Can the easyJet share price recover from last week’s crash?

The easyJet share price has fallen by 40% from the highs seen in May. Roland Head explains why he thinks the airline cold now be a takeover target.

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After crashing last week, the easyJet (LSE: EZJ) share price has fallen by 40% from the 922p high seen in May.

Last week’s decision to raise £1.2bn by selling new shares in a rights issue surprised me and seems to have taken the market by surprise too. This popular airline is now starting to look like a takeover target to me. I’ve been taking a closer look to see if I should consider buying easyJet shares.

Will takeover hopes lift EZJ?

Alongside last week’s cash call, easyJet slipped in another bombshell. The orange-topped airline said it had received a takeover offer from an unnamed rival. The offer was rejected by easyJet’s board. But the unsuccessful bidder has since been widely reported as FTSE 250 rival Wizz Air.

I think that easyJet is probably still in play as a potential takeover target. The airline’s mid-cost approach means that it’s in danger of being squeezed between ultra-low-cost operators like Wizz and Ryanair, and higher-cost flag carriers like British Airways. To rebuild its share price, I think easyJet will need to expand more aggressively.

easyJet CEO Johan Lundgren has already said publicly that he expects to see merger activity in the European airline sector as we exit the pandemic. In my view, this is probably one reason why easyJet decided to raise so much cash.

By cutting debt now, easyJet should be safer from lowball bids. Having more cash on hand could also allow the group to explore expansion opportunities itself.

Turnaround expert takes charge

easyJet’s decision to hold a rights issue comes less than a month after the group appointed a new chairman, Stephen Hester. 

Hester is something of a turnaround specialist. If his name seems familiar, it’s probably because he was chief executive of Royal Bank of Scotland Group (now NatWest Group) after the 2008 financial crisis. He then became CEO at RSA Insurance, where he secured a takeover offer for the business.

Hester doesn’t take up the chair’s role until December, but he’s already on easyJet’s board as a non-executive director. I’d imagine that he was involved in the decision to raise cash.

Why the easyJet share price could stay low

Assuming that air travel returns to normal, what’s a fair price for easyJet shares? My approach to solving this problem is to start look at the airline’s pre-pandemic profits.

In both 2018 and 2019, easyJet reported an after-tax profit of about £350m.

My sums suggest that if the shares continue to trade around 555p, the airline will have a market cap of about £4.2bn after the rights issue.

That means that at the current share price, easyJet is trading on around 12 times historic earnings. In my view, that’s probably high enough until we see signs of a stronger recovery.

I don’t expect easyJet shares to rise quickly from current levels. But Lundgren has been on a serious cost cutting drive over the last year. It’s possible that when air travel returns to normal, these changes will make the airline more profitable than it was in the past. This might justify a higher valuation in the future.

I’m not buying easyJet shares yet. But I will be watching for a strategy update when Hester takes charge later this year.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Wizz Air Holdings. 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.

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