Is it time to bail out of easyJet plc and buy GlaxoSmithKline plc instead?

Updated
Easyjet airplane about to land
Easyjet airplane about to land

The main takeaway I get from today's half-year report from airline operator easyJet(LSE: EZJ) is that net cash from operations is down 40% compared to the equivalent period last year and the firm made an earnings-per-share loss of 5.1p, which compares to a profit of 1.3p per share last year.

///>

No wonder, then, at 1,500p, the shares are down around 14% since the beginning of 2016. Whichever way we dress it up, this isn't a good result for easyJet and the firm's shareholders.

Precarious profits

The outcome here demonstrates what a precarious juggling act it is to keep an airline profitable and growing. During the period, easyJet faced pressure on its business from justifiably skittish customers due to travel strikes and terror attacks on European capitals.

That's the thing with an airline: we never know when a natural disaster such as an Icelandic volcano or man-made disasters such as war, conflict, strike, terrorism or commodity speculation will shoot down the firm's profitability. But it gets worse than that. Airlines are also at the mercy of macroeconomic events making airline businesses and their shares among the most cyclical on the stock market.

That cyclicality has implications about how the market is likely to value businesses such as easyJet. The more mature a macro-cycle becomes, the lower I would expect easyJet's valuation to be as the market tries to anticipate the next cyclical down-leg by discounting high earnings in the boom times.

Consumer demand strong

Right now, easyJet trades on a forward price-to-earnings (P/E) ratio of nine for the year to September 2017 and sports a twice-covered 4.7% dividend yield. I wouldn't expect a higher valuation than that, so any further share price progress probably needs to come from business growth rather than from a valuation rerating.

Carolyn McCall, easyJet's chief executive says: "easyJet has delivered a robust financial performance during the half year despite the well-publicised external events. Underlying consumer demand has been strong with UK beach traffic providing a healthy start to the half and easyJet's biggest-ever ski season helping to deliver increased passenger numbers and higher revenue during H1."

Okay. But it's precisely when things are going at their best that we should expect a cyclical top, often followed by a descent into the next cyclical bottom. Nobody knows when the top will arrive, but I'm taking these first-half losses as a warning shot and now I'm avoiding easyJet shares.

A more robust business model

Pharmaceutical giant GlaxoSmithKline(LSE: GSK) enjoys a more robust business model than easyJet's. The stable nature of demand for medicines makes GlaxoSmithKline's operation far less cyclical and keeps the cash taps flowing as consumers repeat purchase drugs.

Sure, the pharmaceutical industry had its challenges over patent expiry issues as once high-earning formulations lost exclusivity in the market and the firm saw a flood of generic competition erode profits. However, the company is moving on from that and hopes a new generation of blockbusters will return the firm to enduring growth.

City analysts following the firm expect earnings to grow 16% this year and 4% during 2014. At today's 1,475p share price GlaxoSmithKline trades on a forward P/E rating of just over 16 for 2017 and yields a dividend of 5.4% covered just over once by forward earnings. That's a fair valuation for a defensive business with reasonable forward growth prospects.

I'd rather take my chances with GlaxoSmithKline than with easyJet, and on the question of GlaxoSmithKline's attractions, I find myself in agreement with The Motley Fool's market-beating analyst team. They single out GlaxoSmithKline as one of five quality, growing firms and they feature them in this special Motley Fool investment paper.

The Fool's analysts believe that focusing on high-quality businesses, with an investment time horizon measured in years, can produce market-beating returns. You can judge the strength of these stock market opportunities for yourself by downloading this free report right now.

Click the link that follows to get instant access to research on GlaxoSmithKline and four other quality firms, free and without any obligation. To find out more, click here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Advertisement