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Clear skies after turbulence at EasyJet

Published: 07:00 06 Jun 2015 BST

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It has been a lacklustre week for equities as uncertainties over the outcome of debt negotiations in Greece and mixed US data deterred investors.


Greece and its creditors, the International Monetary Fund and European Central Bank, are said to be at final stage discussions over their rival reform plans, in a bid to reach a deal that would finally unlock €7.2bn in vitally needed bailout funds for Athens after a four-month stand-off. Spanish Economy Minister Luis de Guindos said that he was certain a deal would be reached between Athens and its creditors.


A strong report on US manufacturing activity reinforced expectations that the economy’s weakness in the first quarter would prove to be short-lived. The Institute for Supply Management’s manufacturing index edged up to 52.8 in May from 51.5, ahead of expectations and its highest reading since February, while the new orders and employment components came in at multi-month highs.


A weak report on US factory goods, however, took the shine off the dollar. Factory orders fell 0.4% in April, marking the eighth drop in nine months and below expectations for an unchanged reading. As the recent strength of the dollar subsides there are signs that growth is accelerating amid business spending outside the energy sector.   
The Euro gained ground against the dollar as consumer prices in the region jumped by 0.3% in the year to May, more than economists had expected, easing the threat of deflation in the region. The highest inflation reading for six months, coupled with improved data across the bloc may make the ECB willing to taper its quantitative easing programme before the target date of September 2016.


Chinese equities were encouraged by a rare piece of upbeat economic data and headlines on Bloomberg that suggested policy makers are considering doubling the size of a local bond swap programme. The headline HSBC/Markit Purchasing Managers’ Index for May was 53.5, up from 52.9 in April and comfortably ahead of the 50-point level that separates expansion from contraction. The new business sub-component rose at the fastest pace in three years, while employment grew by its most since January 2013.


On a domestic front, optimism among British construction firms hit a nine-year high last month, supported by the Tory’s decisive election victory. The Markit/CIPS UK Construction PMI rebounded to 55.9 in May from April’s two-year low of 54.2, beating expectations of 55.0. The PMI also showed construction firms took on staff at the fastest rate in five months, as confidence surged back to its highest level since early 2006.


UK mortgage approvals also jumped by the most in more than six years, although growth in Britain’s service sector suffered its sharpest slowdown in nearly four years. The Markit/CIPS services PMI drifted back to 56.5 last month, still comfortably in growth territory, but down from 59.5 in April.


Technical analysis of the FTSE 100 illustrates the index moved below the 50-day moving average at 6950, but recovered after trading minor support at 6805. After trading mid-range for weeks, the oscillators are nearing oversold territory, indicating the selling may be nearly exhausted. Support is seen at 6805 and 6750, while a close above near-term resistance at 7050 might be needed to reinvigorate the bulls.


In conclusion, aside from Greece, the headwinds facing the market appear to have eased, while equities should benefit from improved global macro-economic data and supportive central banks. Greece appears close to reaching an agreement with its creditors, but until the deal is done equities are likely to tread cautiously.


Airline stocks have benefitted from a low oil price, increased spending and takeover activity within the sector. International Consolidated Airlines are buying Aer Lingus for €1.4 billion, of which Ryanair, the budget carrier, owns a 29.8% stake.


Market leader EasyJet (Epic: EZJ), however, has underperformed the sector, falling 17% after guiding towards a tougher second half performance, despite beating expectations in the first half of the year.


Interim results on 12th May showed the company swung to a profit of £5 million in the six months to 31st March, compared with a loss of £53 million, as revenue rose to £1.77 billion from £1.70 billion. Airlines traditionally make a loss in the winter months as travel demand is lower and costs are higher due to travel disruptions and additional costs like de-icing planes.


Looking forward, the low cost airline warned of a “difficult” April, when air traffic control strikes in France prompted the cancellation of more than 600 flights, knocking an estimated £25 million off full-year profits.


Revenue per seat rose 2.6% on the year, buoyed by improvements in load factor, strong trading in October and the earlier timing of Easter. Cost per seat was up 2.9%, despite a 6.3% drop in fuel cost per seat, as some airport charges and increased disruption in the second quarter reduced margins.
Traffic statistics this week revealed EasyJet benefitted from a strong rise in passenger numbers and fuller planes in May. This represents a bounce from a slower April and brings the airline’s growth back to the levels last seen earlier in the year. EasyJet said it flew nearly 6.5 million passengers in May, up 7.2% from a year earlier, while its load factor, a measure of how full its planes are, rose to 91.6% from 89.4%.

 


The chart of EasyJet illustrates the recent weakness, sending the shares back to major support at 1590p. The bullish divergence evident from the rising MACD histogram and RSI, is worth noting and suggests the shares will outperform should the wider market assist. 


After recent share price weakness EasyJet trades on 11.7x prospective earnings, a vast discount to the sector on 18.1x, while offering a growing 3.4% yield. I believe the fundamental investment case for the business remains robust and the 17% fall is an over-reaction to what was ultimately a small underlying consensus downgrade.


At the time of writing the share price is 1592p, which traders might consider buying with a tight stop-loss below support at 1544p, offering an attractive risk/reward bias. Targets are seen at 1655p, 1735p and 1890p.

This report was written by Mark Allen – Head of Derivatives at SI Capital Stockbrokers. The writer does not hold a position in EasyJet, but client accounts may. The material in this report has come from SI Capital’s internal data sources and EasyJet’s corporate website.

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