Like a gazelle stotting in front of a lion, easyJet wants to prove it’s not to be taken down easily. Its riposte to would-be buyer Wizz Air? Show that it has the balance sheet strength to withstand any prolonging of the crisis in consumer travel and also take market share.
Unfortunately, achieving said liquidity via a £1.2 billion rights issue hardly screams you’re fit for a fight. JP Morgan has cut its target price for the stock to just 595p. At least short-term liquidity concerns should be allayed, should travel restrictions remain for longer than expected.
Net debt had risen to just over £2 billion at the end of June, an 81 per cent jump on the end of 2020. Once the dark clouds have cleared, there will be scope to cut debt. Berenberg forecasts that leverage will be reduced to 0.9 times earnings before interest, taxes, depreciation and amortisation (ebitda) by 2023.
But it also allows the airline to go after market share by taking advantage of the weakness of legacy carriers and potentially reduced flying capacity within the market, as well as investing in at-seat services and “standard-plus” fares that might boost ancillary revenue.
It’s just the latest effort by easyJet to boost its access to capital — the product of a financial review by new finance chief Kenton Jarvis. Earlier attempts include a sale and leaseback of about £1.4 billion of its fleet and a £500 million cost-saving programme, about half of which is expected to stick longer-term.
All airlines have taken a battering during the crisis but easyJet is the cheapest of the three budget carriers, with an enterprise value of just four times 2023 ebitda, versus a multiple of about six enjoyed by its peers. Surely it’s a bargain then? Not quite.
Even prior to the announcement of its latest rights issue, easyJet lagged rivals Wizz Air and Ryanair. Since March last year, the share price return was roughly a third of that generated by its would-be acquirer. That’s partly due to the dilutive impact of a prior placing in June last year, which raised £419 million.
But there’s also the fact that its balance sheet was weaker and its margins lower than its rivals. Flying in and out of desirable, primary airports such as Gatwick and Paris Charles de Gaulle incurs higher operating costs than using the locations favoured by Wizz Air.
Operating more routes between the UK and continental Europe means that confusion around travel restrictions and costly PCR tests have taken a greater toll on easyJet than for rivals, who can benefit from more seamless travel for citizens within the Continent that benefit from digital green certificates.
It’s shifted flights from roughly 50 per cent from within the UK to about 60 per cent in the short term. But nevertheless, capacity has been slower to return for easyJet. In the current quarter it expects capacity to reach 57 per cent of 2019 levels, rising to up to 60 per cent during the final three months of this year. But still, the relatively fixed costs of flying make empty seats hellish for airline margins.
Maybe there’s another way to look at it: a higher fixed-cost base and greater exposure to more challenged routes also means it has more to gain from a greater return of flying.
Two things need to happen for easyJet to demonstrate it deserves more than a lowball offer. First, greater recovery in passenger volumes. UK travel restrictions mean that is largely out of its hands.
But when limits do get lifted, it needs to show it can hit the mid-teen margins it is targeting, either through capturing the benefits of more market share or ancillary revenue, or even both. Until it can demonstrate more progress here, it will continue to look like easy prey.
ADVICE Hold
WHY A weaker valuation is deserved due to slower progress on recovering passenger numbers and a higher fixed-cost base
Redrow
Housebuilders have had it easy over the past 12 months: the government saw to that via its tax break. So a rise of more than a third in completions and a record forward order book for Redrow is hardly revelatory, although pre-tax profit came in ahead of consensus expectations.
Life isn’t going to be so easy for the sector in the coming months. The exceptional rate of house price growth imbued by the stamp duty break has started to ease. At the same time cost pressures are rising, both in raw materials such as timber and cement, and in labour. Low levels of operational gearing mean sales price fluctuations and rising costs hit housebuilder margins hard.
Mid-cap housebuilder Redrow looks well placed to ride out bumpier conditions. The Colindale development aside, it has withdrawn from London, where affordability constraints have led to weaker house-price growth in recent years.
The net debt position was reversed to a £160 million net cash balance at the end of June, which management expects to improve further over the coming years, and analysts have put that figure rising to £262 million at the same point next year.
The upshot for investors this year is a 24½p dividend, equivalent to a decent 3.5 per cent yield at the current 701p share price. Admittedly, that’s not as generous as the one on offer from Persimmon or Berkeley, but at 1.2 times forecast net asset value and just eight times forward earnings, you’re also paying a lot less for the shares.
What about dishing some of that cash out to shareholders via special returns? It’s a possibility — but not until after 2024, according to the group’s finance chief, Barbara Richmond. Growing the scale of the business to hit targets of at least £2.2 billion in revenue and an operating margin of about 19.5 per cent is the first priority. It hopes to hit those targets by increasing average outlets by about 17 per cent over the next three years, with a return on capital employed (ROCE) of close to 25 per cent.
Redrow’s shares are more lowly valued than some peers with weaker margins and ROCE, which looks too harsh.
ADVICE Buy
WHY The shares offer a decent dividend and scope for further upside if it hits margin and returns targets
