Last month’s quarterly trading update reported an 8% increase in unit revenues for the Oct-Dec quarter and forecast a significant narrowing of first half pre-tax losses from GBP112m to between GBP50m and GBP75m.
Since the trading update, easyJet’s founder and largest shareholder, Sir Stelios Haji-Ioannou, has sold a small portion of his holding as a warning to management against making a new aircraft order and he remains a vocal critic of the company.
In addition, easyJet Chairman Sir Mike Rake, often criticised by Sir Stelios, has announced his resignation in the summer of 2013.
The share price of Europe’s second biggest low cost carrier is up 13% since the trading update and up 97% over the past 12 months, so it seems that other shareholders have been persuaded of easyJet’s strengths and opportunities. So is Stelios right to focus on the weaknesses and threats - or is he the biggest of them?
This SWOT analysis is the first in series of CAPA features.
Pricing. In competing against legacy carriers, easyJet’s main advantage is its price structure, which sees its average fares somewhere around 50% lower than those of the major carriers on short haul routes and 20% to 40% below those of most other lower cost competitors. In addition to this average fare advantage, easyJet’s highly dynamic revenue management system adjusts fares to demand levels in order to maximise revenues, rather than always to charge the lowest fare. The only significant European airline with average fares below those of easyJet is Ryanair.
Unit cost. The only way to sustain a price advantage is to have a sustainable unit cost advantage. easyJet’s cost per seat advantage relative to the major flag carriers is similar to the average price differential noted above. This unit cost advantage stems from a number of factors, including high seat density (as noted above), high load factors (88.7% for easyJet in the year to September 2012 versus just below 80% for AEA carriers), a point-to-point strategy that allows high aircraft utilisation, a young and efficient fleet, lean overheads, labour productivity and a lack of legacy pension costs.
Airport network and market share. easyJet has a presence in 49 of the top 100 market pairs in Europe, more than any other carrier (see Chart 1). Crucially, 46 of these involve primary airports, versus 24 primaries for Ryanair and 34 for IAG. This presence puts easyJet within reach of a large proportion of the European population and its primary airports are beneficial to its yields. Across Europe as a whole, it is number two by passengers, with a share of 9%, just behind Ryanair with 12%.
Moreover, like Ryanair, but unlike the legacy carriers, easyJet has bases all over Europe with locally based aircraft and crews. Not only does this raise its visibility locally, but it also enables a genuine network of routes between its destinations, rather than the more limited radial routes from one or two major hubs typically operated by legacy carriers.
Presence in Europe’s top 100 market pairs: easyJet vs competitors
Fleet. Since its last two Boeing 737s exited the fleet earlier in 2012, easyJet’s fleet now consists of a single aircraft family, the Airbus A320, giving advantages in terms of crew certification, training and maintenance. At 30-Sep-2012, it had 160 Airbus A319s, with 156 single class seats (a more standard two class configuration has 124) and 54 A320s, with 174 seats (versus 150 more commonly). This higher seat density gives a unit cost advantage against legacy carriers operating the same aircraft and easyJet is continuing to grow the number of A320s in its fleet, further enhancing its unit cost advantage.
easyJet's average fleet age is around four years, versus 9-11 years that is typical for European flag carriers, giving advantages in terms of fuel efficiency, maintenance costs and customer perception.
easyJet fleet at 30 September 2012
Brand. Although still seen as a no-frills low cost carrier offering a commoditised product, easyJet has improved its brand perception in recent years. It already enjoyed good brand awareness, particularly in the UK, but this has now spread to other countries and has been supplemented by improved customer satisfaction (in itself due in no small measure to improved on-time performance). Although it is early days, easyJet is showing increasing willingness to hybridise to enhance the brand, both through introducing the opportunity for a form of brand loyalty - but without the costs of a formal FFP - through its deal with UK loyalty card programme, Nectar, and for example in its linking with Emirates and its FFP, Skywards.
Financial performance. Under its (not so) new management team of CEO Carolyn McCall and CFO Chris Kennedy, easyJet has improved its financial performance over the past couple of years. Its strong balance sheet and cash generation and returns that exceed the cost of capital make it all too rare in the airline industry globally.
Management targets a minimum Return on Capital Employed of 12% (including capitalised operating leases in the capital base) or 15% excluding operating leases. In the year to September 2012, it achieved ROCE of 11.3% including operating leases, or 14.5% ex operating leases, just short of its targets, but comfortably ahead of its cost of capital.
Stelios. Although Stelios, easyJet’s founder and largest shareholder, is no longer involved in managing the company and is not even on the board, it has benefited from being associated with him and the development of his ‘Easy’ brand and its positive brand attributes (although, at the same time, recognition of the Easy brand is almost entirely due to the success of easyJet).
