Edmond Jackson's Stockwatch: Flybe dependent on successful UK turnaround

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FTSE Fledgling index-listed low-cost airline Flybe is one of the more exposed companies to the UK and European economies.

It can be a share to play the economic recovery, but needs consumer and business spending to steadily improve so it can reap the full potential rewards from its turnaround programme.

After a plunge from 342p following flotation in 2011 to a low around 40p last springtime, July's appointment of an ex-chief commercial officer of easyJet as the new boss has helped the price recover to 117p.

Despite these being early months with the turnaround it is worth following after the interim results to end-September 2013 showed a £1.6 million like-for-like loss turn into £13.8 million pre-tax profit for interim earnings per share of 18.1p.

Since only 75.2 million shares are issued, a swing to profits quickly impacts earnings and also brings down the price/earnings multiple. Mind that one set of results is just a snapshot.

July's appointment of Saad Hammad as chief executive was "as good as it gets", his being credited as the architect behind easyJet's transformation into one of Europe's most successful airlines.

It may have benefited from the international elite relocating to London yet still needing (and being affluent) to jet around Europe. Anyone using easyJet can see how busy the airline has become and its prices increased with little effect on demand despite times of "austerity".

Certainly easyJet has made its own luck by improving operations and a question surrounding Flybe is what extent similar factors apply to this airline's goal.

The 90-minute airline

The vision is to become "the 90-minute airline" connecting regional cities throughout Europe, also helping people access international carriers at major airports.

A current 10 locations across the UK from London Gatwick, for example, are not extensive compared with the options via rail; but such links could work well for longer distances by reducing time involved; and if oil prices continue to fall as expected then this should help contain costs - versus trains where ticket prices keep rising to cope with investment needs.

On the other hand, there may be a limit to the number of people prepared to travel in some of Flybe's small, propeller-driven planes; and there are anecdotal customer protests online about reliability, e.g. flights being merged into later ones "for operational reasons". So mind the customer experiences.

Yet the numbers suggest good potential. In 2012, Flybe had just a 6% share of total UK passengers but it was 12% in the regions and its share of domestic passengers was 26%.

Outside London it enjoyed a 47% share of the domestic market, being the leading airline at Southampton, Exeter, Belfast City, Birmingham and Manchester; and second at Glasgow.

So you can appreciate a key reason why Hammad judged it worth taking up the challenge and it will be interesting to see how these figures evolve.

Pro-active online marketing

Showing how pro-active Flybe's marketing is: I have only once visited its website but (presumably) its tracker cookies now prompt me to buy flights with advertisements on most web pages I am visiting; also with a post via Facebook to buy a Gatwick to Inverness flight.

Are they tracking my interest in mountains and other Scottish links? They are certainly adept online.

A unified, low-cost operation must still be achieved for this airline to be long-term viable: its workforce has been cut by around 600 to 850 with another 500 job cuts underway. Constructive progress has been reported with trade unions, probably because they see no alternative.

The first two phases are expected to deliver £40 million savings this year and £45 million in 2014/15. Mind the exceptional costs in achieving this: £14 million this financial year and £27 million in 2014/15.

The end-September balance sheet is also a risk factor: it has benefited from disposals of aircraft and slots, such that net debt fell from £66 million last March to £34 million. A gross cash balance of £64 million includes £45 million restricted cash, which is not clarified as to exactly what might benefit the business.

Adjusted net debt including capitalised operating leases was about £680 million versus £50 million equity. So the shares are exposed to potential fears about rising interest rates.

Static revenues despite passenger growth

Revenues on the main UK side are effectively static, with 1.3% "growth" to £328.2 million during the six months to end-September, despite 5.6% growth in passenger numbers to 4.3 million.

A Finnish joint venture enjoyed 127% revenue growth to £162.2 million, helping overall revenue rise by 20.4% to £477.3 million. The group has other smaller businesses but the main question is how successful the UK turnaround proves; then how new routes can evolve to connect cities, also on the Continent.

Forecasts are hard to make and find, so the rally has likely benefited from a more buoyant mood in markets hence an instinct to "buy the story".

Flybe is "high risk/reward": capitalised at £90 million versus potentially £1 billion turnover a few years' hence, if the strategy succeeds, it offers an attractive price-to-sales ratio to wrest substantial earnings - so long as costs are transformed.

Since the shares may already have attracted rather footloose money, dips are possible and worth watching for.

For more information see flybe.com.