Airline stocks have delivered big gains over the last few years. But is the market reaching a turning point?
In this article I’ll look at the investment case for three popular aviation stocks.
Shares in aircraft leasing firm Avation (LSE: AVAP) slipped nearly 5% lower on Friday morning, despite the group announcing a 14% increase in revenue for the first half of the year.
One problem may be that the costs of Avation’s debt pile are starting to eat into the firm’s profits. Pre-tax profit for the half year fell to $5.6m, a 20% drop from $7m in 2014.
The reason for the drop is that Avation’s six-monthly interest costs rose by 50% to $12.2m during the last six months. This was due to $100m of new loans in May 2015, which took the firm’s total net debt to $409m.
It’s an interesting situation, because Avation’s core business seems very profitable. The firm generated an operating profit of $17.9m on revenue of $31.5m during the first half of the year. This gives an operating margin of 57%. The problem is that two-thirds of this operating profit was consumed by interest payments.
Avation says that additional lease revenue from newly-acquired aircraft should boost takings during the second half of the year. But I’m concerned that any future dip in lease revenue could quickly cause problems for the firm.
I’m not convinced that Avation shares are the bargain suggested by their 2015/16 forecast P/E ratio of 6.3. When debt is factored-in, this business looks quite fully-priced, to me.
Dart Group (LSE: DTG) owns the Jet2 travel business and a major haulage company. Growth from Jet2 has been the main reason for the 470% rise in Dart’s share price since 2011.
Dart shares climbed 91% last year as the firm enjoyed a record summer season. However, current forecasts suggest that a repeat this year is unlikely. The latest City forecasts suggest that Dart’s earnings will fall from a record 52.1p per share for 2015/16, to 33.9p in 2016/17.
This gives a 2016/17 forecast P/E of 16.5, which looks high enough to me, given the uncertain outlook.
However, Dart does benefit from very low debt levels and good cash generation. The group has beaten expectations a number of times before and may do again. The shares are a solid hold, in my opinion.
Another airline share I like is easyJet (LSE: EZJ). The group reported an 8.1% increase in passenger numbers during the final quarter of last year and its load factor (how full each flight is) rose by 0.6% to 90.3%. This was despite the disruption caused by the Egypt and Paris terror attacks.
These are solid figures, but easyJet’s shares are now down by 20% from their 52-week high of 1,916p. I suspect that this is partly because of the market downturn, but also because investors are beginning to think that airline profits might be getting close to a cyclical peak.
Airlines are notoriously cyclical and the profit growth seen in recent years won’t continue forever. However, easyJet now trades on 10 times forecast earnings and offers a 4.1% yield. In my view this may be cheap enough to make the shares worth a closer look.
However, investors looking for big growth opportunities may need to look outside the transport sector, in my view.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.