Wizz Air: DCF Shows 40% Upside On Eastern European Airline

| About: Wizz Air (WZZAF)

Summary

I present a comprehensive valuation of Wizz Air using discounted cash flows.

Wizz Air is an ultra-low-cost carrier based in Eastern Europe and traded on the London Stock Exchange.

Wizz Air is expanding rapidly, adding 23% capacity in FY2018.

Based on a discount rate of approximately 8%, I value Wizz Air at £45/share, and rate it as a Buy.

Operating in Eastern Europe is not without risks, and Wizz Air's convertible debt structure and Indigo's recent sale of Wizz Air shares may provide reason to be cautious.

Investment Thesis

In this article, I estimate the value of Wizz Air (LON:WIZZ, OTCPK:WZZAF) using a DCF model based on its future cash flows and growth potential. This valuation is done in Euros, and includes assumptions based on the future growth of the company, its margins, and risks associated with countries in which Wizz Air does business.

Based on my evaluation, I value Wizz Air at £45 (or €51, but Wizz Air is traded in GBP), and rate it as a Buy. For liquidity reasons, I recommend trading the London-based stock rather than the US ADR. The London-based stock is currently trading at approximately £33.

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Source: Yahoo Finance

Over the past two years, Wizz Air's price has been kept down due Brexit concerns and the impact of terrorism on tourism. However, Wizz Air has risen substantially since May on strong summer results and the waning impacts of terrorism and anti-tourist sentiment.

Wizz Air has almost doubled since March, and it continues to have further upside as the company mitigates Brexit concerns, and picks up tailwinds from the demise of competitor Monarch Airlines. While Monarch Airlines collapsed in the competitive low-fare environment in Europe, Wizz Air is perfectly poised to thrive in such an environment: Wizz Air has the lowest unit costs of any airline and has no debt, since all their airplanes are leased.

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Source: Volaris Air presentation, by way of SA contributor Anthony Breen

These factors will enable Wizz Air to thrive in a competitive price environment: Wizz Air has trailing twelve months operating margins of nearly 16%, net margins over 15%, and plans to expand capacity by 23% this year.

Wizz Air Is Growing Quickly

Wizz Air is an ultra-low-cost airline that operates primarily in Eastern Europe, as well as offering flights to Eastern Europe from Western Europe. Like other ULCCs (e.g., Spirit Airlines (NASDAQ:SAVE)), the company offers fares with few extras. In fact, until recently, even carry-on bags cost an additional charge. This fare structure allows for extremely low base fares.

Wizz Air also offers extremely low unit costs, allowing them to compete effectively in competitive fare environments. Further, Wizz Air has nearly no debt, since all of its aircraft are operated on leases.

Wizz Air is growing quickly and makes healthy profits. During the first quarter of 2018, ending June 30, 2017), Wizz Air reported revenue growth of 29%, and the airline is forecasting FY2018 capacity growth of 23%. Last year, Wizz Air reported operating profits of €247 million, and net income of €246 million, on revenue of €1,570 million. This was a 10% increase in revenues from FY 2016, and continues Wizz Air's long-term growth trends. In future years, the company intends to continue to grow capacity by around 15% per year.

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Source: Author, based on Wizz Air annual reports

Estimating Future Growth

In order to value Wizz Air, I first estimate the company's future revenue and operating profit growth based on Wizz Air's fleet growth plan and capacity growth forecasts.

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Source: Wizz Air Q1 FY 18 Results

For 2018, I estimate that Wizz Air's revenue will grow by 25%. This estimate is based on Wizz Air's stated capacity increase of 23% for both the first and second halves of 2018. Based on Wizz Air's traffic stats and other releases, the company has flown 25% more passengers in the first half of 2018 than a year previously. This estimate is further based on an estimate that unit revenue (revenue per available seat kilometer, or RASK) in the last three quarters of 2018 will grow by 0.5%, based on Wizz Air's estimate of "slightly positive" RASK. During the first quarter of 2018, unit revenue grew by 3.3%.

In 2019, I estimate Wizz Air's revenue will grow by 19%, and will grow by 17% in 2020. Both of these estimates are based on forecasting unit revenue increases of 0.9% (matching unit cost increases, as discussed below), and based on the total number of airline seats that the company will offer, based on its fleet plan in its 2017 annual report. Past 2020, I estimate that Wizz Air's unit revenue will continue to increase by 0.8% per year, while capacity will increase 15% per year. This estimate is based on CEO József Váradi's assurance during the first quarter earnings call that 15% is a good approach to modeling the company's growth.