Time to turn the engines on

Elevated inflation and the rise in commodity prices (such as oil) have been negative for easyJet (LSE: EZJ). The budget airline has also struggled with a summer of airport disruption, with low staff levels leading to flight delays and cancellations. Over the past year, the share price is down 51%.

It’s been a bit of a disaster and I’m sure the management team is looking forward to putting 2022 behind it. But what of the outlook for 2023? I think it’ll be better than this year.

If we strip out the woes on pricing and disruption, the load factor and flying hours are increasing. For example, in the half-year report, the load factor was 77.3%. This was up from 63.7% in H1 2021. In a trading update last week, the Q4 load factor could be as high as 92%.

My take here is that fundamentally, easyJet is recovering. It’s being blighted by one-off issues, but none that I think will remain deep into next year. On that basis, it’s a stock I think I need to consider buying.

A growth stock that has halved in value

Another stock that has taking a battering this year is Currys (LSE: CURY). In the past year the share price has fallen by 50%.

The firm has been cautious on the outlook for the business throughout this year. It has flagged up concern around inflation and how this could dent sales. The financial year runs May to May, so I don’t have a perfect vision of how the past few months have been. Yet even during the financial year that ended May 2022, sales only dropped by 2%, despite inflation moving higher.

I actually believe the management team is being overly cautious about the future. Sure, people will be more careful on spending going forward. But we’re talking about Curry’s here, not a luxury fashion brand or high-end designer goods. In the world of TV’s, computers and even washing machines, if I need something I’ll buy it. How many people are going to go without buying a new TV if their old one breaks? Not many.

Importantly, it’s also taking steps to help customers, including the provision of credit for purchases and locking in the prices of certain goods. This could help to get repeat business and also attract new customers from competitors.

Buying in a diversified portfolio

In both cases, my main risk is that these stocks continue to head south. Given the size of the move lower already, it’s feasible for the shares to fall 10%-20% further in coming months. Even though I’m probably going to buy both soon, they won’t be the only stocks I own. Putting them in my diversified portfolio means that my risk is reduced, even if both companies take longer to recover than I anticipate.

Is it worth buying a few shares for my portfolio at the current price? Or are there better stocks to buy today? Let’s discuss.

easyJet shares: is a recovery on the horizon?

easyJet posted a trading update for the year ended 30 September last week, and I thought it was relatively encouraging.

For a start, the company said that demand remains strong. “Our summer 23 season went on sale last week and we were filling the equivalent of more than four A320 aircraft a minute in the opening hours demonstrating the continued demand,” said CEO Johan Lundgren.

This is good to know given that many people are struggling with the cost-of-living crisis. It’s worth pointing out however, that capacity is still well below pre-pandemic levels. For the current quarter, easyJet expects to hit 83% of FY2019 capacity.

Secondly, the group said operational issues are improving. Since the start of July, operations have normalised, with Q4 on-the-day cancellations below 2019 levels.

Third, it also said its balance sheet is robust, with around £3.6bn of cash and money market deposits, and net debt of £0.7bn, at 30 September.

Finally, it said it is well hedged in terms of fuel prices, with roughly 69% hedged for H1 FY2023 at around $802 per metric tonne.

As for profitability, for the 12 months to the end of September, easyJet forecasts it would post a pre-tax loss of between £170m and £190m. This includes a £64m FX loss from balance sheet revaluations (the stronger US dollar has had a negative impact) and disruption costs of around £75m. This loss estimate was roughly in line with what analysts had been expecting (£180m). So there were no nasty surprises here.

Overall, there were a number of positives to take away from this update, in my view. However, the market seemed quite disinterested – the easyJet share price hardly moved after the update.

Should I buy easyJet shares today?

If I was a ‘turnaround’ type of investor, I might consider having a nibble here. The share price has fallen a long way, and if easyJet can deliver an improved performance next year, there’s a chance that the stock could experience some form of rebound.

