U.S. airline investors are missing a great growth story.
Peter Lynch liked to buy stock in companies that made the things that he and his family liked most. This is a good idea if your favorite product is made by a well-run company and the stock is still a good buy in valuation terms.
I was introduced to easyJet (OTC: EJETF.PK) in 2002 when I lived in Amsterdam. easyJet had a base there to bring in all the European tourists in search of Amsterdam's numerous attractions. This meant that an Amsterdam-based traveler had convenient, cheap access to dozens of European destinations.
Like Southwest Airlines (NYSE:LUV), easyJet and its Irish rival Ryanair (NASDAQ:RYAAY) built their networks mostly through lesser-known airports with cheaper gates and landing fees. Why fly from London's Heathrow to Amsterdam if you could go from Gatwick or Stansted and fly cheaper, assuming the additional travel price of getting to the more outlying airport is made up for in the cheaper price of the ticket? Would you be willing to fly into Milan's more distant airport if the ticket price was cut in half? Now you can, on easyJet.
easyJet also copied the Southwest business model by flying a fleet of Boeing 737s with low maintenance costs. Today the company is transitioning to Airbus 319s, the European equivalent of Boeing's short-haul, narrow-body jet.
You can't understand easyJet without understanding its founder, Greek billionaire Stelios Haji-Ioannou. Stelios, as he likes to be called, went to London after high school in Greece to complete his graduate business studies. He founded Stelmar Shipping in 1992 at age 25, listed it on the NYSE in 2001, and sold it to OSG Shipping in 2005 for $1.3 billion. EasyJet followed Stelmar in 1995.
Stelios describes himself as a "serial entrepreneur." As chairman of easyGroup, he presides over not only easyJet but also easyCar, easyCruise, easyBus, easyHotel, easyInternet cafes, and a dozen other easy-branded products and services. If you want to invest in dynamic entrepreneurship in Europe (which can be hard to find), Stelios is your guy. Even Queen Elizabeth thought so, giving Stelios a knighthood in November 2006 for his contributions to the British economy.
So we know that easyJet has a great pedigree, but what makes it a worthwhile investment?
easyJet didn't look that attractive in late 2004, when its share price on the London Stock Exchange dipped below two pounds (or 200 pence, as is the preferred style of quoting stocks on the other side of the Pond). Worries about margins and rising fuel costs had investors shying away. I was living in southern Africa by then. European airlines were hardly on my investing horizon.
Then one day, an analyst on CNBC-Europe (DirecTV subscribers can tune to channel 357 to check them out) made easyJet his featured stock for the day. His predictions for a turnaround at easyJet were 100% correct. Twelve months later, easyJet reported a 23% revenue increase and higher profits. But you could buy that profitable, growing airline in January 2005 (when I did) for less than 1 times trailing sales, or $3.65 for the U.S. pink-sheet ADR.
That's what makes a great Peter Lynch stock -- you know the product and use it often, management is solid, and the numbers say it's still attractive and cheap.
easyJet's preliminary FY2006 numbers were released in November, covering its results through Sept. 30. While easyJet stock now trades at more than $12 in the U.S., it's still very attractive (although not as cheap now as it was two years ago).
Why? Strong revenue growth with improving margins, as its presentation emphasizes. Passenger traffic grew 11% to 33 million, with 122 planes flying 262 routes, 52 of which were added in 2006. easyJet now serves 74 airports in 21 countries. Revenue shot up another 21%.
None of that would matter if easyJet didn't make money for shareholders. Operating margins increased from 6.2% to 8% in FY2006. Apart from fuel, expenses per passenger mile actually dropped. The cost synergies from operating the A319 fleet began to kick in. By 2009, easyJet expects to have 192 of the new 319s in operation.
No worries on the balance sheet. With more than 800 million pounds in cash ($1.5 billion U.S.) and a debt-to-equity ratio of 0.3 (the industry average is a crushing 2.78), easyJet is in excellent shape.
easyJet's yield management strategy continues to pay dividends. If you book your flight far in advance and don't mind flying at off-peak hours or from a non-centrally located airport, your flight across Europe might cost you less than $50 each way. Book the last seat on the plane at peak times, and you'll pay many times more. easyJet's yield management system is now a benchmark for European discount airlines.
"High impact and target marketing" is a top priority for easyJet. Instead of relying on expensive branding, easyJet aims to get its cheap fares and convenient routes in potential customers' faces with heavy reliance on billboards and public-transport shelter posters. You can't get around most major European cities the company serves without frequent reminders that easyJet is probably the cheapest way to fly in and out. Passengers can even rebook flights to an earlier departure for free if seats are available.
easyJet management expects continued growth of 15% or better for the next several years. If you buy the stock today, you'll pay a trailing P/E in the mid-20s (comparable to U.S. discount airlines Southwest and JetBlue (NASDAQ:JBLU) and European rival Ryanair) and roughly 1.5 times sales.
easyJet is another example of "franchise investing," where you find a great company that delivers consistent results and jump on for the ride. You count on management to plan for both good times and bad, and dodge the worst cyclical swings in the industry.
Owning easyJet paid off nicely in 2006 with a 75% gain. Ryanair ran a close second with 60%, but comparable U.S. discounters trailed badly. The most recent analyst upgrade increased easyJet's price target to 750 pence, or almost $15.
After two years and a 250% gain, I still consider easyJet a cornerstone holding in my portfolio. I won't sell unless its execution falters. And the next time I'm in Europe, I'll go to easyJet's website first when I need cheap short-haul travel.
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Fool contributor Dale Baker, a private client portfolio manager and former U.S. diplomat with extensive experience in Europe and Africa, owns shares in easyJet for himself and his clients. He recommends Amsterdam as a tourist destination or a temporary home, and welcomes your questions or comments.