easyJet’s (LSE: EZJ) trading update shows that the company is enduring a very challenging period. It also shows that it’s responding positively to the difficulties it faces, but is now the right time to buy it?
easyJet’s passenger numbers reached a record 22m in the three months to 30 September. This included a strong load factor of 93.9%, with passengers benefitting from low fares across its network. In fact, revenue per seat has declined by 8.7% at constant currency as easyJet has invested in pricing in order to boost passenger numbers.
The reason behind reduced fares is a challenging operating environment. There has been major disruption, lower fuel costs encouraging greater competition from rivals and continued fear regarding terrorism. These factors have contributed to a difficult operating environment for all European airlines.
Stumped by sterling
However, perhaps the biggest material impact on easyJet’s financial performance comes from a weaker pound. Following the EU referendum on 23 June, the pound has dropped significantly against a basket of currencies including the euro and this is set to take its toll on easyJet’s reported financial numbers. It expects foreign exchange rate movements to have a £90m adverse impact compared to the financial year to 30 September.
Looking ahead, there’s little sign that the current situation will be reversed and easyJet’s near-term outlook is relatively uncertain. Although easyJet’s fuel bill is set to decline by between £75m and £85m in the second half of the year, overall its profitability is likely to fall over the medium term.
However, this provides it with an opportunity to build on its market share. It’s expected to increase capacity by 8% in the 2017 financial year and its status as a budget airline could help it to muscle in on more expensive peers such as British Airways owner IAG (LSE: IAG). That’s because if Europe endures a more difficult period and consumer spending is hit hard, budget airlines may prove popular as customers trade down to more affordable options.
Furthermore, easyJet and IAG both offer wide margins of safety that should protect their investors against further challenges ahead. easyJet has a price-to-earnings (P/E) ratio of 6.9, while IAG’s P/E ratio is 8. Both of these figures indicate upward rerating potential over the long term. In addition, easyJet offers a yield of 4.8% versus 1.8% for IAG. This highlights that easyJet continues to have income appeal even during an uncertain period.
In the long run, both IAG and easyJet should provide excellent shareholder returns. The airline industry is by its very nature cyclical and downturns such as this provide an opportunity for investors to buy both companies at a discount to their intrinsic values. With easyJet being cheaper and higher yielding than IAG, it’s the better option right now but both companies have bright long-term futures.
