Deep Dive: Jet2 (JET2.L)
5x earnings power for double digit growth, net cash, industry leading share and management
Summary
Jet2 is a UK package holiday business that is run by an outstanding owner-operator and management team that have grown market share over the last decade from 2% to 20%, leading to the stock multiplying from £0.7/shr to £20/shr pre-Covid, before falling to £9/shr today. The stock has also declined 35% from earlier this year as investors reacted to a poor macro outlook in the UK. However, while these short-term concerns may impact profitability this winter or next summer, they have a limited impact on the company’s true value. The stock sold off many times in its journey from £0.7/shr to £20/shr as investors reacted to short term concerns, and we think this time will be another buying opportunity. We estimate the company will be earning £1.5-£2.0/shr in three years’ time as it emerges from this crisis with a significantly strengthened market share, reputation, customer loyalty, list of hotel partners, and airports to fly from. Based on this earnings power, we expect the stock will be valued at nearly £25/shr over three years.
Situation Overview
Jet2 is a UK based package holiday company that also operates its own airline. The company began as an airline but a decade ago launched its Jet2Holidays package holidays business, and since then has seen its market share grow each year, reaching 20% today. It is important to understand that the package holiday business is now the large majority of the company’s value, with the airline flying schedules to facilitate it and package holiday customers accounting for over half of the airline’s seats. Many investors still view Jet2 as an airline, which is one of the reasons this opportunity exists.
The company is run by its Founder and Executive Chairman Philip Meeson, who owns 22% of the business, CEO Steve Heapy, and CFO Gary Brown. All three have high integrity, exceptional customer focus, and concentrate on long term value creation when allocating capital. They are arguably the best management team we have come across and are the ‘secret sauce’ that has enabled Jet2 to be a huge success in an otherwise famously value destructive travel industry.
Management have done an outstanding job by fostering a culture that is absolutely focused on delighting the customer, which is the key determinant of success in this industry as customers enjoying their holidays is what drives repeat business. In a typical year, 80-85% of Jet2holiday’s sales are to repeat customers, which leads to attractive unit economics and has allowed the company to take share from competitors like TUI, and Thomas Cook before it went out of business. We think that Jet’s source of advantage is very much underappreciated by investors, who are typically focused on costs and short-term macro conditions.
As a result of its customer satisfaction, Jet2 has done a terrific job of compounding value and over the last decade earnings have compounded at 30% per annum despite modest or no net debt. The stock has followed, going from £0.7/shr to £20/shr before Covid struck. It trades at £9/shr today.
The stock has declined 35% from its high earlier this year over concerns about a UK recession, disposable incomes, oil prices, and what those factors ultimately mean for profits next summer. Yet over the last decade, we have seen many occasions when Jet2’s stock has declined heavily as a result of investor concerns over short-term macro conditions, and we view this time as no different.
In our view, the results from last summer or next summer are largely noise in determining the value of Jet2. The stock has increased from 70p/shr a decade ago to £9/shr today and £20/shr before Covid because of its industry leading customer satisfaction causing the company’s market share in package holidays to grow from 2% to 20%. In that intervening periods there have been many good summers and many bad summers. When bad summers have caused the stock to draw down, those have been buying opportunities, and we believe this one is too.
Jet2’s Intrinsic Value
Jet2’s ability to gain market share and compound earnings is based on its industry leading customer satisfaction. Its lead expanded significantly during the pandemic when it was ranked as the best travel business in refunding customers by several independent surveys, and the gap widened further this summer when it operated the only airline in the UK not to cancel a flight.
Meanwhile, Jet’2 key competitors are distracted.
TUI is the joint-leader in the UK with 20% market share but has installed its former CFO as its CEO and will spend the next few years focused on repaying the three bailouts it received from the Germany government during the pandemic. Thomas Cook used to be the no.2 player but went out of business pre-Covid, and Jet2 has taken much of that share but yet to see the full beenfits. EasyJet’s has an up and coming holidays business, but it is run as a separate unit with the main purpose to capture margins that were previously taken by OTAs, rather than build a customer centric holidays & airline package like Jet2.
For these reasons, Jet2’s market share has grown from 14% pre-Covid to 20-21% today. We expect it to continue increasing at 2pp pa for several years. Management appear to think so too, having placed three aircraft orders with Airbus this year and already taken up some of their additional options. In fact, CEO Steve Heapy told travel agents at last week’s Jet2holidays conference that they have 146 aircraft on order and plan to double in size over 5-6 years. The 146 implies they will take up all their aircraft options, while doubling over 5-6 years implies 12-15% seat growth pa.
