Regional flight operator Flybe today announced further bad news in that losses would be greater than expected for this year. You would think that the share price would have no further to go, but another 35% drop ensured that the price has now fallen to an all-time low:
The share price action in recent years has been rather benign, possibly because Flybe have been a near-constant source of bad news for investors. Seven years ago the share was comfortably above 300p, so the fall from grace has been more akin to a car-crash in slow motion as akin to something spectacular.
Flybe became a larger player in the UK by the buyout of BA Connect – British Airways’ regional operations, which serves mainly secondary cities in the UK. This was not a solid business to start, as much of the regional network was difficult to make a profit out of, doubly so with the onset of the low-cost airline. In time, Flybe has become a low-cost carrier itself, and the airline size is fairly large: it operates 78 aircraft.
Passenger numbers and turnover have increased every year for the past decade (albeit at a slower rate than Easyet/Ryanair) but crucially one detail is missing: profits. These have proved to be very difficult to get here, in a tough environment with many headwinds and heavy capital costs. Even in the stable times, operating margins have proved to be small, and in the recent years there seems to be always one event a year that impacts the travel industry.
Perhaps this was not the most unexpected announcement. This year has seen a very poor winter and extremely hot summer, which are both bad for airlines. The first resulted in airport closures and knock-on delays, the second reduced demands for flights overseas as more people stayed at home instead. Additional pressures are the increase in the cost of oil and underlying tensions seen in crew at other airlines.
Flybe has seen good revenue performance in the first half set against the backdrop of increasingly adverse fuel and currency impacts. Recent trading however indicates a softening in the second half revenue outlook and the Board now expects the full year adjusted profit figure to be lower than market expectations.
There was perhaps a tone of good news:
Flybe’s strategy to reduce capacity1 to focus on its most popular routes has delivered both higher load factors2 and revenue per seat3. In Q2, load factors were up year-on-year by 7.2 percentage points to 86.6%, a record load factor for the Summer season. Passenger revenue per seat was up 6.8% as capacity reduced by 10.0%.
For the first half as a whole, the load factor increased by 8.0 percentage points to 84.0%, with passenger revenue per seat estimated to be up 8%. Yield, was down c. 2% (c. 1% of which relates to the impact of the removal of credit card fees from January 2018).
Excluding the E195 provision impact, the adjusted profit before tax for H1 is expected to be similar to last year (2017/18: £9.4m4). This is despite year-on-year cost increases of c. £17m arising from the lower value of sterling and fuel and carbon price increases.
GBP/USD is the same today as it was a year ago, but markedly down on a few years back. As the airlines major expense (fuel) is paid for in USD) it would have an adverse effect.
The warning gets more specific later on:
Consumer demand in domestic and near-continent markets has weakened in recent weeks and the Board now expects this to continue into the second half. This together with higher fuel prices and weaker sterling will impact the expected H2 profit performance.
While the Board’s visibility on Q4 revenue is limited at this stage, it is now estimated that the full year adjusted loss before tax will be of the order of £12m (2017/18: loss of £19.2m4), including the benefit of a c. £10m onerous lease provision release. This includes an estimated £29m of adverse year-on-year impact from weaker sterling, fuel and carbon prices.
Whether this is can be considered good or not, £12m is a substantial loss for a business only valued at £65m today.
It is hard to know what to make of Flybe. For some time now they have been cited as a turnaround possibility. It is true that it would be very difficult for a competitor to enter their markets, with slots at airports being difficult to obtain. The question is, is there enough profitability in those markets? The company have vowed to make their network more efficient and concentrate on profitable routes, but hasn’t this always been the case?
Hammering down costs in this industry also seems quite difficult. The majority of costs are already committed, and making savings on safety can really backfire, as trustworthiness is key when it comes to flying. Not to mention that most airlines are up to more or less the same strategies. Customer demand is also not evenly distributed throughout the year: demand goes up massively during holiday periods, resulting in times of over-capacity and times of under-capacity.
One of the problems that Flybe have had is that they have too many aircraft. 53 aircraft are on lease, with a total rental cost of £101.7m. Given that this has to be paid irrespective, there are pressures to try to use these assets as much as possible (read: cheap fares). Operationally we have seen a slight reversal in the past year: a mixture of returning aircraft and cutting unprofitable routes has seen the number of available seats reduce, but passenger numbers increase.
The balance sheet shows a large amount of debt: at £59.1m, this is almost bigger than the market cap. This has been a massive swing from the past years (where the group showed a large cash position). In part, the reversal has been due to the decision to purchase aircraft, and as such, debt here is slightly less of a problem, as it is secured on aircraft which have fairly predictable values.
This is fine on its own, but pales into comparison when compared to other airlines who have been really making hay the past few years: Easyjet, IAG, Ryanair and even Wizz have reported good profits and decent margins. Wizz last set of accounts showed profits of 275m EUR on a turnover of almost 2bn.
Flybe could well be the same if only somehow it could find the means to get more money from customers. After all, assuming flight costs are the same, any gains would be mostly profit, as most of its fixed costs would stay the same. The trouble is, it does seem that many of the problems it faces are structural. It flies out of mainly secondary airports, which have less defined demand. Its turboprop-dominated fleet offers some distinct advantages (ability to fly to airports with shorter runways) but also some concrete disadvantages, as it is much slower than a jet, resulting in longer flight times.
The environment for more marginal airlines looks fairly bleak in my opinion. Although having said that I do believe there may be value in Flybe being taken over and carved up. There are likely to be some quite profitable regional routes, some routes which can be profitable with subsidies, and some routes that just are loss making. From an investors point of view, someone may be quite willing to pay the price to get into the market and if that happens it would be at a premium to the price today. I’d go 3/5.