FTSE 100 shares have held up relatively well so far this year. The index is down 5.8% year to date as I write. This isn’t a major drop but concerns over fast-rising interest rates, inflation, and political uncertainty could hint at more trouble to come.

Several FTSE 100 shares in my portfolio have performed well over the last few years. So, is it time to quit while I’m ahead and seek alternative investment in the form of gold?

Inflation

Famously, gold has performed well during periods of high inflation. It is often referred to as an inflation hedge, meaning it offers investors protection from the decreasing purchasing power of money. But why is this?

Inflation means higher prices, and higher prices mean my cash won’t stretch as far as it used to.

Assuming the demand for gold remains level, in the face of inflation, 1 unit of gold becomes worth more in the terms of a currency like the pound. This is because the pound becomes weaker and will buy less gold for the same amount of money on the open market.

From 1978-1980, inflation rose sharply from 8.2% to almost 18%. In that period, the price of gold rose approximately 200%.

Safe haven

Gold is transportable, durable, universally desirable, and quite easy to authenticate. Therefore, it is very successful as a store of value. It is often perceived as a wholly “real” asset, unlike a banknote with little intrinsic value.

We saw the gold price jump when Russia effectively declared war on Ukraine earlier this year. Investors naturally have concerns over the likely ripple effects of such events. This is when investors tend to favour high-quality assets that are cushioned by persistent global demand.

Interest rates

As I write, the price of gold is down 12.7% year to date. In this time, interest rates in the UK have risen.

Rising interest rates can cause problems for the price of gold. As interest rates rise, currency strength usually begins to increase. This is because debt becomes more expensive making loans less affordable. This tightens the money supply.

This has placed significant downward pressure on the price of gold since interest rates are rising in many countries around the world.

Conclusion

I expect that interest rates will continue to rise as we emerge from a period in which cheap borrowing was taken for granted.

I also expect that government will not be able to cap energy prices indefinitely and that inflation and uncertainty will outweigh rising interest rates in determining the price of gold.

However, despite the challenges FTSE 100 shares will face with rising costs and falling consumer demand, I will not be swapping any of my positions for gold. I believe my stock picks are well positioned to weather the uncertain climate. I’m also much keener to ride out economic cycles than increase my exposure to more volatile assets like gold.

Any further additions to my Stocks and Shares ISA will be picked carefully. I will focus on stocks with good cash flow, reasonable debt, and product demand exhibited by the underlying business.

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Inflation is high! The prices of almost all the goods used to calculate overall inflation rates have increased. At this rate, cash sitting in my bank account won’t stretch nearly as far next year as it will today. That’s why I think that identifying stocks to buy that might grow my savings faster than the rate of prices is a more pressing matter than ever.

But which stocks do I think will thrive in a climate where prices are rising? Here are two I decided to add to my portfolio last week.

British American Tobacco

British American Tobacco (LSE:BATS) is up an impressive 19% year to date as I write.

Research shows that cigarettes are slightly ‘price inelastic’. This means that if the price of cigarettes increases, the following drop in demand will be less significant by comparison. But much of that lost demand will be likely to substitute cigarettes for oral and vapour-based nicotine products.

British American Tobacco has all these types of products in its portfolio. Raising its prices to protect its profit margins from inflation shouldn’t see demand drop too harshly. The tobacco giant also boasts a 6.5% dividend yield. Topping that yield up with share price growth may quickly find my investment keeping up with inflation.

However, British American Tobacco does have a high level of debt leaving it exposed to rising interest rates. Currently, the company is working on reducing its debt but whether that continues is not guaranteed.

Unite Group

When prices rise and consumers become strapped for cash, you can expect demand for cheap housing to rise. This is particularly the case for students seeking rented accommodation, largely supported by their limited student loans.

Unite Group (LSE:UTG) is the UK’s largest owner and developer of purpose-built student accommodation.

As I write, the group’s share price has been hit hard so far this year, down 25% year to date.

Last week, Unite Group had several positive announcements to make. The group has a large waiting list due to a shortage of accommodation built close to university campuses. The income from property that Unite Group does earn is expected to confidently climb by almost 5% as it looks to pass costs on to the consumer.

With a short supply of university accommodation, it seems safe to expect that students will absorb rent increases, which will be a positive for share price growth.

Unite Group currently has a respectable dividend yield of 3.2%.

