The easyJet (LSE: EZJ) share price has risen by 50% in just two weeks. Investors appear to be piling on board as the airline prepares to restart operations on 15 June.
Thursday’s news of planned job cuts and fleet reductions gave the stock another boost. But with the shares rising so quickly, are they now fully priced? I’ve been taking a fresh look at the potential value of the business.
Big changes ahead
easyJet boss Johan Lundgren says he believes passenger numbers won’t return to 2019 levels until 2023. That may be true, but I suspect he’s also using the coronavirus lockdown as an excuse to make sweeping cuts at the airline. These should help to lift easyJet’s profit margins (and share price) when market conditions improve.
The number of aircraft in easyJet’s fleet will fall to 302 by the end of 2021, 15% below the previously-planned level of 353. The airline is confident its agreement with Airbus will provide the flexibility it needs to shrink its fleet.
Staff face even bigger cuts. Up to 30% of the airline’s employees could lose their jobs, due to fewer aircraft and changes to working practices. Such massive cuts would be hard to push through in more normal times. But with the airline industry on its knees, I suspect Lundgren will get an easier ride from unions representing aircrew.
Is the easyJet share price too low?
I’ve made some rough calculations to see what I think this business might be worth in a year’s time, assuming conditions return to something like normal from October onwards.
I’ve assumed the airline’s load factor (the percentage of seats sold on each flight) will fall to 85%. And I’ve guessed easyJet’s operating margin might fall slightly to 7%. I’ve also factored in a reduction in fleet size from the numbers reported for 2018/19 (the latest available).
On this basis, I estimate easyJet could generate revenue of about £5bn over the 12 months from 1 October. This could give an after-tax profit of around £280m, or earnings per share of about 70p.
Funnily enough, my estimates are pretty close to the latest City forecasts, which suggest an after-tax profit of £304m and earnings per share of 66p in 2020/21.
At the last-seen easyJet share price of 720p, these forecasts value its shares at around 11 times 2020/21 forecast earnings. Should we be buying?
Buy, sell, or hold?
In general, a price/earnings ratio of 11 would suggest decent value. But I think there are a few reasons to be cautious at this time.
Firstly, easyJet is likely to emerge from this crisis with a significant amount of extra debt. The company has secured £2bn of extra borrowing to see it through the pandemic, although we don’t know how much of this will be needed. Management also plans to sell and leaseback some aircraft, adding to future leasing payments.
Secondly, we don’t know how quickly flying schedules and passenger numbers will return to normal.
At a share price of 500p, I thought easyJet shares were probably cheap. Two weeks later, at about 720p, I think the stock looks fully priced.
As a long-term investor, I’d continue to hold easyJet stock at current levels. But I wouldn’t buy more right now.
