This brings me to easyJet (EZJ) and to how I use my views on market cycles when making individual share purchase decisions. EZJ is one of Europe's largest airlines and its website proclaims that its "combination of convenient airports and wide range of destinations means [it] has broad appeal across different geographies and customer types". In my opinion, it has set itself apart well by being a low-cost airline as opposed to a no-frills airline. Whereas I wouldn't dream of flying with Ryanair, I have flown with EZJ and found that it gave me the perfect combination of price, convenience and comfort. I won’t pay extra to fly with BA within Europe, just to get a free drink and a "meal." (Last time, I got a packet of crisps last time - what happened to sandwiches?!).
I'm not the only one who feels this way judging by the impressive revenue growth and earnings per share (EPS) growth over the last five years. Its revenue in 2012 was up 11.6 per cent up on 2011 and EPS growth was 19 per cent for the same period. Trading on a forward price earnings ratio of 15.8 times, the shares are not cheap, but EPS is forecast to grow 37 per cent in 2013 and the forecast dividend yield is 2.1 per cent. The business model is working well, as easyJet is taking market share from national carriers, while it is aiming to grow its position in key business routes.
What troubles me, however, is the single biggest cost to any airline - fuel. Fuel makes up 32.5 per cent of EZJ's 2012 costs and eats up 29.9 per cent of revenue. Net profit margin is pretty slim at 8.2 per cent of sales. In addition, foreign exchange movements are another risk, 47 per cent of revenue is in sterling, and 43 per cent in Euros, whereas 35 per cent of costs are in US Dollars.
To manage these risks, management state that EZJ hedges forward between 65 and 85 per cent of the next 12 months' anticipated fuel and currency requirements and between 45 and 65 per cent of the following 12 months' anticipated requirements.
So any volatility in the price of fuels, either driven by or combined with adverse exchange rate movements, could seriously impact analysts' earnings forecasts. Whilst I believe that easyJet has a great product and is well run, there are two big cost-drivers that are inherently volatile that investors appear to have become complacent about whilst driving the share price up to new highs. As I believe the commodity bull market cycle won't peak until 2015, I think the share price is very vulnerable to any unexpected events that cause the oil price to spike higher.
Of course, the opposite could happen, but investing is all about making decisions based on things you know and your beliefs about future prospects, in order to get the balance between risk and reward. Therefore whilst I am happy to fly EZJ, I won't be buying them for the ValuableGrowth portfolio.
READ MORE...
Get more trading ideas.