However, its dividend track record is not a stable one and its share price growth in the long term is heavily reliant on the popularity of university education.

Conclusion

I think both stocks are well positioned to potentially outstrip inflation over the next few years. Both stocks have reliable income at present. The goods and services offered by both British American Tobacco and Unite Group are experiencing demand that will be difficult to shake off.

I recently added both of these stocks to my portfolio with a £1,000 position in each of them.

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Dan Coates owns shares in British American Tobacco and Unite Group. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Penny shares are certainly not for the faint-hearted. Typically, their prices are very volatile due to the small nature of the underlying businesses. However, Premier African Minerals (LSE:PREM) is starting to rise above its competitors. Following a tough six years, the penny stock has turned things around. It is now up an impressive 100% year to date.

Investors are excited by this metals producer. But is this momentum likely to fade away? Or could I be looking at the early stages of the next mining giant?

A volatile company timeline

Premier African Minerals debuted on the London Stock Exchange in December 2012. The company set out to start a tungsten mining operation covering 1800 hectares. It hoped the operation would be low cost due to excellent nearby infrastructure.

The share price began to tumble until August 2013 when an independent mining study showed strong potential for the tungsten site. This caused the penny stock to shoot up by over 340% in a single week.

The company then reported it was “on-time and on-budget” for its first production in early June 2015.

In June 2015, the Premier African Minerals share price peaked at its all-time high of 3.5p.

The company then began to dilute its shareholders by issuing more shares and expanding its losses with its “next-in-line project”, the Zulu lithium mine, as its next venture.

This was catalysed by complications with Zimbabwe’s National Indigenisation and Economic Empowerment Fund (NIEEF) which drove the tungsten mines out of production in 2019.

Zulu lithium project’s success

The downfall of the tungsten site drove the Premier African Minerals share price to staggering lows of just 0.2p in 2019.

Since the start of 2022, the share price has risen from 0.18p to 0.37p as I write.

A £1,000 investment at the start of 2022 would have bought over 555,000 shares in the company, which would now be worth double the original investment.

Redirecting efforts towards lithium has paid off. The company announced in June this year that it will begin shipping spodumene concentrate from its mine in Zimbabwe to China by March 2023. This followed the signing of a deal with Suzhou TA&A.

The future of lithium

I think it looks like it will be an exciting time ahead for Premier African Minerals shareholders.

China appears to be behind a global acquisition spree for early-stage lithium mining projects. The country accounts for 65% of battery production, of which lithium is a core element. However, China’s access to lithium deposits is limited.

With the demand for electric cars on the rise, it’s no wonder China is so keen to fuel the growth of global lithium mining production to ramp up battery manufacturing capacity.

I think Premier African Minerals is a strong contender to land more attractive deals with China in the future with its proven ability to raise capital.

However, its ability to meet production targets and overcome regulatory hurdles is less proven. Investing in Premier African Minerals certainly comes with significant risk. But having held its shares since 2018, I am tempted to increase my position even now.

I will be keeping a close eye on this penny stock, eager to see how its future unfolds.

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Dan Coates has a position in Premier African Minerals. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Nearing the close of its thirteenth trading week, the Haleon (LSE:HLN) share price has had a tough start. Haleon first began trading at 330p and saw lows of almost 240p by the start of September. But since then, it has confidently recovered.

On Tuesday, Haleon was a top FTSE 100 performer with high volumes traded. As I write, the share price stands at 273p.

So, what does Haleon do? Where has the company sprung from? And should I be looking to invest in it?

A FTSE 100 giant subsidiary

Haleon was born out of GSK, a pharmaceutical giant, as its own independent company. It has taken ownership of some big-name brands such as Aquafresh, Panadol, Voltaren, and Nicorette.

The company is a dominant player in supplying oral health, pain relief and vitamin products.

The American pharmaceutical giant Pfizer owns a 25% stake in the new company.

The separation follows as GSK plans to focus its investment efforts on vaccines and speciality medicines. By contrast, Haleon — with a fresh balance sheet — will be a cash-generative business with quality brand names intended to attract investors looking for sustainable growth.

The latest earnings report

During the first week of trading, claims against GSK that one of its drugs, Zantac, causes cancer applied downward pressure to the Haleon share price.

Soon after listing, Haleon increased its expectations for revenue growth. It claims its brands have relatively inelastic demand even when faced with economic uncertainty.

