Airlines - is it a good time to invest?
Is it a bird? Is it a plane? Yes. Plenty of them actually, but do airline results point to soaring profits for investors.
It’s probably fair to say that the airline sector has had its fair share of headlines this year, for a variety of reasons both good and bad. Widespread air traffic control strikes in France and Italy, rising fuel costs and issues at Ryanair have figured largely in the stories. This follows on from 2017 which saw a number of airlines going into administration including Monarch, Air Berlin and Alitalia.
So it would be easy to assume from all of this that the sector must be in some difficulty, and investors may be wondering how to respond to the latest events.
To start with, it must be said that there is also good news to be found in the sector although it tends to be somewhat obscured by the bad news as is often the case.
Recent figures from Heathrow Airport showed that it enjoyed the busiest first six months of the year in its history, handling 38.1million passengers. Retail revenue rose 4.8% and the airport, which is owned by Spanish group Ferrovial, managed to raise nearly £1bn from investors to help future development.
Prospects were also helped by Parliament’s decision to approve the building of a third runway at Heathrow. The airport claims it will enable a further 740,000 flights per year, but there are many obstacles to overcome before work begins.
International Consolidated Airlines Group (IAG), the owner of British Airways, has the biggest presence at Heathrow and is likely to be a big beneficiary of the new runway, although it is fighting hard against the mooted rise in landing charges that might be needed to pay for the estimated £14bn cost.
IAG has attracted a lot of attention this year for its proposed takeover of Norwegian Air Shuttle. The Scandinavian airline has grown strongly over the past decade and is now the third largest low-cost airline in Europe. Offering more transatlantic routes has made it an even more attractive takeover target for larger airlines but IAG may find itself in a bidding war with German flag carrier Lufthansa, who’ve also expressed an interest. Takeovers of listed companies can often prove expensive, certainly compared to buying assets from companies which have run into trouble or gone bust. That was the case with Air Berlin last year and Easyjet has taken advantage by acquiring landing slots at Berlin Tegel, the city’s main international airport.
Another positive for the sector generally has been the growth in ancillary sales. While ticket prices remain highly competitive many carriers have looked to boost sales by offering a wide range of services, from extra luggage to allocated seating and even theatre tickets.
Once again, Easyjet is one of the clear winners in that area. Recent third quarter figures showed its ancillary sales up 21% in the period and there may be even better to come as the company says it is looking at doing more packaged holidays in future, possibly a move that owes much to the fact that its new CEO has come from global tourism group TUI. The market was impressed with the figures as they showed how resilient the company is despite a range of challenges. Passenger numbers are growing and the load factor, a key measure of how full its planes are, also continues to rise. While fuel costs are likely to increase following the rise in the price of oil the company has hedged a lot of its future fuel costs.
Most impressive was that the airline raised its full-year profit guidance range from £530-£580m to £550-£590m despite the impact of the air traffic controller strikes. Investors also like the fact that it has a healthy balance sheet with net cash of around £660m. That is part of the reason it can pay good dividends and has a yield over 4% which is good for the sector. All of that means we continue to recommend the shares as a buy for medium risk investors.
The contrast with its great rival Ryanair could not be more stark at present. The Irish carrier has hit a patch of severe turbulence mostly relating to internal employee relations issues which has led to strikes by aircrew and the recognition of unions. The combination of rising fuel costs, pay rises for staff, lower air fares and compensation relating to cancelled flights all led to a 22% drop in first quarter profits. The shares have nosedived in recent weeks in response to this news with investors perhaps also influenced by suggestions that a no-deal Brexit scenario could see non-EU shareholders stripped of some voting rights.
Ryanair’s chief financial officer has said the company is keen to see a transition deal agreed by October in order to ease the uncertainty about whether flights into the EU from the UK will be able to operate normally until at least the end of 2020. By contrast IAG’s CEO Willie Walsh has sounded much more relaxed about Brexit saying that he is confident that a comprehensive agreement will be struck before March 2019 allowing flights to continue as normal.
So, overall, the current picture is a little more complicated than normal but the long term trend towards increased demand for both business and leisure travel provide a good background for investors, although some occasional turbulence is to be expected.
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