Shares in Ryanair Holdings (LSE: RYA), easyJet (LSE: EZJ) & International Airlines Group (LSE: IAG) have been seeing some turbulence in recent months, as investors begin to fear the sector may be nearing the top of its cycle.
But, here are 3 reasons to remain bullish:
Rising Passenger Numbers
Strong underlying fundamentals in the industry suggest there may be further gains to be made. Profitability is still growing, with margins widening as a robust UK economy and a stronger than expected recovery in the Eurozone is helping to boost demand for air travel.
In February, IAG, the owner of British Airways, reported 2015 revenues rose 13.3%, while pre-tax profits jumped 64% to £1.4bn. And there are also few signs of slowing down, with Ryanair today reporting a 28% increase in March passenger numbers, its fourth consecutive monthly increase.
What’s more, airline load factors are rising too, as passenger numbers have been growing faster than the recent increases in seat capacity. Higher load factors lift profit margins, by allowing airlines to make use of their assets more efficiently. This is particularly helpful for the carriers that we are looking at, because margins have come under intense pressure from growing competition on intra-European routes in recent years.
Lower Fuel Costs
Fuel is generally the largest single cost item for airlines – for Ryanair, it accounts for as much 40% of operating costs. Lower fuel costs therefore have a massive impact in improving margins, and this is even more so because strong passenger demand has meant air fares have remained relatively high despite lower industry costs.
More gains are likely to come as airlines typically hedge a significant proportion of their fuel needs, which locks them in at the higher prices of the past. Ryanair is one of the most heavily hedged airlines, meaning it has yet to fully benefit from lower prices. But, the company is now taking advantage of recent oil price weakness to lock in more of its fuel needs further into the future. It has 95% of its fuel needs hedged for 2017 at an average oil price of $62 per barrel, with another 50% of its 2018 H1 fuel needs hedged at $52 per barrel.
Valuations
Despite the positive near term tailwinds and the outlook for earnings growth, these airlines trade at very low multiples on their forward earnings metrics.
Shares in IAG are the cheapest, with a forward P/E of 6.3, based on city analysts anticipating that underlying earnings will grow by 48% this year, to €1.10 per share. But Ryanair is expected to have the fastest earnings growth prospects, with underlying EPS set to grow by 50% this year, to €0.96. Nevertheless, with a forward P/E of 15.1, this also means its shares are also the most expensive of the three.
Meanwhile, easyJet offers a good balance of income and growth. Its forward P/E is just 10.0, on expectations that underlying EPS will grow 7% this year, to 149p. Although growth is slower, easyJet is more generous with shareholder payouts, with shares currently carrying a forecast dividend yield of 4.0%.