Market commentators speculated otherwise, expecting that consumers would be downgrading to supermarket own-brand products. However, September earnings met expectations with no downside surprise.

This has acted as a springboard for the share price, which has stabilised at 5% higher since the earnings report.

Should I invest?

Meeting its initial growth targets is growing confidence among investors in the new corporate entity and its strategy.

Encouragingly, the company’s e-commerce sales are growing fast and have climbed to 9% of all revenue generation. Analysts are forecasting a 6.8% in annual revenue growth in the medium term.

Over 10 research firms have assigned Haleon a rating of “hold” as their recommendation.

Haleon’s balance sheet currently has relatively low levels of debt in comparison to GSK. Its rich cash flow also gives it plenty of opportunity to manage the debt going forward. This is certainly something I like to see in the face of rising interest rates.

Haleon’s strong portfolio of brands is already holding up against economic decline. With the company newly established, I certainly think there’s an opportunity for the share price to reach new highs as investors chase defensive stocks.

However, the UK recently reported a 0.3% economic contraction. The extent to which contraction continues nationally and internationally may begin to have a more noticeable influence over consumers substituting brands.

There is also a question about GSK’s potential legal liabilities due to its sale of Zantac. Trials will begin next year. Haleon is also at risk to liability but claims otherwise as it has never marketed Zantac. Either way, the outcome of the dispute is likely to have a big impact on the price for both companies.

I plan to buy shares in Haleon should the price fall below 270p again, with the hope that the earnings report on 10 November will be just as solid as the last.

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Dan Coates has no position in any of the shares mentioned. The Motley Fool UK has recommended GSK plc and Haleon plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

What is an index?

An index tracking stock markets is a value that represents the performance of the total valuation of a collection of companies. For example, the S&P 500 is an index that tracks the value of the largest 500 companies listed on US stock exchanges.

Typically, larger companies will be given a bigger proportional influence in the movement of an index.

What is an index fund?

An index mutual tracker fund or an exchange-traded fund (ETF) will hold portions of shares in all the companies currently in an index proportional to the weights.

To illustrate, a £500m index fund could have £500m invested into companies in the tracked index. It will therefore rise and fall in line with the index.

My £100k growth strategy

The Vanguard S&P 500 ETF (LSE:VUSA) is a liquid, low-cost exchange-traded fund tracking the S&P 500 index. ETFs are publicly traded on an exchange. New shares are created and dissolved as needed to match demand.

I can easily buy the Vanguard S&P 500 ETF in my Stocks and Shares ISA so that any gains are protected from tax.

The S&P 500 index over the past 100 years has annualised average returns of 9.6% accounting for likely dividends paid, management fees, and inflation associated with a tracker fund. With such a well-established track record, a similar rate of return could be achievable in the long term going forward.

Investing £5,000 into my chosen S&P 500 ETF and leaving it for 33 years could achieve £103,000 with 9.6% average annual returns.

Adding consistent monthly contributions of £200 could make that figure £109,000 in just 16 years!

Potential obstacles

This is certainly no “get rich quick” strategy. However, a financial advisor would still tell me this is a high-risk approach to investing my savings.

This is due to the volatility I am likely to witness in the value of my investment over the years. For example, holding the Vanguard S&P 500 ETF from 1998-2003 would have given me a -10% year-on-year return.

Losing patience and confidence during a sustained slide in the US stock market could quickly turn my projected £100k into a loss on my initial investment. This is where using a costlier actively managed fund could be more beneficial to me to help smooth out my gains and manage my expectations.

Conclusion

Investing in the performance of an index like the S&P 500 is like investing in the US equity market average. To do better than the market average would require skill, time, and competing against institutions. Even professionally managed funds have no guarantee of outperforming the average.

Market indices across the globe are starting to slide. So, I’m considering accumulating index ETFs to build capital over time and taking advantage of compounded potential average returns. However, it is not something that I plan to rely on as past performance is not to be relied on.

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Dan Coates does any of the shares mentioned in this article. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

The discounted cash flow model is a popular metric for valuing a company. Currently, by my calculations, it yields an enterprise value of around £11bn for Rolls-Royce (LSE:RR) shares. The equity value, by contrast, stands at around £7.5bn, suggesting a fair value for the shares is a little over £1 each – 33% higher than current prices.

