A couple of weeks ago, I wrote a piece stating that I would buy airline stocks. Since then, each airline stock has risen sharply. easyJet (LSE: EZY) is one of these shares, and in the last two weeks, it has risen by around 65%. The shares have also doubled from their recent lows. This is due to the news that some flights will resume from 15 June. But while this is undoubtedly good news for the company, the airline industry is still having to deal with huge issues.
A second wave could cripple easyJet shares
A second coronavirus wave has seemed ever more likely in the UK, especially after the easing of lockdown rules. While a second wave would negatively affect the whole market, easyJet shares would be damaged disproportionately because of their reliance on the tourism industry. A forced return to grounding fleets would therefore be catastrophic for the budget airline. Even if easyJet could still run flights, I believe demand for air travel would be minimal at best due to consumer fears about the risks associated with flying in the ‘new normal’. Airlines are therefore hugely challenged.
Airline industry to be much less profitable?
Even if the UK is able to prevent a second wave, I still can’t see the airline industry thriving. Instead, I think it will become a significantly less profitable sector. For example, one of easyJet’s plans includes leaving the middle seat free on its planes. This would immediately reduce profits if ticket prices didn’t rise radically, thus damaging the price of easyJet shares. Costs will also rise due to having to disinfect the planes consistently. This will increase capital expenditures at the same time as operating cash flow is decreasing. And rather than ticket price rises, discounts will also be necessary in order to encourage more customers. In such a high expenditure industry, I expect that profit margins will therefore be very low over the next few years.
A rights issue may be necessary
If easyJet is in need of more cash to stay in business, there’s also the significant possibility of it launching a rights issue. This was speculated on by City analyst Mark Manduca, who thinks it’s likely easyJet may have to raise between £700m and £1bn. Issuing shares would probably be the way forward for the firm if it sought more cash and a rights issue could have a negative impact on easyJet shares overall. After all, more shares on the market dilutes the stock price.
So in the final analysis, I would avoid easyJet shares for the time being. Although this contradicts my previous article, I believe that the 65% rise since I wrote about the firm has left easyJet shares over-priced. I personally sold my stake in the airline recently because I believe that investors are now being too optimistic. They’re expecting the shares to fly, despite the many struggles airlines will have to face over the next few years.
Stuart Blair has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.