The easyJet (LSE:EZJ) share price dropped like a stone last week and the stock plunged by over 10% in a single day. I think it’s fair to say the past 18 months haven’t been too kind to this business. The pandemic forced travel restrictions that saw its airplanes grounded for most of last year. And even today, flights remain far below maximum capacity. But overall, it seems things are improving. So, what’s behind the stock’s most recent tumble? Let’s look at what’s going on and see if this is a buying opportunity for me.
Sharp drop in the easyJet share price
When shares fall suddenly, it’s typically triggered by a less than satisfactory earnings report. But in the case of easyJet, the situation is a bit different. Firstly, the firm had been approached by a competitor for a potential buyout. There’s little information available regarding this possible acquisition offer. But the management team announced that it was “highly conditional” and “fundamentally undervalued” the company. So, it was rejected outright.
But to raise additional capital to fuel its long-term growth strategy, easyJet has announced a £1.2bn rights issue. In other words, it’s issuing new shares, triggering an enormous dilution effect. Existing shareholders will have the right to buy an additional 31 shares for every 47 they own at a discounted price of 410p.
Before the recent drop in the easyJet share price, this discount represented a 50% reduction. That certainly sounds like a good deal, except when considering that the rights issue is triggering a roughly 40% dilution effect for those unwilling to increase their stake. So, I’m not surprised to see investors close their positions before this happens.
As unpleasant as the dilution effect can be, it’s important to remember that it also provides an increase in usable capital for easyJet. The management team intends to use the raised funds to take advantage of various investment opportunities within the travel sector now that the effects of the pandemic are beginning to wear off.
Looking at the prospectus, easyJet aims to continue upgrading its fleet to the next generation of aircraft. These planes are estimated to be approximately 15% more fuel-efficient and 50% quieter during take-off and landing. Besides the lower impact on the environment, the fall in fuel consumption will likely translate into lower operating costs.
What’s more, management intends to continue expanding its ancillary offerings like easyJet Holidays to improve the average revenue per seat on each flight. Given that aviation experts have predicted pre-pandemic flight capacity won’t fully recover until as late as 2023, this pursuit of alternative revenue growth sounds like a prudent move. At least, I think so.
The bottom line
All things considered, easyJet continues to look like a recovering business in a sector decimated by Covid-19. Personally, the spending plan proposed by management for the rights issue looks credible and, more importantly, sensible.
Having said that, I won’t be adding any shares to my portfolio today. That’s simply because I think there are better opportunities to be found elsewhere.
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Zaven Boyrazian 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.