However, I want to make sure my stock picks will outperform the market average. Even with value attributes, I think there are some deeper structural challenges facing Rolls-Royce.

I think it’s worth exploring the specific factors affecting its intrinsic value and noting the pressures it faces going forwards.

Restructuring efforts

After big losses in 2016, Rolls-Royce took some drastic actions. It made a reduction to its staff headcount amounting to 5,500 personnel. This reduced annual outgoings by £400m. The pandemic increased the headcount reduction to a total of 9,000 personnel.

Rolls-Royce hoped this would save it £1.3bn by the end of this year. But has this reduced its capacity for growth going forward?

Before the pandemic, Rolls-Royce’s operating expenses steadily declined. Revenue did continue to grow during this time. However, profit margins did not, and Rolls-Royce remains unprofitable at present with 2022 interim earnings of -£1.8bn.

Loss of demand

Given the global economy’s recent depression, it has been hard for the aviation and power systems industry to drum up orders. Rolls-Royce shares have certainly fallen victim to this.

Almost 50% of Rolls-Royce’s revenue comes from its Aerospace division. Revenue generated in this sector is derived from new engines sold, engine usage, and service agreements. Analysts do expect the aviation industry to return to 2019 levels, but no sooner than 2023.

For the large aircraft engine sector, 8.7% year-on-year growth is expected for the global market size for the next 10 years as a best-case recovery scenario.

Furthermore, the marine market has analysts predicting an annual growth rate of 4% for the next 10 years. This subtends from a surge in demand for environmentally sustainable power systems.

Overall predictions see Rolls-Royce quickly reclaiming the share price growth it has lost in the event of an economic turnaround.

The catch

To survive the pandemic, Rolls-Royce holds almost £7bn in debt. With rising interest rates, financial costs are increasing and will be pressuring profitability.

As a result, Moody’s Investors Service downgraded Rolls-Royce to a Ba3 rating with its increased credit risk. This ultimately makes it harder for the company to strike deals and increases the cost of its bonds, as it has a higher probability of insolvency.

However, Rolls-Royce is taking debt disposal seriously. The deal to sell ITP Aero for 1.7bn in 2021 is promising evidence that the company will be able to raise enough cash to avoid further expansion of its debt. Over time, I expect its debt-to-equity ratio to steadily reduce.

To conclude, I think the growth rate of Rolls-Royce will be slow and steady for the next 10 years. It faces a lot of financial headwinds. However, I wouldn’t be against investing in the medium term to benefit from the share price potentially rebounding to fair value.

At this time, I don’t think we have seen the lows for Rolls-Royce yet. I’ll be keeping an eye on its share price into next year before deciding whether to buy into the company or not.

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Dan Coates has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Higher interest rates and increased uncertainty among investors and economists alike have seen the FTSE 250 down over 20% year to date. Many investors have turned away from equities as a result. However, I’m confident that I may not have to hoard cash in my Stocks and Shares ISA to protect my gains.

Despite all the negatives in current market fundamentals, I’ve noticed two trading platform shares that seem to thrive on it, with impressive balance sheets, past performance, and dividends.

Why are trading platforms thriving

Trading platforms that specialise in providing solutions to retail traders who are looking for rapid execution, and short-term positions benefit from a very profitable business model. These traders, more experienced in financial markets and keen to take on higher risk, make a high number of trades regularly compared to traditional investment accounts.

The popularity of trading apps particularly has seen tremendous growth. Traders in these markets will also often use leverage on their position, allowing platforms to collect revenue from interest swaps as well as their markup on each trade.

The cryptocurrency bull run of 2021 certainly helped fuel demand for such trades, but since then uncertain equity markets have been just as attractive to opportunistic traders seeking volatility.

Plus500

The first of these shares is Plus500 (LSE:PLUS). The Plus500 share price boats 25% year-to-date growth at the time of writing. This follows several positive outcomes, compared to market expectations, in the company’s financials.

Earnings for Plus500 have grown to all-time highs of approximately £801m – 22.57% year-to-date – however, its profit margins (44.80%) are lower than they were last year (53.10%).

Plus500’s balance sheet is cash-rich and debt-free, meaning a rising base rate is unlikely to be of concern. It also positions it well to achieve the board’s plans for US expansion and targeting acquisitions as announced by the CEO, David Zruia, following the interim report.

