Shares in American Airlines, United Continental Holdings, Delta Air Lines Inc and Southwest Airlines soared on the day it was disclosed that Warren Buffett’s Berkshire Hathaway had taken stakes in the US airlines. That is because Mr Buffett has shunned airline stocks since 1989, when he had seen an investment he made in US airways lose value almost immediately and had to write down the value of the investment by three quarters six years later. He has described them as the 'worst sort of business', taking huge amounts of capital to make them grow quickly only to make little or no money.
No-one can be sure what changed Mr Buffett’s mind, but the US airline industry has moved on since 1989 thanks mainly to consolidation and an intense focus on the cost base. That doesn’t mean airline investing is any less difficult – Berkshire Hathaway may have decided that the airline stocks were now too cheap to ignore after they fell in sharply in the summer amid concerns of over-capacity and a sector-wide fare price war.
Ryanair versus easyJet
Which brings us neatly to the European airline sector. Investors in low-cost airlines easyJet and Ryanair had very good years between 2012 and 2015, with Ryanair outperforming its British rival somewhat. Those years marked a period of astonishing growth for the two airlines as they took control of the entire European short-haul market. Sure, they needed plenty of capital to fund the rapid expansion and easyJet’s battle with its founder Stelios Haji-Ioannou over its fleet expansion plans epitomised concerns over this, but the low-cost model was able to translate growth in passenger numbers into profits as planes were filled no matter how many were added.
easyJet flew 48.8 million passengers in its 2010 financial year, reporting a load factor of 87%, revenue of £2.97 billion and pre-tax profit of £154 million. Load factor is a measure of how full aircraft are. By 2015, these numbers had risen to 68.6 million passengers, a load factor of 91.5%, revenue of £4.69 billion and pre-tax profit of £686 million. It’s a similar story for Ryanair with passenger numbers rising to 90.6 million from 66.5 million, load factor up to 88% from 82%, net profit up to €867 million from €319 million and revenue up to €5.65 billion, from €2.99 billion. No surprise then that shares in both airlines rose more than fourfold between the start of calendar 2010 and the end of 2015.
easyJet, in particular, has hit turbulence in 2016, and it hasn’t been a good year for its investors as a result. It is the second-worst performer year-to-date in the FTSE 100 in terms of total return, down 36.5%. Its latest full-year results showed a further rise in passenger numbers to 73.1 million and load factor to 91.6%, but revenue dropped slightly to £4.67 billion and pre-tax profit dropped to £495 million. It blamed falling fares and yields, a high level of cancellations due to strikes, weather and airport issues, and the impact of the Brexit vote and the subsequent tumble in sterling.
Ryanair outperforming its British rival
Ryanair continues to outperform, with its shares down just 5% so far in 2016. It too has warned of the impact of falling fares and yields, but has the big benefit over easyJet of being an Irish airline that reports in euros and not sterling. Both will feel the impact of sterling’s tumble on the UK holidaymaker, but easyJet also has the problem of paying for dollar-denominated jet fuel with a much weaker pound.
So does 2016 mark the end of the good years in terms of Ryanair and easyJet, or does the fall in stock prices make for a buying opportunity?
As you’d expect, easyJet boss Carolyn McCall remains bullish, claiming that 'half a billion pounds' of profit is a strong performance given the shocks the airline has faced this year. It’s all part of the airline cycle, she says, adding that easyJet and Ryanair will get stronger and the weaker competitors will get weaker.
She’s probably right on the first and last points. Ryanair and easyJet have a very strong dominance that’s unlikely to be broken. However, can the two airlines continue the growth they’ve seen over the past few decades? That’s less clear. The market is maturing fast. The legacy carriers may have yielded the short-haul market to easyJet and Ryanair, and those two may yet take out some of their smaller rivals, but there isn’t much further the pair can grow in Europe.
On a short-term basis, the dip in easyJet shares have made them look cheaper on a historical basis, but metrics like blended forward price-to-earnings ratios are still only in line with long-term historic averages. Earnings are currently expected to fall again in the current financial year before recovering in the two subsequent years. And the broader analyst community has not yet turned on the stock having been reducing expectations since the start of the year – currently nine have the stock at 'Buy', four at 'Sell' but 15 at 'Hold', and the average target price is below the current price.
easyJet does trade at a discount to Ryanair in terms of both price-to-earnings and enterprise value to operating profit, but there’s nothing to suggest the British carrier will start to close the gap with its Irish rival in terms of market fundamentals like market share. While easyJet has been closing the gap with Ryanair in terms of cost base, the Irish airline's 'Always Getting Better' customer service drive has been closing the gap with easyJet in terms of revenue performance. Indeed, Ryanair’s earnings are expected to continue growing over the next four financial years even as easyJet sees a two-year hiatus. That’s one of the reasons why 21 analysts have Ryanair at 'Buy', six at 'Hold' and none at all at 'Sell'.
Technical analysis — easyJet
From a technical perspective, easyJet shares have significantly suffered over the past year, losing 39%. Since breaking below the key £12.07 support level, we have seen a clear downtrend come to fruition. Recent weeks have seen shares regain ground, rising into the 61.8% Fibonacci retracement level. As such, this rally is seen as a retracement rather than a recovery, with a push back above £12.28 required to bring a bullish outlook. Until then, further losses appear likely in a continuation of the weakness we have seen since the first-quarter 2015 high of £19.28.