Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Airlines flew back onto the radar this past week as holidays abroad became a possibility once again and low-cost operators struck an optimistic tone about the near term future for air travel. Ryanair said it could come close to breaking even this financial year, subject to vaccine rollouts and the easing of European travel restrictions, even as it reported a record annual loss1. Then easyJet said on Thursday it expects to see demand rise from next month2. So do blue skies really now lie ahead for airlines?

The story for airlines has become one of survival through the most difficult of times, coupled with hopes the phasing out of travel restrictions will release waves of pent-up demand. The low-cost, short-haul carriers are expected to be in prime position to capture an upswing over the short term.

It’s only a year since Ryanair declared its first 99% monthly fall in passenger numbers and, with most countries still on the UK government’s “amber” and “red” lists, the reality is the skies are still far from clear3. With fleets still largely grounded, restrictions on travel to most countries still in place and cash reserves still being burnt, air operators continue to face an uphill struggle.

Investors, however, have clearly decided low-cost airlines are attractive recovery plays. Shares in Ryanair and Hungary’s Wizz Air are already trading back at pre-pandemic levels, with easyJet and AIM-listed Jet2 not too far behind4.

That doesn’t seem to make a lot of sense unless you believe in a post-Covid expansion of air travel above 2019 levels – and fairly soon. So why should investors own them now?

There are reasons, some of them well-established, such as the long term upward trend in air travel. IATA thinks this trend will re-establish itself after Covid, and that air passenger journeys will grow at an average annual rate of 3.7% over the next 20 years5.

Other reasons are more transitory – the cash that consumers saved during the pandemic, for example. There’s also the peculiarly restrictive nature of the crisis we have just lived through, leading to an unusually high desire among consumers to spread their wings.

The big carriers like BA owner IAG – more reliant on lucrative corporate and long-distance fliers – may have to wait several years to regain lost ground. Their share price performances in relation to those of smaller airlines so far this year suggest that too.

In the meantime, the opportunity falls to the low-cost carriers to attract value conscious leisure customers and stimulate traffic on their particular routes. That already appears to be happening at easyJet, which said last week it added more than 105,000 seats as soon as the UK government published its green list of destination countries requiring traveller testing but no quarantine6.

Investors will have taken heart from patterns in the aftermath of the 2003 Iraq war, during which time the low cost carriers expanded rapidly even as the industry’s large incumbents in the US and Europe were more focused on cutting costs.

This time too, the low cost airlines are planning expansions. Wizz Air, for instance, says it wants to launch new routes to four Greek Islands and Marrakech by the end of this year7. This is potentially good news not only for the long term future of airlines, but also for businesses like Rolls Royce, whose aviation business derives the majority of its cash flows based on the number of hours its engines are working for customers8.

Further encouragement comes from countries that successfully contained the coronavirus last spring. At around 12,000 per day, domestic flights in China have been above 2019 levels since the beginning of March. In Australia, domestic flights surpassed year-ago levels two months ago and they’ve kept on rising ever since9. If similar patterns can be reproduced across Europe, the share price moves of low-cost carriers so far this year will look far less racy.

Then there are the non-ticket revenues that some low-cost airlines were successfully growing before and even during the pandemic. Passengers opting to make their flights more comfortable with add-ons like assigned seating and extra luggage enabled both Ryanair and Wizz Air to grow their non-ticket revenues per customer at double-digit rates even during a rarefied 202010.

So while many airline stocks appear to have discounted a lot of good news lately, there remain some good reasons to stay positive. Big ticket purchases of cars or white goods using cash saved during the pandemic may be high on consumers’ wish lists currently, but they will most likely be one-off events. Holidays and other leisure trips, on the other hand, come round much more frequently.

Source:

1'3 Ryanair, 17.05.21
2'6 EasyJet, 20.05.21
Bloomberg, 20.05.21
5 IATA, May 2020
7 BBC News, 08.05.21
8 Rolls Royce, 11.03.21
9 Radarbox, 20.05.21
10 CarTrawler and IdeaWorksCompany, 26.01.21

Important information: Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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