I’ve held Plus500 shares since 2021, and I’m looking at possibly adding to my position while retail traders still seem keen on high risk, particularly when the current 6.8% dividend yield is on offer.

IG Group Holdings

IG Group Holdings (LSE:IGG) is my second strong contender for medium to long-term growth. The share price is down 8% year to date as I write – respectable losses compared to the FTSE 250.

IG Group has a similarly strong balance sheet, however. The full-year 2022 results showed revenue at approximately £965m, up 13% from last year’s results. Profit margins decreased to 41% from 44% in FY2021, a lesser decline than Plus500.

With earnings per share also exceeding analyst estimates by 6.7%, this leaves market expectations optimistic, with forecast revenue growth of 5.5% next year.

IG’s current dividend yield stands at 5.83% but, unlike Plus500’s, has been steadily increasing on average over the last five years.

I’m keeping a close eye on IG Group, as I think it has the potential to provide competitive dividend income as well as share price growth that is, most importantly, sustainable.

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Dan Coates has a position in Plus500. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Which companies benefit from a strong dollar?

Several FTSE shares earn large portions of revenue in $USD. Furthermore, when dividends are paid out in $USD, they are worth more to investors when they are inevitably converted back to £GBP. This could boost such dividends by 10-20%.

However, if a company’s main manufacturing operations are outside the US, for example, then the currency markets will work against them. So, here are my top two picks for capitalising on potentially boosted dividends.

Dividend growth potential

The share price of 4imprint Group (LSE:FOUR) is up almost 20% year to date.

As I write, 4imprint’s payout ratio is low. This means earnings are easily covering investors’ dividends. Interim earnings this year for the supplier of custom promotional merchandise grew to almost $1bn. Profit margins grew too, and analysts expect earnings per share to grow by 27% over the next two years.

Over 90% of 4imprint’s revenue comes from the US. Also, a large portion of its manufacturing occurs in the US, with blank products being purchased from Chinese suppliers.

So, it seems most of the group’s transactions will benefit from a stronger dollar, especially £GBP dividend payments. The dividend yield currently stands at around 2%.

I think this has the potential for significant growth going forward, which is why I will be buying these FTSE shares for my portfolio in the coming days.

However, demand for marketing and promotional products does decrease during times of economic hardship. This could impact 4imprint’s revenue if its services aren’t deemed essential.

A dividend legend with big stakes in the US dollar

The current dividend yield for GSK (LSE:GSK) is much higher, at over 7%, and has a very reliable track record. Since 2015, the company have almost always exceeded an annual dividend yield of 5% for its investors.

Earnings grew by 16% for the pharmaceutical giant over the past year, and analysts predict them to grow by around 10% next year. GSK is one of the biggest players in the FTSE 100 and has very diversified international operations. Over one-third of its revenue is $USD.

Ahead of its Q3 results, GSK expects a 10% tailwind to its revenues. Earnings per share over the period are expected to increase by 12% from these favourable currency fluctuations.

However, the company does have a high ratio of debt to equity, which isn’t favourable in a climate where interest rates are surging.

Still, the high and reliable dividend yield is hard to resist especially with currency tailwinds. I’ll be keeping an eye on the GSK share price as a result, with a view to adding it to my portfolio in the near term.

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Dan Coates has no position in any of the shares mentioned. The Motley Fool UK has recommended GSK plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

With the FTSE 250 already down around 25% since the start of the year, on top of record-high inflation, things may look bleak for stock markets. However, certain sectors benefit financially from increased interest rates. So, let’s look at two shares for me to potentially buy that I think will outperform the market going forward.

Why do some sectors benefit from higher interest rates?

Interest rates are very influential in determining the prices of stocks and shares. Generally, theory indicates that returns on debt increase as the costs incurred by borrowers rise. This can cause stock prices to drop as that cost may increase business’ future cash outflows, reducing their present values.

However, financials will directly profit from rising returns on debt as net interest margins will increase while the associated costs will stay relatively level. This is particularly applicable to banks that conduct most of their business through traditional banking activities such as mortgage lending, where an incremental change to interest rates can have a significant effect on the average cost of monthly mortgage payments.

Alternatively, the uncertainty induced by falling share prices from higher interest rates may increase demand for fund managers effective in mitigating market losses, as well as benefit companies with an interest in gold prices — a popular safe haven for capital.

