Weaker demand reported by airlines, and Rolls-Royce bucks the trend with a bout of optimism

“It is another catastrophic day for investors as global stock markets continue to fall. After a very large sell-off on Wall Street last night with the Dow Jones down nearly 5%, Asia followed suit with 3%+ declines.

“The FTSE 100 fell 2.8% on Friday morning to 6,607 with airlines, insurers and miners among the worst hit.

“This has been one of the worst weeks on the markets in a very long time, leaving investors’ portfolios battered and bruised.

“There is no sign of widespread bargain hunting by investors despite the cut-price shares on offer. That might not happen until there is a clearer picture of how far and wide coronavirus has spread and how different countries are trying to contain it,” says Russ Mould, Investment Director at AJ Bell.

International Consolidated Airlines / EasyJet

“Both International Consolidated Airlines and EasyJet have confirmed what the market has been fearing for days, namely that all the negative headlines around the coronavirus have led to a weakening of demand to fly.

“EasyJet’s problems are currently focused on Italy, however International Consolidated Airlines is reporting weakness on a much bigger scale.

“The health incident is clearly going to have a negative impact on the airline sector’s earnings; the big question is how bad will it be?

“Shares in airline companies have plummeted in the past week as investors looked for obvious sectors that would be negatively impacted by the current panic.

“Sharp share price declines have subsequently made this one of the sectors in the sights of contrarians. EasyJet is one of the most bought stocks on the AJ Bell investment platform this week as some investors look for potential bargains.

“In downturns airlines have to reduce the number of planes they are flying and also cut ticket prices to stay competitive. Both those factors can be negative for earnings.

“The falling oil price will be positive as it should lead to lower fuel costs. However, the big problem is going to be weaker demand. If people are fearful about travelling to certain parts of the world, or indeed about going to airports and being surrounded by a large number of people, then demand for airlines is almost certainly going to suffer.

“Airlines therefore need to prepare now to cushion any hit to earnings. Labour is a big cost to the sector so it seems unlikely airlines will want to hire anyone at present and they will also look at their existing workforce to see if any cutbacks can be made. Aircraft will be redeployed to routes that are still seeing decent demand.

“Just as we’ve seen in previous hard times for the sector, the difference between strong and weak balance sheets will separate the winners from the losers. Airlines drowning in debt will look very vulnerable in the current situation. International Consolidated Airlines makes the point that it has a strong balance sheet and substantial cash liquidity to withstand the current weakness.”

Rolls-Royce

“Full year numbers from aircraft engine maker Rolls-Royce got a champagne reception from the market on a day when the FTSE 100 again fell.

“Record engine deliveries helped to outweigh both the ongoing problems with its Trent 1000 model and the possible impact on its customer base of the coronavirus outbreak.

“Unlike the airlines, which operate on a very short time-frame based on flight demand, orders for new planes are a much more long-term proposition. And, as Rolls points out, the long-term growth dynamics in this market remain intact for now.

“Perhaps the biggest plus point for shareholders is the cash flow performance. This has been a nagging issue for several years and one of the key priorities for CEO Warren East when he took over in 2015.

“In fact he has been very explicit about flagging free cash flow, or the readies left over once bills have been paid, as the best way to measure the company’s performance.

“The strong performance of its aftermarket business will also garner positivity. Before Rolls undermined its reputation with a series of damaging profit warnings in the last decade, one of its key strengths was its leading position in the aerospace aftermarket.

“The company has a significant installed base of engines which fall under its total care management maintenance (spares and repairs) package and the recurring revenue from this activity helps underpin earnings visibility.”

These articles are for information purposes only and are not a personal recommendation or advice.


The daily market update is written by Russ Mould, AJ Bell’s Investment Director and his team. The article highlights the movement in the main index, winners and losers on the day and any macro-economic announcements.