Can Airline Stocks Recover?

VIDEO: Airlines have been some of the worst hit company's in the Covid-19 crisis. Can they recover? Morningstar analyst Joachim Kotze takes a look 

Holly Black 2 February, 2021 | 10:47AM
Facebook Twitter LinkedIn

 

 

Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Joachim Kotze. He is an equity analyst at Morningstar. Hello.

Joachim Kotze: Hi, Holly.

Black: So, Joachim, you have been looking at the airlines industry, which has obviously been one of the hardest hit in the last 12 months. Can you tell us a bit about the state of the sector after Covid and what potential recovery looks like?

Kotze: Yeah. I think it comes as no surprise that the industry is facing the biggest devastation and the worst downturn in its history. Most flights are grounded globally due to restrictions and basically revenues disappeared and causing major cash outflows for the airlines. This financial strain on the industry is leading to a lot of airlines making use of state support packages in the form of either guaranteed loans, bailouts or furlough programs to show up group liquidity. Their recovery unfortunately remains extremely uncertain. What we see now with the vaccine rollout, there's some hiccups. We see new variants of the virus, and we've got strict new lockdowns to combat the second wave. Companies such as Air France and Lufthansa, they'll emerge with a massive pile of debts and that could take years to repay and may require some restructuring at some point in the future.

Just coming back to the recovery, obvious that the short haul domestic and regional leisure travel should recover first, which will benefit the low-cost short haul airlines such as Ryanair, EasyJet, and Wizz Air, and then we will see a more prolonged recovery at international and business related travel which will impact network airlines such as Lufthansa, the British Airways Parents, IAG and Air France-KLM.

Black: Well, that's it. Even in the most dire of circumstances, the best or the most agile companies can usually find an opportunity. So, what opportunities are there for airlines?

Kotze: That's quite correct, Holly. I mean, if you're well-positioned, there are some really good opportunities. Just circling back to the industry as a whole, I think the major opportunity is cost reduction. The industry as of late seen bloated staff costs, which is a major cost for the industry due to restrictive labor agreements, especially at your network carriers who are heavily unionized. We will see some of the airlines using this opportunity to renegotiate with unions as the bargaining power is shifted and perhaps use this opportunity to lower the staff cost component, which as I said is the second biggest cost item after fuel. What we could also see happening is perhaps going forward with the agreements making use of more seasonable labor into the future, whereas airlines can then balance their costs with demand seasonality.

Going back to the airlines who have the strong balance sheet and the liquidity, here, I'm talking about the likes of Ryanair and Wizz Air, they can make use of this opportunity to negotiate attractive discounts with aircraft suppliers such as Boeing in Ryanair's case and Airbus in Wizz Air's case and negotiate attractive discounts from list prices and also negotiate with ground handlers and airports for landing fees.

Black: Okay. So, with all that in mind, have you got a top stock pick in the sector?

Kotze: Yeah, of course. We obviously need to highlight that the outlook for the industry as a whole is extremely uncertain. And while we are more optimistic about the growth prospects for both Ryanair and Wizz Air, our top pick is actually EasyJet and that is in terms of their risk-reward ratio. Our fair value estimate of £10.90 represents about a 30% upside from the current or prevailing share price. And there's a couple of opportunities for the group here.

Firstly, and I think this is the biggest one, is their long overdue cost restructure. They've lagged low-cost peers in terms of their cost structure. It's quite important to note that EasyJet differs slightly from their low-cost peers Ryanair and Wizz Air, and that they focus on primary airports, whereas their peers serve secondary airports. So, EasyJet actually shares a greater route overlap with that of their network legacy carriers such as Air France, British Airways, and Lufthansa.

So, what they will do is they will focus on consolidating their positions at their key hubs in Europe and an attempt to try to gain share on the high traffic routes at primary airports. This could lead to them potentially benefiting from business travel downtrading as we emerge from the downturn and they could also be relative to other legacy players benefit from an early uptick in short or intra-European leisure travel. So, overall, we are optimistic about the cost restructuring efforts at EasyJet, their ability to gain share, and while the valuation offers a decent margin of safety in our opinion to compensate for some of the risks that are currently facing the industry.

Black: Joachim, thank you so much for your time. For Morningstar, I'm Holly Black.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Holly Black  is Senior Editor, Morningstar.co.uk