Description

We’ve been accumulating Jet2 in the last 6 months as this mini-BKNG is now trading at 1/10th of BKNG’s valuation (approx. 85% of both revenue and earnings are now asset-light package holiday earnings). No, it's not a real comp to OTAs, but most profit is asset-light nowadays.

Jet2 now has 74% of its flight passengers going on a package holiday. While the stock has been range bound since CV19 (well below the peak which occurred briefly after our last write-up & post Thomas Cook administration), the company itself has never taken a pause from growing & executing, and the stock has once again become (very) cheap. At a deep value territory earnings multiple of 3.6 - 5.5 X EV / NOPAT (depending on some adjustments one is comfortable with), the thesis is mainly just how cheap the company has become: I believe there is an edge in buying this just as the coming year’s earnings have de-risked. We do add some points why we believe the next years will bring greater profits and why we think Jet2 is an above average business.

Jet2’s intelligent aircraft fanatic founder has taken all the right fleet choices:

1. Current fleet: largely made up of an end-of-line order of b737-800NGs. As Bloomberg reported recently, this is the most in-demand current tech aircraft today (as measured by % appreciation in constant-age aircraft secondary market value)

2. Future fleet sports a 

   1. Scaled order.. 

   2. ..placed at pre inflationary 2021 of..

   3. A320neo family (most in-demand new gen aircraft family right now measured by % appreciation)..

      1. ..more than half of which are A321neo’s (given the structural global aircraft shortage and lack of lift, the most in-demand aircraft type)

      2. All of these powered by CFM engines (with P&W grounding hundreds of A320s because of issues)

Asset conversion play: there’s now billions of interest yielding cash on the balance sheet (3.1B total cash, of which 1.3B own cash excluding customer deposits) waiting to be converted into the right aircraft with the right engines, at pre-inflation prices. The real capex ramp up will only start in Summer 2027 as Jet2’s multiple orders start overlapping.

Sell-side research seems to be solving for the current valuation in its estimate for this year, and has taken a view of flat profits this fiscal year (ending March 2024), or +2.7% YoY PBT worth only 14 MGBP, despite the facts that:

1. 2023 saw some extraordinary costs from Greek wildfires evacuations and the ATC systems failure 

2. Seat capacity up >12% YoY & consensus revenue growth of 14% means quite a bit of operating leverage potential

3. The last trading update confirms a 1 pp higher load factor YoY at the same booking cycle point

4. Revenue growth also means growth in the financial result (with ST GBP rates at 5%): higher customers’ cash deposits (up 20% to 1.9B) and growth in company’s own cash balance (up 30% to 1.3B) means a tailwind of 30 MGBP EBT YoY

This has to be weighed against cited “weak consumer”, and “cost pressures” for both hotels and the airline (pilots e.g.). Regarding the former factor, I would note Pound Sterling is up 3% YoY against the Euro during the months of summer booking.

Valuation

For names in deep value territory (i.e. high cost of capital), my preferred way to look at valuation is to make adjustments for near-term de-risked earnings first. For example, the summer booking season for 2024 is largely over. Last month’s trading update told us the load factor is tracking up 1% YoY at the same point, with pricing modestly up. Nothing special has happened on Google Trends since then (on the positive side, it was exceptionally rainy), and hence the main volume/price risk associated with being an airline that makes all its money in summer can be considered approximately over for this year (barring CV19 2.0). 

To calculate an appropriate EV for Jet2, we sum

1. Headline net cash March ‘24 from trading update (3.2B)

2. Remove customer advances (obtaining “own” net cash” of 1.3B)

3. Add back total financial debt of 0.7B (I’m not counting 0.6B of capitalised leases)

4. Subtract 75% of consensus earnings this running year as “de-risked” (75% x 400 = 0.3B)

We obtain an adjusted enterprise value of 1.7B. 

Consensus EBIT is at 463 MGBP (ex interest on all cash), translating into an EV/EBIT of 3.7x or an EV/NOPAT (after 25% corp tax) multiple of 4.9x.

However, there’s multiple posts on this board on the benefits of “float”. Granted, this is a seasonal business (H2 is ~33% of H1 revenue), and not the most stable sector to say the least. The truth, however, is somewhere in the middle. With revenue growing at least 15% YoY, the upcoming September end customer cash advances will be at least 1.1B (last Sept) x 1.15 = 1.25B. This is a good proxy for the seasonal low in customer float. If we value the seasonal low at 50% (because of inherent business volatility), the EV/NOPAT multiple falls to 3.1X. 

