Unlike many companies that face rises in the cost of production, airlines find it very difficult to pass on increased costs to consumers. That’s because airline consumers are relatively price elastic, meaning they focus on price above almost any other factor when deciding which airline to choose or, as the case may be, whether to fly at all.
So, the increasing cost of oil is definitely bad news for airlines such as EasyJet (LSE: EZJ), International Consolidated Airlines (LSE: IAG) and Thomas Cook (LSE: TCG) since it increases costs and does little to improve revenue.
Indeed, with unrest in the Middle East seemingly likely to continue in the short-term at least, how might the three companies fare in future? Could there be a buying opportunity amidst the present challenges they face?
Despite making a poor start to 2014 — its shares are down 6% while the FTSE 100 is up around 1% — EasyJet could prove to be a strong long-term investment. Not only are its shares relatively attractive at current levels following their price fall this year, they are expected to deliver strong growth over the next two years.
Indeed, while the FTSE 100 currently trades on a price to earnings (P/E) ratio of 14.2, EasyJet has a P/E of 12.6 and is forecast to grow earnings per share (EPS) by 13% in the current year and by 15% in the following year. Although its shares may be weak in the short run, they could prove to be winners over the medium to long term.
Although not exclusively an airline, the rising price of oil is also a major concern for Thomas Cook and is a key reason why shares have been weak of late. Of course, the company is only in the early stages of recovery after posting three successive years of losses. It is, however, forecast to return to profitability in the current year and, following that, is expected to deliver EPS growth of up to 50% next year.
Since its shares have fallen over 19% in 2014, they are fairly priced on a P/E of 12.4 and could prove to be good value, although there may be some lumps and bumps along the company’s road to recovery.
International Consolidated Airlines
An advantage that International Consolidated Airlines has over Thomas Cook and EasyJet is that its customers are less price sensitive. In other words, while price is important to them, International Consolidated Airlines’ customers look for more than just the cheapest fare and instead take into account reputation and perceived quality, too. Therefore, International Consolidated Airlines may be better shielded from the rising price of oil than its competitors and, ultimately, may be hit less hard by a rising oil price.
As with EasyJet and Thomas Cook, shares in International Consolidated Airlines appear to be good value on a P/E of 12 and are forecast to deliver double-digit earnings growth both in the current year and next year.
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Peter does not own shares in EasyJet, Thomas Cook or International Consolidated Airlines.