Cost base is not as low as that of Ryanair. As noted above, easyJet has a unit cost advantage against most competitors, but not against Ryanair. Its cost per seat is around 50% higher than Ryanair’s, so it is vulnerable to direct competition on airport to airport pairs or even city to city pairs from its Irish rival. Although the two only compete head to head rarely, this competition could increase in the long term as each exhausts growth from its existing network and as the opportunities to add new airports become less frequent.
Brand vs legacy carriers. easyJet’s brand is probably stronger than many LCC competitors, but LCCs as a whole probably still suffer from a brand disadvantage relative to the major legacy carriers. As noted above, however, this is slowly changing as easyJet improves its on-time performance, continues to focus on primary airports and offers additional product features such as allocated seating and re-ticketing flexibility (for a premium). Nevertheless, the product still has fewer ‘frills’ than that of legacy full service carriers and this means that price will remain the key dimension of competition.
Seasonality of earnings. As for the industry in general, easyJet’s earnings are highly seasonal, with its profits increasingly relying on a strong summer half year (April to September) to offset a loss-making winter (October to March). This makes it vulnerable to any unexpected problems in the summer in an industry that is beset by ‘one-offs’.
easyJet’s half yearly profit before tax (GBP, mill): 1H2005/06 to 2H2011/12
Stelios. Disputes in recent years between Stelios and management have generated adverse publicity and arguably damaged the brand, particularly where they drew attention to factors such as poor on-time performance. Moreover, some of Stelios’ public comments have had a negative impact on the share price. Share price volatility, if sustained, adds to a company’s cost of capital.
Market growth. Although notoriously cyclical and currently going through a sluggish phase, the aviation sector remains a growth industry in the medium to long term, by common consensus. easyJet, as a significant market player, is well placed to participate in this growth. Moreover, given its cost and price advantages and current capacity cuts from most of its legacy carrier competitors, it looks set to enjoy market share gains too. As the carrier takes cautious steps into connecting with other airlines, the opportunities that come with partnerships will also open new doors.
Further cost cutting. In order to maintain its price advantage, easyJet must ensure that it maintains its unit cost advantage against legacy carriers that are continually looking to trim costs and are transferring significant parts of their short haul networks to low/lower cost subsidiaries. The ‘easyJet Lean’ initiative has identified areas for cost reduction, such as airports, ground handling, engineering and fuel, and aims to cut costs by GBP190m by 2015, of which it had delivered c.GBP100m to the end of September 2012.
Fleet. Management is currently assessing its options for a major new order to drive fleet growth from 2017 and considering its interim fleet plans for 2014-2017. Based on scheduled deliveries and options under its existing Airbus contract, it has significant fleet growth flexibility to 2016.
It could choose to track typical market growth rates of 3%-5% pa, or to cut the fleet by 2% pa, depending on demand levels.
easyJet fleet count and flexibility in fleet planning to 2017
The evaluation of a possible new aircraft order provides easyJet with a significant opportunity to secure its long term growth with modern, new generation, fuel efficient aircraft. It will also hope that its size and purchasing power can secure a price advantage for these aircraft, although it seems unlikely that it will match the massive discounts secured from Airbus in 2002, given the much bigger order backlog currently enjoyed by both Airbus and Boeing. easyJet is considering airframes from Airbus, Boeing and Bombardier and engines from Pratt & Whitney and the GE/Snecma JV CFMi.
If easyJet were to change from Airbus, it would presumably only do this if the price was very favourable to offset initial diseconomies in terms of crew certification, training and rostering and maintenance costs. Indeed, on a recent conference call with analysts, CFO Chris Kennedy was keen to stress that “we will not do a deal [with any manufacturer] if we can’t get the right price”.
Business passengers. In 2011, 18% of easyJet’s passengers were flying for business purposes and easyJet aims to increase this to 20%-24% over three to five years. Success in this initiative should be beneficial for yields, given that business travellers book later and pay a premium as a result. Indeed, CEO Carolyn McCall stressed on the Q1 analyst conference call that yield benefit and not market share is the goal for its business passenger initiatives.
Attractions for business travellers include its primary airports, a relative focus on higher frequencies (compared with other LCCs) and its flexible fares product, which allows a passenger free date changes. In addition, and in contrast to LCCs such as Ryanair, easyJet inventory is available through GDSs and easyJet has recruited a sales force to target TMCs and corporate travel departments. Allocated seating should also help to attract business travellers.
Allocated seating. Following trials on 4-5% of its capacity that commenced in April 2012, easyJet announced in October that it would roll out allocated seats across the network. Although management is cagey about its possible impact on revenues, surveys during the trial period revealed that it was popular with both passengers and flight staff and easyJet’s initial focus has been on operational performance. This should enhance yields and does not so far appear significantly to have added to complexity or adversely affected turnaround times.
