Shares in FTSE 100 budget airline easyJet (LSE: EZJ) are down 17% from their 10 April 12-month traded high of £5.90.
Such a drop may signal a bargain to be had. So I took a closer look to ascertain whether it is.
Are the shares undervalued?
On the price-to-book ratio, easy Jet currently trades at just 1.3 against a peer average of 2.9. These comprise Jet2 and Southwest Airlines at 1.8, International Consolidated Airlines Group at 3.9, and Wizz Air at 4.
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So easyJet looks very undervalued on this key measure that I have trusted for over 35 years of private investment.
The same is true on the price-to-sales ratio, with easyJet at 0.4 compared to its competitor average of 0.5.
However, it looks overvalued on the price-to-earnings ratio at 8.4 against a 6.1 peer average.
To get to the bottom of the valuation, I ran a discounted cash flow analysis using other analysts’ figures and my own. This examines whether a share seems undervalued compared to where it should be, based on future cash flow forecasts.
This analysis shows easyJet shares are technically 63% undervalued at their current £4.88 level. So the fair value for the stock is £13.19, although market unpredictability may push it lower or higher than that.
What are the higher valuation catalysts?
I see the key risk to its valuation being the intense competition in the airline sector that may squeeze its earnings.
That said, analysts’ forecast easyJet’s earnings will increase by 9.3% each year to the end of 2027. And it is this growth that ultimately powers a firm’s share price higher over time.
In easyJet’s case, such bullishness looks well founded in its full-year 2024 results. Profit before tax soared 34% to £610m from £455m for the UK’s biggest budget airline. And headline profit before tax per seat jumped 24% to £6.08 from £4.91.
The airline forecasts capacity growth for full-year 2025 of around 3%. And it projects about 25% growth in holiday customer numbers over the year, from a base of 2.5m.
I think an additional boost for its earnings should come from a significant increase in its presence in Italy. On 11 December, the European Commission granted easyJet five additional planes at Milan’s Linate airport and three at Rome’s Fiumicino. This will take the airline’s country total to 38, making Italy its second-largest market after the UK.
Will I buy the shares?
A key to investing in my experience is to realise where one is in the investment cycle and to buy stocks appropriate to that.
I am aged over 50 now, so am at the later part of my investment cycle. Consequently, I am focused on shares that generate a very high dividend income for me. This should allow me to continue to reduce my working commitments.
EasyJet currently delivers an annual yield of 2.4% compared to the near-9% I get from my dividend income stocks. So it is not for me at my point in the cycle.
However, if I were even 10 years younger, I would be strongly tempted to buy it based on its strong earnings growth potential. This should drive its share price (and dividend) much higher in the coming years, in my view.
