to FY2019 and 16.6% year-on-year. Full Service Carrier revenues grew 17.5% compared to FY2019 and this was driven by 17.2% growth in international passenger revenues on a capacity recovery of little over 85% compared to the pre-pandemic setting from January 2019 through December 2019. Domestic passenger revenues were 0.6% lower, with a little over 96% of the capacity recovered. Those results point to significantly higher unit revenues in the international passenger segment and 3.2% higher unit revenues in the domestic segment.

The cargo business saw revenues decrease 40.7% year-on-year as more freight capacity is coming online and demand is on the softer side. Nevertheless, the revenues are still 45.5% higher than in FY2019, driven by higher unit revenues. The LCC business has no pre-pandemic comparable period, but since this is basically a fresh arm of operations for Japan Airlines, it also does make sense to look at sequential improvement rather than year-over-three or any pre-pandemic comparison. Year-on-year revenues grew nearly 120% with Zipair, the long-haul arm of the LCC operations, achieving 140.9% revenue growth on a 70.7% expansion in capacity while Spring Japan saw revenue growth of 61.1% on capacity expansion of 69.3%.

Putting it all together, the international part of the business saw strong growth and the domestic part also saw growth but a lot softer. Full Service passenger revenues were up 28% compared to FY19 and 49.1% sequentially on 12.2% and 24.4% growth in capacity. Interesting to note is that capacity in Europe and Asia/Oceania is down 14 to 15 percent, but revenues are up by around a third. China and Hawaiian operations are down a third to 40 percent in terms of capacity and in terms of revenues that means 14 to 24 percent lower revenues in those markets. The highlight in the operations seems to be long-haul America operations, with an 8.1% higher capacity and nearly 60% growth in revenues. So, the operational performance is quite uneven per geographic segment

The overall capacity growth was 1.9% with 19.2% growth in revenue. That indicates strong unit revenues driven by the international business. Focusing on the cost side, we see ex-fuel costs increased 11.3% which exceeds the 8.7% inflation and coupled with capacity expansion the increase was 52 bps higher than expected. So, we can’t really say that there is extremely strong cost control, and the year-on-year numbers show pretty much the same. Besides that, fuel costs have increased significantly. The reason why EBIT margins have improved is because the international unit revenues on passenger traffic as well as cargo have held up well so far. However, one can wonder whether that will remain the case.

We probably also should not be extremely surprised that Japan Airlines stock is down. Questions on how long the strength in international unit revenues will remain are lingering in the industry and in its FY2023 presentation it also became clear that international passenger demand had been 300 bps weaker than expected with revenue per passenger being up slightly less than anticipated. On the domestic market, the demand recovery fell short by 200 bps, but there was a bit of a positive sign in better than planned pricing.

Japan Airlines Guidance Shows Continued Strength

For FY2024, we see that nearly 17% in revenue growth is expected while costs are expected to grow 15.1% pointing at EBIT margin expansion. That is obviously a good indication if true. However, it should be noted that on international and domestic revenues the company is guiding for revenue growth in excess of capacity growth while we saw that demand in the fourth quarter of FY23 was below expectations.

Japan Airlines Stock Is Still A Buy

While going through the financial results and while writing this report, I expected that I would have to downgrade the stock back to Hold. However, after carefully implementing the balance sheet data and forward projections, I believe that the stock is still a buy with 31% upside. There are various reasons why the stock remains a buy. The first one is that FY2023 EBITDA came in stronger than expected, which results in the total EBITDA in the 2023-2027 timeframe to be around 8% higher. This is offset by a reduction in free cash flow generation, which is now expected to be 30% lower than initially expected due to the continued need for fleet renewal. With significant delays in aircraft deliveries from Boeing (BA) and Airbus (OTCPK:EADSF), there could be some positive impact on the CapEx.

The second reason for maintaining the buy rating is that Japan Airlines trades below its median EV/EBITDA valuation, which is a valuation multiple that is already discounted to peers. The third reason why I am maintaining my buy rating is because the upside is higher than the 19% I previously saw. That is because the stock price has decreased and while the stock price has decreased, analyst estimates for EBITDA have held up pretty well, potentially creating an attractive reward for investors. It should be noted that the price target has been dropped from $11.29 to $10.32. So the increase in relative upside is mostly driven by the reduction in stock prices.

Conclusion: Japan Airlines Stock Provides An Interesting Investment Case

I believe that Japan Airlines provides a very interesting investment case. It is, however, not a straightforward investment in the sense that there are many complicating factors. For instance, we saw that demand has recovered slower than expected in Q4 FY23 and that puts some question marks behind the FY24 guidance that has been provided. Furthermore, we see weakness in the markets for travel to China and Hawaii and domestic results that could eventually plateau. The brighter spots in the market are the continued expected strength in international unit revenues and the results achieved in the US market, as well as the growth in the low-class carrier segment. So, there is a lot to be cautious about, but also a lot to be positive about. Given that Japan Airlines trades below its median EV/EBITDA as well as the industry EV/EBITDA, I believe it is worth the investment for investors that can stomach the volatility that investment in the airline industry is plagued by.

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