easyJet (LSE:EZJ) shares are up 33% since the start of the year. Resurgent travel demand has also boosted shares in International Consolidated Airlines Group (LSE:IAG), which are up 25% year-to-date.
Investing well is about looking past cyclical fluctuations though, and towards the long-term trend. So for an investor with an eye on 2030 and beyond, which is the better stock to buy today?
Consolidation
At the moment, European air travel is a very competitive industry. A race to the bottom in terms of pricing causes most participants to earn poor returns on investments in capital-intensive operations.
By contrast, the US market is much more consolidated. It’s dominated by four main carriers – Delta, American Airlines, United Airlines and Southwest.
This results in lower competition and better returns for each of the main participants. And according to Ryanair CEO Michael O’Leary, something similar is on the way for the European market.
In O’Leary’s view, European air travel is likely to consolidate down to IAG, Air France-KLM, Deutsche Lufthansa, and Ryanair. In the process, easyJet gets acquired by IAG or Air France.
If this happens, investors in both businesses stand to benefit. But I think easyJet’s shareholders would be in a better position.
easyJet vs IAG
It’s absolutely possible that O’Leary’s anticipated consolidation won’t happen. And if it doesn’t, the current economics of air travel mean both businesses may well generate mediocre returns.
But the possibility of a less competitive environment is positive for both companies. In the case of IAG, it should allow it to earn better returns on its investments.
For easyJet, being acquired by a larger carrier – whether IAG or anyone else – could give investors a decent payday. Furthermore, I would expect any deal to involve payment in stock, rather than cash.
That means easyJet shareholders are likely to become owners in the resulting business. And they would therefore stand to benefit from the improved economics that consolidation brings on.
As a result, I see easyJet shares as a better bet from an investment perspective. I think the long-term prospects are broadly similar, but easyJet comes with a short-term upside potential.
Warren Buffett
When analysing airlines, there’s always a big elephant in the room. Warren Buffett has long been sceptical of airlines as investments and pointed to their poor returns as justification for this.
Nonetheless, the Berkshire Hathaway CEO invested in each of the major US airlines in 2016. In my view, this is likely the result of the industry consolidating down to those four companies.
Investing in airlines is risky, as Covid-19 demonstrated for Buffett. But if the European market consolidates – as Michael O’Leary believes it will – then easyJet and IAG could be great investments.
I wouldn’t buy easyJet shares just because of the possibility of a buyout. But combined with the prospect of more favourable long-term unit economics, I think the stock might be attractive.
