Since the British voters chose to leave the European Union on Friday, financial markets have entered a state of turmoil. With its obvious exposure to international relations, shares of easyJet (OTC:EJTTF) ADR (OTCQX:ESYJY) have sold off massively, losing more than a third of their value. At this point, it becomes interesting to assess whether the real impact of a Brexit justifies a downgrade of this magnitude. A closer look at the different factors of influence reveals a clear overreaction. Although I wouldn't immediately jump all-in at this point (let's see how much cheaper it can get), it is certainly worthwhile to look for a long position.
A short recap
On June 23th, the British people voted in a referendum to leave the European Union. The following shock on financial markets was enormous, with the pound dropping more than it did in on the day Lehman filed for bankruptcy, back in 2008. A main catalyst for this turmoil was that the majority of market players anticipated a different outcome. In fact, most polls predicted a 'remain' vote, albeit with a small majority. Combined with the natural tendency of people to favor the status quo when faced with uncertainty, a remain outcome seemed likely, and tracking errors and safety margins were overlooked.
Consequences for easyJet
The most important consequences for easyJet stretch further than just passenger numbers. The most obvious risk is regulatory. For practical reasons, the company may have to apply for an Air Operator's certificate (AOC) in a member country. In that context, it has explored the option of starting a separate European business. A second issue is sterling, that has dropped more than 11% against the dollar and over 8% against the Euro. This causes two additional sources of trouble. First, the relative purchasing power of British citizens declines with the currency, causing holidays in euro and dollar areas to become more expensive. On top of an expected economic slowdown, this can lead to lower demand and, consequently, lower holiday traffic. Second, is downward pressure on profits, as some costs (and debt components) are denominated in other currencies, while the company reports in pounds. easyJet stated this will add £25 million in costs alone. All in all, these components make easyJet one of the most exposed companies with respect to the Brexit scenario. The company released a statement, However, the bad news does not end here.
The perfect storm of adversity
Brexit-related issues are just part of the adversity. There is never a good time for such an event, but this moment was particularly poor. First of all, increased terrorist activity in Europe put pressure on airlines, as increased fear reduces perceived flight safety. On top of that, a Russian aircraft crashed in May in Sharm el-Sheikh, an important tourist destination in Egypt. After that crash, all flights to that destination were suspended for a while, causing additional revenue pressure. Second, after French air control personnel started with a four day strike, Easyjet's cockpit personnel followed on June 14th. Easyjet was able to prevent most damages by reallocating personnel from other countries, but faced legal actions by the Dutch union. The Dutch court has prohibited all strikes until July 1st, but forced parties to be more open in solving the conflict. These strikes, combined with bad weather and logistic issues at London's Gatwick airport have caused over 1,000 flight cancellations already. As a result, easyJet announced that revenue per seat will decrease by 8.6%, not the 7% that was stated in the previous outlook. These results have to compete with strong comparables, as low oil prices caused strong results last year.
Although , there are some positive elements that appear to be overlooked in this doom scenario. First, and most importantly, these issues are industry wide, and have nothing to do with the quality of ESJ's product offering. In fact, within the entire industry, easyJet continues to take away market share from the traditional (more expensive) airliners. In addition, most adversity is of temporary nature. Influences such as strikes, bad weather and terrorism can have their impact, but are isolated and do not persistently affect demand negatively. The Brexit problems do have this negative demand pressure. However, at the time of its profit statement, company management declared that it will intensify its cost cutting program. This could potentially cushion some of the weaker demand.
Speaking of demand: the currency impact potentially works both ways. With the pound at historical lows versus other main currencies, England (London in particular) has become a lot cheaper to visit. This could increase interest in the area as a tourist destination. easyJet is well positioned to take advantage of such a demand boost. Until that happens, the company is ready to weather the storm, with high liquidity (£940m in cash, $380m unused credit facility), and low leverage (net debt is negative, debt to equity ratio just 22%). The dividend seems safe too, with a payout ratio under 40%.
With its main office in the UK and the main travel routes consisting of traffic between the UK and continental Europe, easyJet seems one of the obvious casualties of the Brexit vote. On top of issues of strikes, weather and terrorism , this has created the perfect storm of adversity, and share price reactions have acted more than accordingly. When taken a step back from all the chaos, it becomes clear that most of these issues are not caused by the underlying business quality, nor are they likely to persist for long periods of time. With the latter in mind, it is good to know ESJ has the balance sheet to weather the temporary storm without having to take heavy measures. At prices around 1000p (in London), the company is valued attractively, even given current conditions. The relative rise of the dollar makes the opportunity even bigger for US investors. This is a good time to diversify (dividend) exposure by investing in a solid name. It can hardly get any worse, and the stock is priced accordingly. The upside potential makes the stock not an obvious, but a potentially very rewarding buy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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