This airline’s unjustifiably low valuation will correct – but prepare for turbulence
Inflation is less of a concern than ever for this airline as holidays shift from luxury to staple
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The near-term prospects of easyJet are highly uncertain. The FTSE 100-listed budget airline faces a tough operating outlook over the coming months largely due to growing pressure on disposable incomes. Although wages continue to rise at a faster pace than inflation, and have done continuously since April 2023, it would be wholly unsurprising if their positive real-terms growth comes to an end.
After all, inflation is due to reach 3.7pc later this year. This is likely to prompt a degree of caution from the Bank of England regarding further interest rate cuts that means wage growth could stall and the cost-of-living crisis may come sharply back into focus. In turn, this could cause consumers to cut back on their discretionary spending.
The airline, however, is well placed to weather a period of elevated uncertainty. It has a net cash position of £181m and access to over £5bn of liquidity, should it be required. Moreover, its status as a low-cost carrier and increasing exposure to budget-friendly package holidays mean it may benefit from consumers trading down to cheaper alternatives. With an annual holiday viewed these days more akin to a staple, rather than discretionary, item by many consumers, demand for the firm’s products and services could prove to be more robust than many investors currently anticipate.
Indeed, in Questor’s view, the stock market’s valuation of easyJet remains unjustifiably low. It currently trades on a price-to-earnings ratio of just eight at a time when the FTSE 100 index is close to an all-time high. Furthermore, the company’s earnings are expected to grow at a double-digit annualised rate over the next two financial years. Its discounted share price therefore suggests that it offers a wide margin of safety, with scope for significant capital growth over the coming years.
The company’s latest trading update showed that it is making solid overall progress. Although it made a pre-tax loss of £61m in the first quarter of its current financial year, this represented an improvement of £65m on the same period of the previous year. Its reduction was partly driven by passenger growth of 7pc, with seat capacity rising by 5pc and load factor up by two percentage points year on year to 88pc.
The firm’s financial performance was also boosted by a growing contribution from its package holidays division. Its profits rose by 39pc to £43m, with the company expecting customer numbers for its package holidays segment to rise by 25pc for the full year. Overall, the firm still expects to generate £1bn of total annual pre-tax profits over the medium term. If met, this would represent a 64pc increase versus its most recent financial year.
Its chances of meeting that goal are set to be bolstered by falling inflation and interest rate cuts over the coming years. Although increasingly rapid price rises and a continued restrictive monetary policy may work against the company in the short run, ultimately inflation is set to meet the Bank of England’s 2pc target over the medium term. This should provide scope for sustained interest rate cuts that encourage positive real-terms wage growth. In turn, this is likely to prompt higher demand for leisure travel and improved operating conditions for easyJet.
Of course, the stock’s price is likely to remain volatile in the meantime as uncertainty continues to dominate the wider travel and leisure sector. Questor, therefore, does not necessarily anticipate a fast-paced recovery following its 13pc decline since the start of the year, nor do we expect the hugely disappointing 66pc capital loss since the company was tipped as a ‘buy’ in this column during July 2017 to quickly be reversed.
Over the long run, though, we are optimistic about easyJet’s capacity to deliver strong absolute and relative share price performance. Its wide margin of safety suggests there is scope for significant capital gains, with the firm’s medium-term £1bn annual pre-tax profit goal having the potential to act as a significant catalyst.
When combined with the company’s solid financial position, increasing exposure to package holidays and status as a budget carrier, all of which mean it is well placed to overcome potential near-term difficulties, the stock’s risk/reward ratio remains attractive.
Questor says: buyTicker: EZJShare price at close: 484.8p
Read the latest Questor column on telegraph.co.uk every weekday at 5am. Read Questor’s rules of investment before you follow our tips.
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