By setting aside macro conditions over the next 12-18 months and instead focusing on the company’s earnings power three years from now, we estimate that Jet2 is worth £24/shr, 168% higher than its £9/shr today.
In addition to seat growth, Jet2 should benefit from an increasing mix shift towards package holidays. The company’s seats were split around 50-50 between package holiday and flight-only customers pre-Covid, and management say that for FY23 package holidays are currently 12 pts higher in that mix. That is a material improvement because a flight-only customer typically spends around £110 on their ticket and ancillaries, whereas a package holiday customer spends around £750. That adds nearly 10% to sales growth for the year, and going forwards we expect this mix shift to continue at a slower pace. The fact that Jet2 owns its airline also gives management the ability to flex this up or down – if the demand for package holidays is stronger than expected, management could quickly make substantially more seats available without having to buy or lease more planes.
On the other hand, our Bear case comes to a valuation similar to Jet2’s stock price today, and we think represents a depressed valuation. To reach this, we assumed:
10% pa growth in seats, despite aircraft orders suggesting 12-15%.
Negative ASP growth of 3% pa, despite historic growth and management guiding to further growth in the current inflationary environment.
5% EBIT margins, at the low end of management’s ambitions for 5-8%.
A 6.5x EV/EBIT multiple, in line with Jet2’s average before the Thomas Cook collapse and the company’s stronger competitive position post-Covid.
We think that it is very unlikely all of these assumptions will occur, and therefore believe that over a three year time horizon the risk of a permanent loss of capital is low for a patient investor, making an investment at today’s stock price an asymmetric risk/reward over that horizon. Nevertheless, we think the stock is likely to remain volatile as investors react to short term factors, but that further drawdowns should be seen as opportunities to add to our position.
Risks
The travel industry is notoriously vulnerable to changes in macro conditions, and these tend to be what investors focus on. Aside from the limited impact these have on the value of the business as discussed above (other than in extreme conditions like Covid lockdowns), we think investors are underestimating the strength of the travel recovery and outlook for Jet2.
The impact of rising inflation, energy costs, and mortgage payments were highlighted by Jet2’s management several times in its July statement, which caused the stock to decline significantly:
"Inflationary pressures coupled with the uncertain UK economic outlook for consumers, lead us to conclude that in the medium term prices are likely to come under some pressure."
However, management wrote in the same results that:
“Overall demand for our leisure travel products has continued to strengthen… whilst pricing remains robust.”
Based on management’s commentary, our data, and results from other companies, we believe that the acceleration in inflation and macro uncertainty over the last six months has had no visible impact on travel demand so far. While it may seem inevitable that there will be an impact at some point, we find those types of macro predictions incredibly hard to make accurately, although many people try. Sentiment can reverse very quickly, as evidenced by the rapid change in inflation concerns this year.
An equally compelling argument to us is based on what we observe in the US, which relaxed Covid restrictions earlier than Europe and so had a record domestic leisure travel season in summer ‘21. This summer has been an even bigger record, suggesting that the pent-up demand caused by Covid restrictions lasts for at least two summers. More recent commentary from a variety of travel businesses suggests that demand remains very strong, with the traditional end of summer season being extended, winter bookings strong, and pricing/margins robust.
We don’t think anyone knows which of the two factors above will ultimately prove decisive for demand next year and so try to stay away from making short term macro forecasts. Instead, we value Jet2 over three years while requiring that any business we invest in to have the resilience to withstand a variety of difficult macro condition that will inevitably occur at some point. (Just think about how conditions have varied over the last 3-5 years!) We consider Jet2 to have the best management team of any business we have come across, but if we had any criticism of them it would be that their conservatism has on occasion resulted in comments to investors that turn out to be overly conservative.
Management’s actions, however, tell a different story.
In the days after results both the CEO and CFO bought shares on the open market, which is only the second time either of them has done so. The other time was in March 2020 when the stock was at £3/shr. Just as indicative in our view is that Founder and Executive Chairman Phillip Meeson elected not to sell any shares post results. Meeson is 74 and has been on a plan for several years that sees him typically sell some shares after results.
Jet2 has also since made several further announcements of aircraft purchases, and in late October repaid its £150mm short term loan early. All of these actions suggest that the near term outlook is stronger than investors are pricing in.
Our thesis continues to be based on Jet’2 long-term intrinsic value as it emerges from Covid and a UK recession as the industry’s leading package holiday provider. We estimate the company will be earning £1.5-£2.0/shr in three years’ time as it emerges from this crisis with a significantly strengthened market share, reputation, customer loyalty, list of hotel partners, and airports to fly from. Based on this earnings power, we expect the stock will be valued at nearly £25/shr over three years.