Is the easyJet share price undervalued?

The easyJet share price has almost halved in three months, but is now the time to buy? Or is there a bigger threat on the horizon?

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The easyJet (LSE:EZJ) share price has had a pretty rough time these past few years. And 2022 doesn’t seem to be any different, so far. Over the last three months, the stock has taken a 15% tumble, dragging its 12-month performance to a disappointing -38% return.

But with the operating environment improving and passenger volumes taking off, is this low valuation actually a buying opportunity for my portfolio? Let’s explore.

The bull case for easyJet’s share price

Looking at its latest earnings report, there are plenty of encouraging signs of recovery. Throughout the last three months of 2021, easyJet watched its losses half while simultaneously reducing operating cash burn.

The reduction in losses can largely be attributed to a significant jump in passenger volumes. Throughout the quarter, easyJet operated at 64% of pre-pandemic capacity versus only 18% a year before. This number actually reached as high as 71% in December, despite the negative impact of the Omicron variant on the travel sector.

Being a largely fixed-cost business, these performance improvements were insufficient to turn a profit. However, as I just said, headline losses for the period practically halved, coming in at £213m versus £423m in 2020.

Now that Covid-19 is slowly loosening its grip on the travel sector and the world in general, easyJet’s return to profitability could be imminent. In fact, analyst forecasts suggest this could happen by the end of 2022. But if that’s the case, why is the easyJet share price still limping on?

Problems on the horizon

One of the biggest expenses any airliner has to deal with is fuel. And with oil prices skyrocketing recently, businesses like easyJet are undoubtedly feeling the pinch on margins. Consequently, even if passenger volumes fully recover, the company may not return to the same level of profitability as before. This risk is only further exacerbated by the increased debt burden.

Unfortunately, the problems don’t stop there. The ongoing war in Ukraine also adds fuel to the fire, albeit indirectly. With Germany seeking to eliminate its heavy reliance on Russian oil, the government has relit many of its coal power plants. The strategy seems to be working from an electrical generation standpoint. But the impact on the environment is far more severe due to the surge in carbon emissions.

Consequently, this is driving up the price of the European Carbon Allowance. In other words, the taxes on carbon emissions are going up. Currently, airliners like easyJet have an exemption from this tax. But it seems the European Commission is currently seeking to phase out this exemption. And with the company’s operations based almost entirely within Europe, profit margins could soon be under even more pressure. Needless to say, that’s bad news for the easyJet share price.

Time to buy?

At the current share price, easyJet has a market capitalisation of around £4bn. Compared to the £5.3bn revenue forecast for 2022, this valuation certainly looks cheap. At least, that’s what I think.

But personally, I remain untempted by this potential opportunity. With so many external forces influencing its future profitability, the company doesn’t appear to be in charge of its own destiny. And that’s not something I’m interested in adding to my portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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