Time for a more positive stance on leading LCCs
* Downward earnings momentum close to bottoming: fragmenting of low cost industry is understood
* easyJet’s shares and estimates have been hit the hardest. Its strategic position remains strong. Double upgrade to Buy
* Ryanair has recovered from its post Brexit trough. A longterm winner, but less attractive risk reward. Upgrade to Hold
* We prefer low cost carriers to flag carriers: We continue to see a challenging
market for short haul airlines in Europe with excess capacity. Structural instability in
the low cost carrier sector continues as Wizz and Norwegian absorb very significant
fleet deliveries and Eurowings, Transavia and Vueling all target the bronze medal in
the Pan European low cost industry. We see these challenges as widely understood.
We do not think this is the case for the flag carriers’ key profit-generating North
Atlantic market, which we expect to become increasingly competitive.
* Ryanair and easyJet should outperform low cost peers: Next year Ryanair and
easyJet will benefit from significant fuel price improvements, in contrast to their low
cost competitors, whose fuel hedging has seen the benefit from falling market prices
sooner. Ryanair and easyJet remain the long-term strategic winners in the market
with solid strategic positions and strong balance sheets. Despite easyJet’s current
short-term commercial and operational challenges, we continue to see it as one of
the two market leaders.
* easyJet strong valuation case: On our estimates, easyJet trades on a CY17 PE of 9.2x,
a 21% discount to Ryanair and an 18% discount to its own 5-year average. Thinking long
term, assessing easyJet and Ryanair on the basis of their mid cycle PBT margins of 10%
and 19% respectively, easyJet trades on 8.7x, at a 35.8% discount to Ryanair. If easyJet
management fail to turn its trading around, we would expect peers to be interested in its
strategic position, network and brand.
* Upgrade easyJet from Reduce to Buy; Ryanair from Reduce to Hold: We raise our
DCF based target prices from 800p to 1,150p for easyJet, from EUR8.50 to EUR12 for
Ryanair, both on raised near-term estimates and slightly higher mid-term margins.