However, this isn’t my investment style. I’m a ‘quality’ investor with a long-term focus. In other words, I buy shares in high-quality companies that are consistently profitable (and have significant long-term growth potential), and hold them for the long run.

Airline shares aren’t a good fit for my portfolio because the industry tends to experience a crisis on a regular basis (as we’ve seen with easyJet in recent years). Airlines can be great ‘trades’ at times but, typically, they don’t make good long-term investments as something always eventually goes wrong.

So I’m going to pass on easyJet shares. All things considered, I think there are better stocks to buy for my portfolio today.

Recovery isn’t easy

When easyJet released its latest trading update, its shares didn’t pop as expected. Its Q4 numbers were generally positive as the company flew 26.3m seats and operated at 88% of its pre-Covid levels. However, despite a strong performance, the airline still expects its full-year profit before tax to come in negative at -£183m.

From these figures, it’s easy to understand the lack of enthusiasm surrounding easyJet shares now. The budget airline still lags behind its pre-pandemic numbers by quite some distance, and a return to profitability still looks quite some way off.

No turbulence?

Nevertheless, there are a couple of things investors can cheer for. For one, easyJet expects to fly around 20m seats in Q1, which is a 30% increase on an annualised basis. More importantly, however, load factors are reported to be currently ahead of the same point in 2019, thus showing that the company is successfully battling through strong headwinds of a potential recession.

“Our 2023 summer season went on sale last week and we were filling the equivalent of more than four A320 aircraft a minute in the opening hours, demonstrating the continued demand.”

CEO Johan Lundgren

The second thing would be the company’s hedging strategy going into FY23, as it battles high fuel costs and a strong US dollar (USD). easyJet has increased its share in fuel and the greenback hedges, with around 56% and 62% hedged respectively. Moreover, the firm has been able to hedge these commodities at significantly better rates than the overall market.

Although these rates should allow easyJet to protect its bottom line, hedges are also a double-edged sword. That’s because a sudden decline in fuel prices and/or USD strength could further eat into the company’s profits. That being said, analysts are still expecting unhedged parts to impact the firm’s bottom line.

Up and away?

Taking everything into account, has the easyJet share price bottomed? Well, there’s no way of telling given the current geopolitical and economic climate. Even so, its outlook remains promising despite challenging times, as competitor IAG also released a bullish trading update yesterday.

Furthermore, easyJet’s balance sheet is well equipped to weather another slow down in travel demand. Management reported that the company finished its financial year with cash levels of around £3.6bn with net debt of approximately £0.7bn.

After all, Peel Hunt reiterated its ‘buy’ rating with a price target of £2.93 for the stock. What’s most lucrative, though, is the average price target among analysts, at £5.71. This means that I can almost double my money if I decide to invest at current levels, provided analysts get their estimates right.

Despite that, I’m not a fan of the company’s business model as it produces low profit margins. Hence, I won’t be investing in easyJet shares. I still think the company has plenty of potential and I wish them and their shareholders the very best.

I don’t own easyJet shares in my portfolio. But if I’d invested in the stock at the start of the year, I’d be seeing the decline as great news. 

The stock

If I’d invested £1,000 in easyJet stock at the start of the year, I’d have taken ownership of 164 shares. At today’s prices, I’d be able to sell that investment for £464.

Turning £1,000 into $464 isn’t a great investment result. But I don’t think this is the best way to think about investing or to measure the success of an investment. 

As an investor, my aim isn’t to find stocks that I can buy now and sell for a profit after a few months. I don’t think that’s what investing is about.

Investing, as I see it, is about finding quality businesses that I can own and earn a return from as they produce more cash over time. It’s not about betting on a stock going up in the near future.

If I’d bought easyJet shares in January because I thought it would be a good investment, I’d be feeling great about things now. The falling share price would allow me to buy more shares at better prices.

