As the travel industry makes a comeback, I would’ve expected airline stocks to take off. So, it’s odd to see easyJet (LSE: EZJ) shares doing so poorly, as it’s down 30% this year. So, here’s why the easyJet share price is crashing.
A dissipating tailwind
On Monday, easyJet released its summer trading update. The good news was that, “Demand for travel has returned“, according to CEO Johan Lundgren. Passenger occupancy for the months of April and May was seven times higher than last year, with expectations for capacity to reach 87% of pre-pandemic levels this quarter. Unfortunately, that’s where the good news ends.
Despite the upbeat tone, investors punished easyJet stock as management lowered its initial guidance. Although 87% capacity of 2019 levels is still high, this is lower than the 90% initially guided. The firm’s outlook for Q4 also saw a decline to 90% of 2019 levels. Additionally, higher operating costs soured investor sentiment even further.
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Not so easy
Pent up demand and the lack of airport staff have led to chaos at British airports. Gatwick Airport, easyJet’s base, has announced daily flight caps as a result. This is part of the reason why the FTSE 250 firm has had to lower its guidance, as growth in passenger numbers hit a ceiling.
Gatwick Airport normally operates 900 flights a day in August. But it’s capped its daily operations to 825 flights a day in July, and 850 flights a day in August for this year due to staff shortages. This has led to delays and flight cancellations.
Many analysts are predicting that these delays and cancellations could cost easyJet up to £200m. Nonetheless, management believes that its high frequency network allows for most passengers to be rebooked onto flights within the same day, thus preventing a big loss in revenue.
Turbulence or engine failure?
Whether this chaos will have a devastating impact on the company’s top line will be revealed in its next trading update. What I do know, however, is that the board is bullish about the airline’s long-term growth. It recently announced a mammoth order for 56 Airbus A320neo aircraft, and converted its initial order of 18 A320neos to the bigger A321neos. These aircraft are more fuel efficient and provide bigger capacity. As such, I’m expecting the Gatwick-based firm to reduce its operating expenses in the long term, and reverse its declining profit margins.
| Financial Year | Profit Margin |
|---|---|
| 2015 | 11.7% |
| 2016 | 9.4% |
| 2017 | 6.0% |
| 2018 | 6.1% |
| 2019 | 5.5% |
| 2020 | -35.9% |
| 2021 | -58.8% |
That being said, I’m worried about the easyJet share price in the short-term. High fuel costs and rising interest rates present heavy economic headwinds, with analysts bracing for a potential recession. This would undoubtedly impact sales figures.
Fortunately for the firm, it’s got sufficient cash (£3.5bn) to covers its debt (£3.1bn). However, it goes without saying that its debt-to-equity ratio is still disproportionately high, at 126.4%. On that account, another couple of bad quarters may hinder the budget airline’s return towards profitability.
Nevertheless, easyJet’s business model isn’t my cup of tea. Its history of low-quality earnings paired with high levels of uncertainty makes it a risky investment for me, hence why I won’t be investing in easyJet shares. Instead, I’ll be investing in other growth stocks that have better profit margins.
