Cube Midcap Report (8 Oct 2020) – easyJet flies low with first ever loss

Cube Midcap Report (8 Oct 2020) – easyJet flies low with first ever loss

Good morning, it’s Roland here with today’s Midcap report. On my list today are:

  • easyJet (EZJ) – full-year trading update
  • Hargreaves Lansdown (HL) – Trading update

We’re continuing to trial a new, shorter-format report, so I should be finished by 9am.


easyJet

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Market cap £2.4 billion
RNS Year-end trading update
Writer disclosure No position.

Anyone interested in the airline sector might want to take a look at this piece. The author drills down into the pressures facing airlines right now, but also makes the interesting point that many of the changes we’re seeing were already underway. COVID-19 may just have forced a brutal acceleration of the industry’s evolution.

Right now, one point that’s very clear is that airlines haven’t ever had to deal on a global scale with both safety fears and a massive slump in GDP (and hence spending) at the same time.

FY20 guidance: Against this backdrop, it’s no surprise that FTSE 250 budget airline easyJet expects to report its first ever full-year loss for the year ended 30 September. Today’s full-year trading update includes some pretty big numbers:

  • Passenger numbers down 50% to 48m
  • Expected headline (adjusted) pre-tax loss of £815m-£845m
  • Exceptional items of £440m

The exceptional costs for the year relate to money lost on unused hedging, restructuring costs and impairments on lease contracts.

Operating performance – signs of hope?

easyJet says it achieved a load factor of 76% since flying restarted in July. In other words, 76% of available seats were sold.

My understanding is that as a rule of thumb, airlines need a load factor of around 70% to break even. So this appears to support easyJet’s contention that it is focusing on profitable flying.

During the fourth quarter (July-Sept) easyJet flew 38% of its original schedule. Flight numbers dropped sharply in September due to changes in quarantine rules. However, this quarter represents the seasonal peak for European short haul.

The next quarter is traditionally quieter. easyJet expects to fly just 25% of planned capacity during the final three months of 2020. I don’t know how long this level of flying will be sustainable without a permanent, structural reduction in the airline’s capacity.

The hope is that demand will surge into the summer — management say that booking levels for summer 2021 are currently “in line with previous years”. That sounds promising, but I’d guess it’s too soon to be sure. I know I’ve never booked a summer holiday this early.

Liquidity: easyJet says that liquidity remains strong with a cash position of c.£2.3bn at the end of September and a net debt position of £1.1bn (FY19: £326m). It remains to be seen how easily the airline will be able to deleverage in coming years.

My view

I’ve been cautiously optimistic about the medium-term outlook for easyJet in my coverage this year, while noting that timing an entry is likely to be very difficult.

Today’s numbers haven’t changed my view and if anything have strengthened my conviction that this business should be a long-term survivor. I’m inclined to think that c.500p is a good entry point, but I’m not in any rush to get involved. In my view, a better way to invest in a recovery in air travel is through essential technology providers.


Hargreaves Lansdown

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Market cap £7.1 billion
RNS Trading update
Writer disclosure No position.

The FTSE 100 fund supermarket and DIY investment platform has released a trading statement for the quarter from July-September.

As we’ve come to expect, the numbers look pretty solid.

  • Net new clients +31,000 (2019: +35,000)
  • Net new business +£0.8bn (2019: £0.8bn + £0.9bn of institutional transfers)
  • Assets under management up by 3% since 30 June 2020 to £106.9bn

However, the growth in AUM was more dependent on market movements than last year:

HL Q1 FY21 AUM

My view

Hargreaves’ new business was boosted during this period last year by two “back book transfers” from larger institutions. These totalled £0.9bn. Excluding these, new business was flat on the same period last year, at £0.8bn.

Market performance was much stronger this year, but I think it’s hard to avoid concluding that Hargreaves is now a relatively mature business, only able to deliver incremental growth.

However, I think Hargreaves’ valuation reflects this, as does the increased dividend payout ratio. Although the stock looks expensive on around 30 times forecast earnings, this is supported by operating margins and returns on capital in excess of 65%. That’s pretty exceptional.

Cash generation is good and the 80% dividend payout ratio provides a relatively attractive 2.5% yield.

I see this business as a high quality compounder. I don’t think the current valuation is unreasonable. I’d be prepared to drip feed money into Hargreaves stock at current levels.


That’s all for today. Thanks for reading, I hope you’re enjoying this new shorter format — please do let us know what you think and leave a thumbs-up below if this report has been useful!

Cheers,

Roland

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COMMENTS

Wordpress (3)
  • comment-avatar

    Agree on Easyjet Roland although I’m looking for an even cheaper entry than 500p. Same with Jet2
    I just don’t think the market is pricing in enough risk for the airlines currently.

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  • comment-avatar

    Thanks Roland,

    I’m also waiting and trying to figure where the bottom might be for Easyjet (also Ryanair and Jet2).

    But when you say “My understanding is that as a rule of thumb, airlines need a load factor of around 70% to break even”, is that not taking into account all their planes and staff? In “normal” times these would be kept working pretty hard. There must be considerable costs incurred in lots of both being held sitting on the sidelines so maybe that c70% of operating flights figure needs to be somewhat higher to cover the costs of their total fleet/staff??

    Or have I got that wrong?

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    • comment-avatar

      Hi Laughton, that’s a good point. The costs of keeping the majority of your staff and planes on the ground are considerable. easyJet is cutting costs but even so expects cash burn of c£700m for the fourth quarter (Jul-Sept). No guidance was provided for the current quarter but I guess a similar figure is likely.

      However, I think it’s also useful to look at the profitability of the planes which are flying. Ultimately the airline can shrink capacity if it needs to, but only if it can operate the remaining capacity profitably. At least, that’s my thinking!

      Cheers,
      Roland

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