Risks

As I see it, the underlying business hasn’t changed that much this year. I think that easyJet’s biggest issue is its debt and with rates rising, I see that as a significant concern.

But easyJet’s debt is nothing new – it’s the result of travel restrictions during the pandemic. If I wasn’t worried about the company’s debt in January, then I wouldn’t be worried about it now.

I might feel differently if I’d bought shares five years ago. £1,000 invested in October 2017 would have bought 94 shares. Today, I could sell that for around £264.

If I’d bought easyJet shares five years ago, I wouldn’t be worried about my investment because the share price has fallen. I might be worried by the decline in the underlying business, though.

The company’s long-term debt has increased by 243% and the number of shares outstanding has grown from 397m to 544m.

easyJet shares

To me, easyJet looks significantly different to how it did five years ago. So I can see that I might want to sell my investment if I’d bought shares in 2017 and the falling share price would give me a problem in that situation.

If I’d bought the stock at the start of this year, though, I’d see things differently. I don’t think the business has changed much since the start of the year, which would make this an opportunity for me to buy more shares at lower prices.

The travel sector

The travel sector as a whole has improved remarkably since the start of the pandemic. Demand has increased as the ‘revenge travel’ trend means people are making up for lost trips.

Budget travel sector growth is also presenting companies with a wealth of opportunities. This is especially true for easyJet, as it is one of the industry’s leading players.

In a business update, easyJet reported that summer travel was “strong” and the company has sold 86% of tickets for Q3 2022. 

Despite these positive numbers, easyJet still made a pre-tax loss of £114m in Q3. The company also cancelled 10,000 flights across the summer months due to staff shortages, an ongoing problem.

A potential dividend stock

Another factor I’m considering is the company’s dividend. easyJet isn’t exactly known for its sustainable dividend – it cut payouts in 2019 due to higher fuel prices before axing them altogether during the pandemic – but this may change. The business expects to bring back a dividend for shareholders next autumn at 4.5p per share, representing a 1.5% dividend yield. 

Even if dividends grow in the future as the airline industry recovers, I think it would take several years for the yield to be higher than the FTSE 100 average of 4%. Therefore, I am unlikely to consider investing in the stock for passive income alone. 

easyJet’s future

I see two problems for easyjet right now. 

Firstly, inflation is pushing up costs for the airline and profit levels are impacted as a result. Costs are also increasing as fuel becomes more expensive due to the war in Ukraine. 

Secondly, the rising cost of living is likely to impact the travel industry. As people have less money to spend on non essential goods, easyJet ticket sales could slow down. 

The current share price does mean easyJet looks impressively cheap. It has a price-to-earnings (P/E) ratio of 12, far lower than competitors such as Wizz Air, which has a 74.46 P/E ratio.

Forecasts also show that easyJet will return to profit by next year. The company is expected to generate earnings per share of 38.5p and a net profit of £290m. 

Will I be investing? 

Whilst the current share price is tempting and growth opportunities seem plenty, I don’t think easyJet’s future is plain sailing. Rising costs for the company are impacting profit and, as the cost of living worsens, I’m not convinced travel demand will continue to grow at the same levels.

That’s why I won’t be adding easyJet shares to my portfolio right now. 

Yet many investors believe the former FTSE 100 company is now a brilliant bargain stock to buy. Should I buy easyJet shares as the travel sector steadily improves? And should I buy the business for next year’s dividend?

Dividends to return?

Yes, you read that right. It’s true that easyJet hasn’t been a reliable dividend stock for years. But City brokers think all this is about to change.

The low-cost airline was slashing annual dividends in the run-up to the pandemic. In the financial year to September 2019, it cut the full-year reward to 43.9p per share from 58.6p a year earlier as high fuel and currency costs hit profits.

The business then axed shareholder payouts entirely in fiscal 2020. And isn’t expected to pay a dividend this year either. However, easyJet’s expected to get things rolling again with a 4.5p per share reward for the new year beginning in October.

