Do cheap flights translate into cheap shares?

Delayed release

Next time you are flying with one of the leading European airlines, they may ask whether you would like to purchase some of their shares along with the drink they just handed you. You then think to yourself, “surely I could afford to, especially since I passed up the opportunity to take the same flight to Lisbon for just £19 with Ryanair or Easyjet.”

According to JP Morgan’s Christopher Combe, the European airline industry is carrying an average 8.9x price-to-earnings for 2016. Accordingly, Air France-KLM, International Airlines Group and Lufthansa are well positioned with below average industry P/E. Ryan Air and Easy Jet sit above the industry average. A major net revenue driver for the industry has been fuel savings. However, Combe expects a positive growth in Brent oil price for 2016-2017, albeit revised 25 per cent lower than previous estimates.

Air France-KLM (AFK) share price closed at €7.44 on February 16, 2016, which represents a 12 per cent drop from the top of its 52 week range of €8.49-5.52. This morning’s announcement of a 4.6 per cent rise in annual revenue to €26,059 will likely give a much needed boost to its share price, especially as AFK has not seen positive net earnings since 2010.

While AFK kicks of 2016 on a front foot financially, it continues to be constrained strategically. Proposed restructuring plans, such as Transform 2015 and Perform 2020, were interrupted by announcing thousands of job cuts in October 2015. Fortunately, AFK executives only had their shirts ripped off in the process. Strength of the labour unions continue to plague the profitability outlook of the airline, especially as 79 per cent of revenue came from its scheduled passenger air transportation.

Revenue analysis: AFK is exposed to a dependency on scheduled passenger sales. Of the €26,059 million in 2015 annual revenue, €20,541 million represented scheduled passenger sales (or 79 per cent of revenue). Broken down by geographic region, €12,723 million sales are from Europe, representing 62 per cent of total scheduled passenger sales. Notably, North America and Asia Pacific made up €2,994 and €2,048 million, representing 25% of scheduled passenger sales.

Expense analysis: AFK incurred external expenses of €15,682, salaries and related costs of €7,852, aircraft leasing costs of €1,027, and depreciation expense of €1,631. As a percentage of external expenses, 39% was aircraft fuel, 25% aircraft maintenance and other operating costs, and 12% landing fees and air route charges. Wages and pensions made up 85% of the €7,852 salaries and related costs.

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