2016 has been something of an annus horribilis for easyJet (LSE: EZJ) as shares of the UK?s leading budget airline have plummeted a whopping 44% since the beginning of January. With shares trading at 9.35 times trailing earnings and a dividend yield topping 11% value investors will certainly be circling like sharks in the water. But, the first question they must ask themselves is whether 2017 will be any better than 2016 for the budget airline.
Personally, I have my doubts. The reason isn?t the obvious answer of Brexit or the weak pound, but rather a more systemic problem that…
2016 has been something of an annus horribilis for easyJet (LSE: EZJ) as shares of the UK’s leading budget airline have plummeted a whopping 44% since the beginning of January. With shares trading at 9.35 times trailing earnings and a dividend yield topping 11% value investors will certainly be circling like sharks in the water. But, the first question they must ask themselves is whether 2017 will be any better than 2016 for the budget airline.
Personally, I have my doubts. The reason isn’t the obvious answer of Brexit or the weak pound, but rather a more systemic problem that has haunted the airline industry for its entire history. That, of course, is the boom and bust nature of a sector where major players increase supply exponentially during the good years only for this optimism to bite them in the behind when cyclical demand inevitably falls.
The American airline industry appears to have learnt from previous mistakes and through industry consolidation and, as some in the Department of Justice believe, collusion, have kept supply growth manageable and prices high. The bad news for easyJet is that the European budget airline sector has done anything but correct prior mistakes. In the year ahead it’s planning to up capacity by 9%, Ryanair expects 11% more customers and Wizz Air is increasing capacity by 18%-20%.
Meanwhile, demand growth is slowing due to terrorism fears, a sluggish EU economy and the weak pound leading to fewer overseas trips by Brits. It doesn’t take a maths genius to work out that supply growth outstripping demand growth will lead to price wars. Indeed, over the past year, easyJet’s revenue per seat, a key industry metric, fell 6.4% year-on-year. This problem will only grow worse in 2017, and with dividends tied to falling earnings, both growth and income investors are likely to feel the pain in the coming year.
2016 has been slightly kinder to clothing retailer Next (LSE: NXT), whose shares are down only 34%. While Next is still solidly profitable, the company has been battered by the broader industry trend of falling footfall at physical stores. Profits from these retail locations fell 16.8% year-on-year in the first six months of the year as Next resorted to deep discounting to lure shoppers into stores.
The second, and more worrying, headwind is slowing sales growth from the brand’ s online directory business. In the nine months through the end of September full-price sales from this segment increased a mere 3.2% year-on-year, which hasn’t been enough to compensate for much larger decreases from retail sales. This led to management to issue a profit warning in November and lower full-year sales and profit guidance.
After the dramatic reversal in prices so far this year, shares are looking quite cheap at 11 times forward earnings with a 3.3% yield forecast for 2017. This does mean shares could see a pop as value investors snap up what is still a profitable company with a well-covered dividend and healthy balance sheet. But, unless management can prove that the slide in retail sales can be halted and growth picks back up from the directory business, I don’t expect share prices to rocket back to previous highs in 2017.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.