A fast-growing market

With easyJet’s share price at 339p per share the dividend yield sits at a handy-if-unspectacular 1.3%. To put this in perspective, the FTSE 100 average sits just below 4%.

But that alone isn’t necessarily enough to rule out easyJet as an attractive future dividend stock. Shareholder payouts could grow strongly as the civil aviation sector steadily improves and profits rebound. This could make the airline a great passive income stock to buy.

There’s no disputing that the budget airline sector is tipped for impressive growth over the long term. And as one of the industry’s leading players, easyJet could be in one of best seats to ride this opportunity.

Analysts at Allied Market Research, for example, think the global low-cost airline sector will grow to be worth $440.5bn by 2030. That represents a compound annual growth rate of 10.4% over the next eight years.

A high-risk stock

That said, easyJet isn’t a future dividend star that I’m prepared to buy right now.

I’m actually less than impressed by the company’s ability to ride the travel industry rebound. It swung to a pre-tax loss of £114m for the three months to June, latest financials showed. Flight activity has rebounded but staffing issues have weighed heavily (it had to cancel around 10,000 flights over the summer).

A shortage of cabin and ground crew remains a big threat to airlines, including easyJet. And it’s a problem that could persist due to post-Brexit immigration rules. So does the prospect of another surge in oil prices that could shove up fuel costs.

There’s also a danger that ticket sales could dry up again as the cost-of-living crisis hits consumer spending. And over the longer term, revenues and margins at easyJet could suffer as competition in this fast-growing industry intensifies.

Improving capacity and narrowing losses

The most recent set of results indicate to me that the short-haul airline’s business is beginning to bounce back.

By just about every metric, the firm showed improvement in a report for the three months to 30 June. The number of flights flown was over 140,000. During the same period in 2021, this figure stood at just 24,600.

Also, more than 22,000 passengers flew on easyJet aircraft, compared to just under 3,000 in 2021. This translated to a capacity figure of 87% of 2019 levels, compared with 16% for the same three months in 2021. For the current quarter, the company expects capacity to reach 90%.

All these positive results are also beginning to filter into financial data. Group revenue for the most recent quarter was in excess of £1.7bn, about eight times greater than in 2021. Furthermore, it reported narrowing pre-tax losses of £114m.

These results strike me as very positive indeed. Yet since their release, the share price is down over 15%. I find it difficult to make sense of this and think that the market hasn’t fully factored in the financial improvement into the shares quite yet.

Are the shares really cheap?

The firm hasn’t been without it challenges, however. An uptick in demand after the pandemic blindsided the airline, leading to staff shortages and flight cancellations. The business responded by hurriedly recruiting cabin crew, promising a £1,000 sign-on bonus.

Jet fuel prices have also become an issue since the war in Ukraine began, but easyJet has hedged much of this at lower levels. In any case, the underlying price of crude oil is beginning to fall, so I don’t think this should be a long-term issue.

easyJet also has some of the lowest debt levels in the sector, reducing this to £200m at the end of June. It stood at £600m the previous quarter. Additionally, it has a cash balance of £3.9bn, meaning it should easily be able to deal with any further challenges.

Furthermore, with a trailing price to earnings (P/E) ratio of 11.99, the firm may indeed be cheap at the current share price. This is significantly lower than a major competitor, Wizz Air, that has a trailing P/E ratio of 74.46. The lower ratio is an indication that easyJet shares could be a bargain at current levels. 

Overall, this is a company that looks to be improving. But it’s obvious that the share price doesn’t yet reflect this. To that end, I’ll add the firm to my portfolio soon, because I think the share price could climb.

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.

easyJet shares: I would have lost money this year

At the start of 2022, easyJet shares were trading at 556p. As I write on Friday morning however, they’re trading at 352p. That equates to a decline of 36.7%.