Why I would buy Virgin Money UK

Back in May this year, when the Bank of England raised the base rate to 1.0%, Virgin Money (LSE: VMUK) was able to increase its net interest margin to approximately 1.85% for the year, up from 1.75%. I expect this margin to increase further, which is very exciting for a bank with 80.43% of gross customer loans on their balance sheet being mortgages according to their 2022 interim report. In comparison, mortgages make up 56.21% of NatWest’s lending in the same report.

However, up until now, interest rates on saving have remained low despite base rate increases. If banks like Virgin Money start to compete on higher savings rates, this will start to put pressure on net interest margins and profitability again. However, Virgin Money does not have a notably high exposure to interest-bearing liabilities.

Why I would buy Legal & General

Legal & General (LSE:LGEN) is, undoubtedly, a big name in investment management, pensions, and protection in the UK. Since 2014, Legal & General has not experienced much growth in its share price. L&G currently has around £1.3trn in assets under management and is the UK’s market leader in pension annuities.

A large portion of L&G’s pension product funds will be invested into bonds to generate retirement income for clients. Previously, the low interest rate environment will have been hindering L&G in terms of pre-tax profits since lower bond yields require more funds invested to generate the same amount of income. Clearly rising, interest rates are already relieving pressure on L&G, with its 2022 interim report showing a 212% increase in its solvency ratio.

Quality and a strengthening balance sheet certainly make L&G a potentially solid choice for my portfolio in an uncertain, contractionary market.

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Dan Coates has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

The airline industry is highly sensitive to the global economic outlook. Record-breaking highs for the industry in 2019 were, of course, crushed by Covid-19. Now, geopolitical uncertainty driven by Russia — coupled with volatile fuel prices — have been adding to the downward pressure on profits. The Wizz Air (LSE:WIZZ) share price has now sunk to less than 2,000p. However, low-cost airlines, particularly Wizz Air, have been utilising their market position to make operational changes that look to make them a competitive bet going forward in an uncertain market.

Key challenges facing Wizz Air

It has been difficult for Wizz Air to influence the costs of landing fees, maintenance, and fuel over the last couple of years as these costs were dependent on the number of flights it operated. Consequently, cutting crew costs has proved pivotal for low-cost airlines like Wizz Air, with staff predominantly paid flexibly by the flight hour and not a fixed full salary.

During the pandemic, European low-cost airlines took on £9.18bn in debt in order to raise funds to rescue cash flow. As a result, rising interest rates will ultimately stunt recovery, increasing the cost of debt.

With rising liabilities, there is also an increased importance placed on liquidity. Money tied up in assets certainly threatens this, especially with added pressures on airlines to reduce their emissions and invest in cleaner aircraft.

How is Wizz Air best positioned?

Wizz Air’s reported operating loss for the second quarter of 2022 was 285m euros, with CEO Jozsef Varadi stating that the “Ukraine war dented our momentum”. This certainly doesn’t instil confidence in me. Yet the ultra-low-cost airline has seen its liquidity “strengthen significantly to 1.6bn euros” in the same report.

Compared to competitors, Wizz Air has been the most aggressive in trying to generate cash inflow through sale and leaseback transactions. This is where an airline will buy aircraft directly from manufacturers, proceed to sell it to a leasing company for more than they paid and then lease it straight back for an agreed period. 

As a result, the average age of Wizz Air’s fleet of aircraft is just under five years, making it the youngest of any major airline. Not only does this mean assets are converted to cash more regularly, enabling Wizz Air to respond to industry changes more quickly, but a younger fleet ultimately means lower maintenance costs.

Wizz Air is not without its faults, however. It has had to cut flights due to its lack of fuel hedging and data from the Civil Aviation Authority shows it had the biggest share of flights delayed in 2021. Yet, the share prices of Wizz Air and competitors like Jet2 and easyJet have all suffered fairly equally this year. I believe with some of the most aggressive cost-cutting measures, and its adaptability, it could grow much stronger than competitors.

Consumers are still uncertain and suffering from the effects on inflation. The rising costs of air travel will likely only grow their demand for cheap tickets. It will then be a case of how much can they stomach a compromised service?

Although I don’t currently have a position in Wizz Air, I will be looking to buy once the share price sees some sustained recovery from its current slide.

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Dan Coates has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.