Furthermore, the 600 MGBP financial debt is made up of 400MGBP 1.6% yielding out of the money convert bond (1900 pence conversion price) and pre-CV19 amortising debt on in-demand aircrafts. Everywhere you look this company looks in good shape.

Business

Much has been discussed in prior write-ups. The net promoter score of >65 (approval percentage) has been stable and very high for this business, only matched by niche luxury package holiday providers. Repeat business is high (above 55%). For those interested: look at Which? and Skytraxx ratings.

Scale: the airline is now the third biggest in the UK, while the packages business is number one. As publicly communicated, key competitor Ryanair has bigger issues of aircraft shortages to the point they prefer to cancel certain flights and pay EU261 compensation. Jet2’s latest trading update had this to say:

• Booked to date pricing for Summer 2024 across both our leisure travel products is showing a modest increase compared to the same period last year which is helping to mitigate previously announced increases in input costs, although recently, pricing has been more competitive, particularly for April and May departures.

We think a little bump in shoulder season is largely irrelevant and summer will be strong given supply issues at competitors (Boeing and P&W engine issues).

For a management known for its prudence in investor communication, the following comment was pleasing regarding the recent in-housing of the in-air food (recall the former Dart Group had a food distribution biz):

• Our new Retail Operations Centre is now fully operational and our Customers are seeing tangible benefits from much improved on-board product availability

Given Jet2’s customer-centric nature and leading ancillary revenues, we think vertical integration amidst issues with product availability is a logical step.

Jet2 has warned of inflationary pressures, with prices only “modestly” up. However, for long-term followers, this isn’t surprising. Jet2 has always communicated conservatively about the future. By way of just one example, when Jet2 was about to grow EBT 10% YoY with margins only down 0.9% last reporting year (despite some extraordinary items last summer such as wildfire evacuations and ATC chaos), this was the summer update in 2022:

In the medium term, inflationary pressures coupled with the uncertain UK economic outlook for consumers, lead us to conclude that prices are likely to come under some pressure. However, we believe we have the right product for these tougher times. 

In short, the wording was worse for last year, with profits up.

Jet2’s main challenge will be to maintain a high return on capital over the long term (currently ROE in the 30s): in the past, the summer seasonality of leisure travel was matched with a fleet made up of opportunistically purchased old aircraft. As the fleet becomes younger as a result of the 146 new aircraft Airbus order, how will Jet2 maintain a high return on capital?

While the ROE will probably come down a bit, we think there’s a few important contributors to decent incremental ROE’s / sustained high overall ROE’s:

1. most all revenue and profit is - and will be - from the asset light package portion 

2. flying new aircraft at a good ROE will require magnifying the advantage of new tech efficiency specs (low cost per pax-km). The advantages to be maximised are two-fold:

   1. Flying all the time (aka becoming less seasonal): Jet2 should push more winter holidays (think ski, city trips, but also northern light etc.). We note not that much has to change, as the current fleet (126 planes) has an avg. age of 15 years and can still function as a seasonal fleet while the new aircraft function as the ‘base’. For reference, H2 23/24 had 38% of H1 22/23’s seat capacity.

   2. Flying longer ranges: Locations such as Turkey, Morocco are taking market share again in general. Jet2 has also been launching new routes to Turkey. This is just speculation (we’re not talking to management) but here goes: a mix shift towards these more distant locations are the logical choice for Jet2 and good for another reason. There’s less package holiday competition and profit margins are higher in these markets (but there’s a heightened geopolitical risk however). The synthesis: it seems logical Jet2 can take market share (and indeed grow the market) in these locations, given that Jet2 has the highest NPS, and package holiday customers are risk averse travellers by definition. For that reason, a high NPS is also a bigger competitive advantage in more risky geo’s.

The founder has stepped down to non executive board member with age, but the current CEO Steve Heapy has been succesful for long, and has the "Buffett minimum" of high single digit equity vs salary invested in Jet2.

Catalyst

Conversion of balance sheet cash into earnings (competitively purchased aircraft) 

Another year of profit beat