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Investors are taking a gamble on the easyJet share price: here’s what I’d do

Rupert Hargreaves
Dice engraved with the words buy and sell

Shares in low-cost airline easyJet (LSE: EZJ) have nosedived over the past 12 months. From a 52-week high of nearly £18 per share, the stock has fallen by 51% and is currently changing hands for £8.80. The company is now on track to be booted out of the FTSE 100 in the index’s quarterly reshuffle this week.

Undervalued 

Following the stock’s recent weakness, bargain hunters have started to buy into the easyJet share price, and it is easy to see why. Shares in this household name are currently dealing at a forward P/E of just 9.6 and support a dividend yield of 5.3%. Historically, the shares have changed hands for between 11 and 17 times forward earnings, implying that the stock is somewhat undervalued at current levels.

However, as I have explained before, the European airline industry has changed dramatically over the past few years. EasyJet, which used to be the sector leader, is now under fire from all sides. Competition is growing and costs are rising. There’s no longer any guarantee that this company will be able to emerge victorious in a fares war.

The better buy

On the other hand, easyJet’s peer, Ryanair (LSE: RYA) does still seem to have a robust competitive advantage over the rest of the airline industry.

Even though the company is well known for its poor customer service, this doesn’t seem to have impacted its growth, and that might be because customers don’t really expect much from the airline anyway, so when they are greeted with delays and cancellations, there’s no surprise.

Customers have come to expect a slightly higher level of service from easyJet. They are paying more after all. The average easyJet fare is €60 compared to Ryanair’s €39. At the same time, Ryanair flies to nearly 100 more airports and offers almost 1,000 more routes that its smaller peer.

The lower average fee and range offered to customers goes some way to explaining why the Dublin-based airline is growing faster than its Luton-based peer. Over the past six years, Ryanair’s reported earnings per share have increased at a compound annual rate of 15.8% as net profit has grown at an average of 11.1% per annum.

Meanwhile, easyJet’s net profit has fallen from £398m to £358m in the six years between 2013 and 2018. It doesn’t look as if this trend is going to end any time soon. While both companies are expected to report declining earnings overall this year, analysts have pencilled in a much worse performance for easyJet, with a contraction in earnings per share of 30% expected, compared to just 15% for Ryanair.

Today’s numbers from Ryanair, which show total group traffic up 13% to 14.1m customers during May support the City’s view, in my opinion.

The bottom line

Considering all of the above, I think it is quite clear that Ryanair is the better investment. However, shares in the airline are a bit more expensive, dealing at a forward P/E of 12.3 based on current City estimates, falling to 10.2 for fiscal 2021. According to my calculations, that’s a premium of nearly 30% to easyJet’s current valuation.

However, considering the company’s competitive advantages, and track record, I think shares in Ryanair deserve this premium. I would much rather pay a higher price for a sector leader, than a bargain price for one of its struggling competitors.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019