Stelios. As noted above, comments by Stelios have sometimes had a negative impact on the brand and share price. Nevertheless, his role as an ‘activist’ shareholder has helped to focus management in areas such as capacity growth and dividend payments, with eventual benefits for its finances and share price. This kind of pressure on management, together with the association with Stelios’ ‘Easy’ brand, could lead to further benefits in the future.
Airport price increases. easyJet’s presence at a number of high cost primary airports, most of which enjoy regulatory price increases, provides a headwind in its drive to streamline its costs.
Labour unrest. As with any labour-intensive service industry, airlines are vulnerable to labour unrest, not only among their own staff, but also among key airport-based suppliers such as ATC, ground-handling, security and ground transport. While easyJet has a much better history of labour relations than most legacy carriers, its size, geographical diversity and growing unionisation increase the risk of internal labour disputes, as illustrated by the recently averted strike among its Spanish ground workers.
Increasing complexity. As the airline has grown and its business model has developed to include unbundled pricing, ‘frills’ such as allocated seating and distribution channels such as GDSs, it has also added complexity. This increasing complexity could be a threat if management were to lose its focus.
Return of competitor capacity growth. easyJet is currently benefiting from a more disciplined and rational approach to capacity growth in its markets than has often been the case in the past. Any loss of this discipline among competitors, for example as the legacy airlines' low cost alternatives enter new markets, could threaten the benign yield environment that easyJet is enjoying.
Competitor capacity cuts vs Easyjet growth
Stagnant economies/austerity. In an industry that remains highly sensitive to economic fortunes, all airlines are vulnerable to continued economic sluggishness. That said, easyJet appears to have benefitted in the current downturn from capacity cuts by legacy competitors and increased consumer focus on value for money. Moreover, a recent easyJet survey found 86% of Britons plan to take two or more overseas breaks in 2013, up 6% year-on-year.
External events. Air travel, regardless of the carrier, is vulnerable to geopolitical events and natural phenomena such as earthquakes and volcanic ash disruption. easyJet’s relatively focused geographic exposure arguably mitigates this exposure relative to airlines with a more global network. With a hitherto unblemished record when it comes to fatal accidents, public perception could be adversely affected if easyJet were to be involved in a major accident.
Fuel price and currency movements. The price of jet fuel, which accounts for around 30% of easyJet’s costs, is highly volatile. This reflects not only the unpredictable price of crude oil, but also variations in the crack spread, or refinery premium. In addition, 35% of easyJet’s costs, but no revenues, are in US dollars, making it vulnerable to a strengthening of the dollar against the pound and the euro. To mitigate these risks, easyJet systematically hedges its fuel price and currency exposures, but, even after hedging, the company says that a US$10 per metric tonne movement in jet fuel prices could affect its pre-tax profits by USD4m, a USD1cent movement in GBP/USD by GBP1.6m and a EUR1cent movement in GBP/EUR by GBP1.2million (year to September 2013).
Air travel taxes. Due to price elasticity, increases in air travel taxes reduce demand. In general, these taxes represent a higher percentage of the price of a short haul ticket than a long haul ticket, making easyJet vulnerable to recent increases in air taxes in countries such as the UK.
Stelios. Although the relationship between Stelios and management appears to be more constructive and less adversarial than it was previously, any serious disagreement in the future could provide a distraction for management.
Management has had to swot up on Stelios’ views, but will he swat them away?
easyJet has considerable strengths in its cost base and ticket pricing against the legacy carriers and a strong airport network across Europe, served by a modern and efficient fleet and backed by an increasingly visible brand.
Its improving financial results have been reflected in impressive recent share price performance. However, its cost base and pricing are higher than those of Ryanair, which means that it must try to avoid direct head to head competition with Europe’s leading LCC, and its earnings are highly dependent on the summer season.
easyJet share price (pence): Feb-2012 to Feb-2013
That said, there are likely to be profitable growth opportunities for both, given competitor retrenchment, and easyJet could capitalise on these if it can secure a new aircraft order for deliveries from 2017, at the right price, and provided that management continues to target measured growth rates in the low to mid single digit range. Moreover, its network, frequencies, allocated seating, availability on GDS’s and through TMC’s and pricing should make it increasingly appealing to higher yield business passengers.
Sir Stelios’ public campaign against a number of aspects of easyJet strategy has helped to focus management on increasing the shares’ appeal to shareholders by targeting more steady growth, Return On Capital Employed and paying dividends.
However, any return to more frequent public spats between him and management would not be helpful. Perhaps his recent implied threat to sell his shares if management places an aircraft order in the next four to five years points to the only real solution to such disagreements.