Robert Stephens, CFA, discusses the recovery prospects for struggling airline stocks easyJet and IAG.
The past six months have been exceptionally difficult for airlines such as easyJet (LON:EZJ) and IAG (LON:IAG). The vast majority of their aircraft have been grounded, while costs have mounted. This has caused investors to question their financial positions, with severe share price falls being the end result.
Both companies continue to face very challenging trading conditions that may yet worsen in the short run. However, in my opinion, they could offer long-term turnaround potential as the global economy recovers.
Operational challenges
Recent updates from easyJet and IAG have shown the scale of impact that lockdown measures have had on the airline industry. For instance, IAG’s revenue declined by 55% in the first half of its current financial year, while easyJet’s revenue dropped by 99.6% to just £7m in the third quarter of its fiscal year.
Forecasting the outlook for easyJet and IAG is impossible, in my view. Ultimately, nobody knows when demand for air travel will return to 2019 levels. IAG expects this to not occur until 2023, although much depends on how the Covid-19 pandemic progresses.
As well as facing the prospect of ongoing containment measures, the economic impact of Covid-19 is likely to create difficulties for the airline sector. For instance, UK consumer confidence is close to its lowest level since the financial crisis. With unemployment rising, demand for air travel may not rebound quickly even as lockdown measures are eased in many of the two companies’ key markets.
Financial positions
IAG and easyJet have made several major changes since the start of the Covid-19 pandemic to improve their financial positions.
For instance, easyJet has undertaken a programme of sale and leaseback transactions on its aircraft that has raised £405m. It has also conducted an equity placing of 14.99% of its share capital, raising £419m in the process, and drawn on various credit facilities. It now has cash equivalents of over £2.5bn, and is seeking to further reduce its operating expenses through a 30% cut in staff numbers.
Likewise, IAG plans to raise up to €2.75bn through a rights issue. It has also drawn on various credit facilities and government support mechanisms to improve its cash position. It now has cash of over €6bn and plans to reduce its costs in response to a potentially extended period of lower demand across the airline sector.
Investment appeal
Investing in easyJet or IAG at the moment is a very high-risk move. Both companies face extremely challenging operating environments that could worsen before they improve.
However, they appear to have the financial strength to survive further containment measures being put in place, as well as the prospect of weak consumer demand as rising unemployment becomes a reality.
In the long run, both businesses are likely to remain dominant players in what could be a fast-growing airline industry. Therefore, while investment returns may not necessarily be quick or without volatility, they could be attractive in the long run as the world economy recovers from Covid-19.