Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Joachim Kotze. He is an equity analyst at Morningstar. Hello.
Joachim Kotze: Hi, good morning, Holly.
Black: So, Joachim, I think as the vaccine rollout is progressing across Europe, a lot of people will be thinking about travel again, and you've been looking at the airline sector and your favorite pick is Wizz Air. What do you like about this carrier?
Kotze: Yeah. So, basically, we think Wizz Air (WIZZ) as an airline is in the sweet spot of an airline's lifecycle, big enough to matter to suppliers, but still small enough to grow their profits meaningfully over the medium term. The airline is attractively positioned to grow from both a geographic exposure perspective and a capacity expansion perspective and also, we believe, able to outgrow Ryanair and easyJet by a wide margin over the medium term. On top of that, Wizz Air should benefit from margin expansion as they have, in our view, the most sustainable cost reduction opportunities relative to their peers, easyJet and Ryanair.
Black: So, one of the things we do hear about budget airlines is that they do operate on very tight margins. And I mean, they could get tighter as they need to run deals to coax people back into flying again. What do you think about Wizz Air's revenue growth and margin potential?
Kotze: Yeah. So, if you take it from the top down and you look at the revenue aspect of it, from the revenue perspective, we think there are three key drivers supporting of around 15% revenue growth, which is what we forecast over the medium term for Wizz Air. Firstly, the company has the biggest order book in our coverage which could see double its fleet by mid-decade. Secondly, the average seat count will rise about 10% over the same period as most of the aircraft on order is of the larger Airbus A321XLR variant. And then, lastly, Wizz Air enjoys the leading market share in the fast-growing Central European region where they connect passengers from the region to Western Europe. And we believe growth in the region will continue to outpace growth in Western Europe as it has before COVID, and that's largely underpinned by the growing wealth and discretionary spend on things such as travel.
Then the margin expansion opportunities for us, I think, are largely underpinned by ownership cost reductions. Wizz Air's ownership cost is more than 60% higher than peers, easyJet and Ryanair, and that was largely due to a lack of scale historically, as they weren't able to negotiate the large discounts with the likes of the Airframers and lessors, but they currently have the third largest order book globally and the largest in the EU for the Airbus A321 variant. And we think that the group was able to secure some serious attractive volume discounts and that the ownership cost should migrate to that over peers. With that being said, we think that gives them an opportunity to expand their margins to around 17% from 12% currently and coupled with the nice top-line growth actually drive EBIT of more than 20% per annum over the medium term.
Black: Okay. Let's talk share prices though, because I know a lot of the airlines were hit last year as the pandemic unfolded. So, where are we looking at valuation-wise at the moment?
Kotze: Yeah, I mean, most of the airlines were whacked quite hard, but both Ryanair and Wizz Air have recovered to pre-COVID labels. As we released our report on Wizz Air, we simultaneously upgraded our fair value by about 40% to 6,800 British Pence, implying around 50% upside from current price levels.
Despite them having recovered, we don't think that the market fully appreciates the growth and margin opportunities for Wizz Air as we think the market is very much focused currently on highly uncertain near term outlook for the for the industry as a whole. Ryanair and EasyJet, they're both trading near our fair value estimates and we believe the market is fully discounting the opportunities and recovery story there where Wizz Air presents investors with a much higher margin of safety and a great cushion against any short-term recovery hiccups.
Black: Joachim, thank you so much for your time. For Morningstar, I'm Holly Black.
