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Give easyJet a winter break

EasyJet's shares have been jetting north all year, but a planeload of good news is priced in as the company flies into the unpredictable winter months.
December 20, 2012

EasyJet (EZJ) has quite a fan club in the City. Despite a Europe-wide recession and sky-high fuel prices, the no-frills airline has upgraded profit forecasts three times since March and doubled the dividend. Its share price has doubled, too, reflecting all the good news, and more. Given lingering headwinds, we think it's time to bail out.

IC TIP: Sell at 744p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points
  • Record results
  • Doubled dividend
Bear points
  • Austerity hurting Europe and UK
  • Effect of strikes in Europe
  • Sensitive to small change in demand and costs
  • Shares technically overbought

True, easyJet has done well operationally and is grabbing market share as weaker low-cost operators go bust and network carriers cut capacity. Cost-conscious business travellers are trading down and easyJet has the flexibility to divert planes to more profitable routes. Reducing dividend cover from five times to three times means extra income for investors, too.

Analysts have been surprised by the pace of progress under chief executive Carolyn McCall. Espirito Santo's Gerald Khoo says he first pencilled in earnings of just 29p a share for 2011-12, less than half the eventual figure. However, he reckons on just 9 per cent earnings growth this year (see table). "We are optimistic beyond the short term, but not on the same scale as last year," says Mr Khoo.

That reflects easyJet's own modest expectations. About half the winter seats are yet to be sold and the carrier predicts its growth in capacity will slow to 3.5 per cent. Low to mid-single digit percentage increases in revenue per seat will be offset by a similar rise in costs - £70m in extra airport charges, £50m in currency costs and £30m on the £1bn-plus fuel bill.

Clearly, it's tricky predicting an airline's profits, which are notoriously sensitive to small changes in both demand and cost. A 1 per cent move in either could affect operating profit by as much as 12 per cent. Currently, a $10 move in the price of jet fuel affects the fuel bill by $4m, and a one cent change in exchange rates can steer profits £1.6m either way.

And that unpredictability makes us cautious, especially as Europe remains in recession, unemployment is nudging 12 per cent and a sackful of austerity measures kick in next April. The International Air Transport Association (IATA) warns that Europe's airline industry will only break even both this year and next.

High taxes take a lot of the blame. Airlines fiercely oppose them, yet the UK Treasury expects to make almost £4bn from air passenger duty by 2016-17, 40 per cent more than last year. Spain and Italy have already hiked charges and Geneva, Gatwick and Stansted are reviewing theirs. "They are always likely to be a headache as carriers build their networks around popular airports, which have pricing power," says Douglas McNeil, transport analyst at broker Charles Stanley.

EASYJET (EZJ)

ORD PRICE:744pMARKET VALUE:£2.95bn
TOUCH:744-745p12-MONTH HIGH:746pLOW: 377p
DIVIDEND YIELD:3.1%PE RATIO:11
NET ASSET VALUE:453pNET DEBT:4%

Year to 30 SepTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20092.675516.9nil
20102.9715428.4nil
20113.4524852.510.5†
20123.8531762.521.5
2013*4.0633768.322.8
% change+5+6+9+6

Normal market size: 5,000

Matched bargain trading

Beta: 0.8

*Espirito Santo forecasts †Excludes 34.9p special dividend

A relatively hassle-free year at its key hubs helped this year, too. Less than 1,000 easyJet flights were cancelled compared with over 4,000 in 2011 and more than 7,000 the year before. Yet the threat of industrial action is never far away. Anti-austerity strikes across Europe two years ago cost easyJet £50m, and another round of walk-outs last month crippled the region's transport network. Flight controllers are a militant lot and more protests look likely.

Luring business travellers remains a priority. Selling them tickets through global distribution systems makes sense, but easyJet will not feel a full-year's benefit until 2014. And it's unclear what it will make from introducing allocated seating. It narrows the price gap between traditional airlines and the budget crowd, but replacing 'priority' boarding will only boost revenue if enough passengers opt to pay an extra £3 to choose their seat and trials showed the take-up was low.

Then there is a technical concern; after surging over 40 per cent since September, easyJet's shares trade a third higher than their 200-day moving average, which suggests they are heavily overbought. That over extension matches the maximum during this bull run and equals the gap when the shares hit their record high in April 2007. On each occasion the share price fell soon after.