This means that if I had invested £5,000 of my hard-earned money in the stock at the start of the year, that money would now be worth just £3,165 (ignoring trading commissions). Ouch!

What about dividends though? Well, unfortunately, easyJet hasn’t paid any to its investors for a few years now, due to the fact the pandemic has impacted profits and cash flows quite significantly. So I would have received no income from the stock at all in 2022, meaning £3,165 is all I’d have for my troubles.

It’s worth pointing out that if I had bought the stock at the start of 2022, I would have owned it for less than 10 months. That’s a rather short holding period. Generally, experts recommend holding shares for at least five years. In the long run, the stock could recover.

However, I’d still be disappointed if my £5,000 investment had fallen by that much. I’d have to make a gain of nearly 60% from here just to break even.

3 takeaways from the EZJ share price fall

Looking at the performance of easyJet shares, there are a few takeaways, to my mind. One is that, just because a stock has fallen a long way doesn’t mean it will automatically rebound.

Before Covid, easyJet shares were trading near the 1,250p mark (after accounting for recent rights issues). So, at the start of 2022, the stock was more than 50% below its pre-Covid-19 levels. I imagine there were a lot of investors who looked at the large share price fall and bought stock, hoping for a big rebound. Unfortunately, the stock has kept losing altitude.

Another is that there’s a lot that can go wrong with airline stocks. They can experience challenges related to operational issues, staffing, fuel costs, government restrictions, and much more. And this is reflected in easyJet’s recent results. While demand for flights has been quite healthy of late, other issues have hit profits (and the share price).

A third takeaway here is that when investing in stocks, it’s crucial to diversify. If I only owned a handful of stocks and one of them was easyJet, my overall portfolio would have taken a big hit in 2022. However, if I owned 20 or more stocks (as I do), the fall here would not have been the end of the world for me.

As Warren Buffett tells us, the success of an investment depends on what the business does over time. So if I’d bought easyJet shares five years ago, how much would I have now?

Past performance

Let’s start with the easyJet share price. The stock currently trades at £3.55 per share, compared to £10.21 five years ago. 

That’s a decline of around 65%, which means that I could sell my initial £1,000 investment for around £350 today. That isn’t terribly inspiring, but it’s not the full story.

Until recently, easyJet paid a dividend to its shareholders. That’s something else to factor into my return calculation.

Five years ago, £1,000 would have bought me around 98 shares. Since then, easyJet has paid out £1.97 per share in dividends to its shareholders.

Assuming I didn’t reinvest the dividends I received in more easyJet stock, I’d have received around £193 in dividends. Adding that to my £350 worth of shares gives me a total return of £443.

That’s a loss of around 56%, which is not great. It’s significantly worse than the FTSE 100 (which easyJet was part of five years ago).

With the company no longer paying a dividend, the prospect for future returns depends on the share price. So is there reason to think that easyJet shares can generate a good return from here?

Future returns

With easyJet shares down 65% over the last five years, there’s a gain of around 185% to be had if the stock can recover to its 2017 levels. But I think this is unlikely.

While the company’s revenues might recover to where they were five years ago, I think there are some deeper issues. These are debt and the number of shares outstanding.

Right now, easyJet has just over three times the long-term debt it had five years ago. That means that the company is in a weaker position even if it recovers its previous earnings power.

In addition, easyJet has issued a lot of shares over the past five years. The company’s share count is just under 760m, up from around 400m.

In my view, this is the biggest obstacle to easyJet’s share price recovering its previous highs. The business now needs to generate 90% more cash to achieve its previous level of earnings per share.

A stock to buy?

I don’t anticipate adding easyJet shares to my portfolio any time soon. The argument that the business has a bright future as travel demand recovers doesn’t convince me.

I think it’s certainly true that easyJet’s revenues will increase significantly from their current levels. But the business looks fundamentally different to how it was five years ago.

The amount of debt and the increased share count put me off investing in the stock. I think that there are better options available for my portfolio.