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FTSE 250 Index airline fresh air (LSE:WIZZ) saw its share price fall 20% in the day after its last earnings release as engine reliability issues caused profits to fall 98%. But this appears to be a short-term problem.
I don't think this is a good reason to avoid the stock, but the company also has a fundamental pricing dilemma that I think is much more significant and that's enough to keep me away.
Engine problems
Despite slightly increasing revenues, Wizz recorded a 98% drop in profits. This is partly due to 46 of its 179 aircraft being grounded due to engine problems.
The company has been leasing planes and staff to increase capacity, but this has been costly. However, I don't think that's the reason the stock fell 20%.
There are three reasons for my opinion: one is that the engine problems are likely to be a short-term problem and the other is that Wizz is receiving compensation.
But the most important thing is that this is not news. The market has known this since March, so I don't think that's why stocks suddenly fell after the results.
A dilemma
I think Wizz faces a dilemma: in the long term, it has to find a way to charge lower prices than its rivals or charge higher prices without losing customers.
I don't like the company's chances in a price war. Simply put, I don't think the company is in a strong enough financial position.
Wizz vs. easyJet vs. Jet2 total debt 2019-24.
Created on TradingView
Many airlines have taken on debt during the Covid-19 pandemic, but unlike several of its rivals, Wizz still has much of that debt on its balance sheet.
This puts it in a poor competitive position when it comes to keeping costs down. Paying more interest makes it difficult to charge lower prices to customers.
Pricing power
The alternative is to try to maintain prices, but CEO Jozsef Varadi said competition was making that difficult.
This is likely to weigh on earnings. The latest news indicates that net profit for the year is likely to be 25% to 30% lower than previously forecast.
Short-haul air travel is something of a commodity, so this shouldn't come as a huge surprise. The problem is that the airline said otherwise back in May.
That's why I think the stock has plummeted. Wizz's balance sheet means it needs to maintain its prices, but this looks like a challenge.
Reasons to sell
The fact that the planes are grounded means that Wizz's profits are drastically reduced, but I don't think that's the biggest problem.
In my view, Wizz faces a dilemma. Its balance sheet leaves it ill-prepared for a price war, but maintaining prices in a commoditized industry is almost impossible.
That's why I avoid investing in this company's stock, even after the latest drop. I don't mind taking advantage of a recession to invest in an airline, but it's not the one I would choose.