Interactive Investor

Is easyJet profit crash in the price?

15th November 2016 13:50

Harriet Mann from interactive investor

There's been a common theme dominating budget airline accounts these past few years: turbulence. Tragic terrorist attacks, disruptive strike action and infrastructure issues at Gatwick caused a slump in profit and triggered dividend cuts, made worse by sterling's depreciation post the EU referendum.

But a diving share price now means low-cost carrier easyJet offers a prospective dividend yield of 5.2%, and there has been decent progress behind the scenes. And, after significantly underperforming rival Ryanair, is the sell-off overdone?

External events weighed on easyJet's 2016 earnings, with total turnover down 0.4% to £4.7 billion and revenue per seat sliding 6.4% to £58.46. Fierce competition and increased capacity have forced ticket prices lower, while terror events in Paris, Egypt, Brussels, Nice and Turkey, and higher holiday costs after the EU referendum have cooled demand.

Pre-tax profit crashed 28% to £495 million in the year to 30 September, hurt by weaker revenue and a £112 million foreign exchange hit. In all, easyJet estimates that terrorism and the Brexit vote cost it £150 million of profit.

As cheaper fuel costs offset post-referendum sterling's slump, cost per seat improved 2% to £52.26 in 2016. Strip out the fuel sweetener and cost per seat increased 2.6% to £38.31 - slightly ahead of target.

Thanks to hedging, easyJet's annual fuel bill is expected to decline by £245-275 million in the year to September 2017. Passing that on to customers is tipped to trigger a mid-to-high single-digit decline in revenue per seat during the first half.

Basic earnings per share fell 22% to 108.7p and, as management pay out half of pre-tax profits to shareholders each year, the dividend is reduced by 2.5% to 53.8p. Return on capital employed is down 7.6 percentage points to 14.6% - viewed as still "respectable" by broker Panmure Gordon. Net cash more-than halved to £434 million.

Despite these challenging markets, passenger numbers rose 6.6% to a record 73.1 million, and the load factor rose 10 basis points to a best-ever 91.6%. This might not seem like much, but the company did expand capacity by 6.5% to 80 million seats at the same time. Over the next six months, capacity will jump by another 9%.

Nearly half of easyJet's growth will come from the UK next year, where it currently has 20% of the market, helped by momentum in Switzerland, France and Italy. Management pencils in double-digit growth for London, Manchester, Venice, Berlin and Amsterdam, as it looks to beef up its presence in key airports.

"Looking ahead, the easyJet model remains strong, as does the demand environment and we continue to see opportunities in the medium term to grow revenue, profit and shareholder returns," says chief executive Carolyn McCall.

"In a tougher operating environment strong airlines like easyJet will get stronger and we will build on our already well-established network."

Tough winter, crucial summer

Numis Securities reckons pre-tax profit will fall even further in 2017, down to £400 million as costs rise by 1% due to timing differences, and as the airline continues to invest. Although easyJet will come up against easier comparatives with it being the anniversary of the Paris attacks, it must deliver in the crucial summer trading period.

"The summer remains somewhat distant and, as ever, remains key. It will be a tough winter," warns Numis analyst Wyn Ellis.

The shares look cheap on traditional PE valuations of 13.5 times for projected 2017 profits"EZJ continues to see growth opportunities and plans to grow at capacity at c.9% in the short-to-medium term: this is slightly ahead of our forecast of c.8% for FY 2017.

"We see this as a sign of management's confidence, but the market may have some concerns. We await a better buying opportunity."

Climbing over 5% to 1,085p Tuesday, easyJet has surged by a quarter since mid-October. However, put in context, the shares had more than halved since the beginning of 2015, crashing 36% straight after the Brexit vote and now changing hands 44% below 2015 highs.

It looks like a lot of bad news is already baked in, but, with a 1,050p target price, Ellis rates the shares just a 'hold'.

The shares look relatively cheap on traditional price/earnings (PE) valuations of 13.5 times for projected 2017 profits, dropping to just 10 times the 108p forecast by Numis for 2018, although the forecast dividend yield for next year shrinks to 3.9%.

That pick-up in earnings tipped to occur in 2018 would be good news for income seekers; it is certainly something major shareholder Stelios Haji-Ioannou will expect. He and fellow investors will hope management confidence is not misplaced.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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