Not many easyJet (LSE: EZJ) passengers would be happy to keep flying through continuous turbulence. For the airline’s shareholders though, that has been the situation of late. The easyJet share price has halved over the past 12 months.
So now that I can buy two easyJet shares for the same amount of money I would have shelled out for just one a year ago, should I? Is the price below fair value?
How to value airlines
There are two parts to answering that question. The first, today’s easyJet share price, is simple enough to know. The second, deciding what fair value is for the shares, is much more difficult to establish.
Some investors use a price-to-earnings ratio to value shares. But that does not help here, as lossmaking easyJet has not had any earnings for the past couple of years I could use in my calculations.
What if I tried to estimate future earnings? Or, alternatively, future cash flows? By doing that, I might attempt a valuation using the discounted cash flow approach.
The challenge I see is that there are variables involved in making such estimates. In easyJet’s case, they are substantial.
Revenues and costs
For example, what will revenue be? In easyJet’s most recent quarter, it came in at £1.8bn. But scroll back just one year and the figure was only £0.2bn. Travel restrictions imposed in response to the pandemic mean that passenger numbers have been all over the place in recent years.
That could happen again. From the 2001 US terrorist attacks to an Icelandic volcano erupting in 2010, the aviation industry was no stranger to sudden and dramatic drops in passenger volumes even before the pandemic. That can drive revenues down sharply, overnight.
The cost side of the equation is also challenging to estimate. In its most recent quarter, for example, the airline booked a £133m charge to cover costs arising from disruption at airports over the summer. If those problems continue, will that add more costs?
Meanwhile, aviation fuel costs have skyrocketed, but will likely fall again at some point. But nobody knows when.
Falling fuel prices could yet boost profitability, making today’s easyJet share price a bargain for my portfolio. After all, the airline benefits from a popular brand and wide route network. But, like its peers, it faces a moveable feast of costs that is very hard for me to predict.
My take on the easyJet share price
To some extent, all industries face such challenges. Future demand is often uncertain, while costs can move without much warning.
But passenger aviation is particularly prone to such issues, in my opinion. Much travel is discretionary, so a shift in public confidence or ticket prices can make the difference between full planes and half-empty ones.
Fixed costs like aircraft leases and purchases are high whether or not people fly. Variable costs such as unhedged fuel purchases can make the difference between a profitable quarter and a lossmaking one, sometimes dramatically.
So I see no way of pinning a fair value on the easyJet share price that does not involve a lot of assumptions. Despite the shares halving, I am not buying.
I would prefer to invest in businesses I think have clearer visibility on what is coming down the line.