The FTSE 100 closed at a record high of 7,787 on Thursday night, helped by the price of Brent Crude oil hitting $80 for the first time since 2014.
It’s good news for investors in oil stocks and index-tracking funds, but it isn’t good news for all firms. Higher oil prices mean rising fuel prices. And that could hit transport business such as airline group easyJet (LSE: EZJ).
The shares could keep rising
So far there’s no sign of trouble. easyJet shares have climbed 10% in the last month alone. They’re now at a level last seen at the start of 2016, when oil briefly dropped below $30 per barrel.
One reason for this strong performance is that easyJet has already secured fixed prices on much of its fuel for the next 18 months. The company has hedged 76% of its fuel for the six months to 30 September 2018, and 56% of its fuel for the year to 30 September 2019.
Based on current fuel prices, I estimate that these hedging contracts will allow the airline to buy fuel at around 25% below the current market price.
The business is also still growing strongly. Passenger capacity rose by 7.8% during the six months to 31 March, but despite this growth, the airline’s load factor rose by 0.9% to 91.1%. Load factor is a measure of how many seats are sold — more than 90% is very good indeed.
I’d keep buying
The airline’s cost per seat excluding fuel rose by 1.6% to £43.11 during the first half, excluding currency effects. But revenue per seat rose by 8.3% to £54.10 over the same period, suggesting that easyJet’s pricing power remains quite strong.
Analysts expect the group’s earnings to rise by a 29% to 107.1p per share this year, as recent expansion adds profits to the bottom line. Similar growth is expected next year. With the shares trading on 16 times forward earnings and offering a 2.9% dividend yield, I believe easyJet remains a buy.
A potential bargain?
Fast-growing budget airlines have delivered strong returns for investors. But they’re not the only choice. British Airways owner International Consolidated Airlines Group (LSE: IAG) has also performed well in recent years, but its share price has lagged behind.
I can see several possible reasons for this. Competing in short haul is becoming tougher for traditional airlines, which earn more of their profit from long haul and premium class tickets. These costly services depend more heavily on business travellers, so profits can fall fast during a recession. Another concern is that the budget airline model is starting to gain market share in the long haul market. This could push down economy ticket prices, squeezing profits further.
However, IAG is testing its own budget long haul offering and delivered a 19% increase in operating profit last year. This positive performance continued during the first quarter of this year, when adjusted operating profit rose by 75% to €280m, compared to €160m during Q1 2017.
This could still be a winner
I think that IAG remains attractive at current levels. Earnings are expected to rise by 6% to €1.09 per share this year, with similar growth pencilled in for 2019.
Based on these forecasts, the airline’s shares trade at just 7.2 times 2018 forecast earnings, with a 3.8% yield. I’d continue to rate the stock as a buy at this level.
