Ryanair shares: short-term pain for long-term gain
The market is tough; a restructuring is underway and severe measures have been introduced in preparation for a possible no-deal Brexit. We have a look at the investment case for Ryanair.
It is a turbulent time for the European airline industry. Airlines are grappling with significantly higher costs at a time when competition is intensifying, and many have raced to consolidate to survive. Still, we have already seen three airlines collapse since the start of the year - Flybmi, Germania and WOW Air – and they will certainly not be the last.
Ryanair chief executive officer (CEO) David O’Leary warned in May that the airline was facing a ‘painful’ couple of years and the Dublin-based firm has a far more pessimistic, or realistic, outlook compared to its peers. However, while the entire industry is battling against numerous headwinds, from rising fuel costs to the threat of Brexit, Ryanair has its own problems to solve too.
Ryanair shares have fallen more than a third over the last 12 months and have lost 45% of their value since hitting an all-time high in the middle of 2017. With shares now trading at levels not seen for more than four years, we have a look at what is weighing on the Ryanair share price and consider where it is headed next:
Ryanair prioritises growth over earnings
Ryanair’s average fare in the year to the end of March 2019 fell 6% to just €37. The number of available seats on short-haul flights has increased and this has put pressure on many airlines, particularly low-cost carriers like Ryanair, which would rather fill its planes by offering rock-bottom fares than fly half-empty planes.
Fares are so low that low-cost carriers are losing money. Ryanair, easyJet and Wizz Air are only managing to make a profit by squeezing out additional revenue from ‘ancillary services’. These include all the extras passengers pay on top of their ticket, such as baggage.
Source: Ryanair financial reports. Financial years to the end of March
Although the reduction in fares has capped the growth in revenue it generates from tickets, up just 1% in its last financial year, ancillary revenue jumped 19% thanks to more passengers coughing up for priority boarding and to reserve seats. Fares may be low, but it seems customers are willing to spend more on extras as a result.
This strategy may have allowed overall revenue to grow by 6% in the last financial year, but a 16% rise in operating costs pushed down profit. Fuel and staff costs spiked, up 23% and 28%, respectively, with notable increases in maintenance and marketing costs too. This pushed pre-tax profit down by 30% to €948 million from €1.6 billion the year before. While that drop was exacerbated by the purchase of Austrian outfit Laudamotion, profit still declined to €1.1 billion excluding the acquisition. That was in line with its revised guidance it released in January, when it issued its second profit warning in just four months as fares continued to drop more than anticipated.
Still, Ryanair prefers to see the opportunity rather than the threat. O’Leary has said the airline will continue to drive down fares as low as they need to go to beat the competition. He has admitted this could be ‘painful’ for one or two years but believes it is the best strategy to drive-out its weaker rivals. While relying on ancillary revenue and constantly cutting fares is not a sustainable business model, it could be a beneficial short-term strategy considering the number of airlines that have collapsed over recent years - including Monarch, Air Berlin, Primera Air - and that others are in trouble, such as Thomas Cook.
O’Leary said Thomas Cook and others, such as Norwegian, will not be able to survive a prolonged period of cut-throat pricing. Ryanair is banking on more airlines failing, which in turn removes the excess capacity that caused the race to the bottom on prices in the first place.
Ryanair has a more cautious outlook than its peers
It is clear there will not be a material rise in fares for some time, but Ryanair is expecting costs to continue increasing. Ryanair is expecting fuel costs to jump another 19% in the current financial year to the end of March 2020, although other operating expenditure should only experience a mild 2% increase. An 8% rise in traffic and a 3% rise in fares should help to partly mitigate the increase in costs, with Ryanair stating profit would be between €750 million to €950 million.
The grounding of Boeing 737 Max 8 aircraft following two fatal crashes also means Ryanair has had to postpone the delivery of 50 planes until the problems are solved and regulators allow the aircraft to fly again. Ryanair has purchased the planes because they are more economical and can deliver cost-savings but, with them grounded, this means the airline won’t gain these benefits as soon as first thought. It has said the cost-saving elements won’t kick in until 2021.
Investors should take a very cautious view on the outlook following the profit warnings from last year. Plus, Ryanair has warned its guidance is ‘heavily dependent on close-in peak summer fares, second half (H2) prices, the absence of security events, and no negative Brexit developments’ – all of which are highly uncertain.
Ryanair has been hit by a wave of labour strikes across its European operations over recent years and in late 2017 the airline reluctantly reached out an olive branch to unions by opening up discussions. While this has led to deals being struck with pilots and other staff in countries like Germany, Belgium and Italy (one of the reasons why there was such a large jump in staff costs), Ryanair is far from harmonising its European employees. Discussions continue with unions in Spain and Reuters reported only last month that British pilots were considering strike action to demand better pay and conditions.
Ryanair restructures to address problems
Ryanair has said it plans to undertake a sizeable restructuring to solve some of its biggest problems, including relations with staff in different countries and its perceived reliance on its CEO. Currently, all operations are run from its headquarters in Dublin. But the new structure will be similar to that of International Consolidated Airlines Group (IAG), which has its multiple brands like British Airways and Iberia managed by different people that all report to the central head of IAG, Willie Walsh. This will see a different person manage Ryanair, Ryanair Sun in Poland, its new Brexit-induced subsidiary Ryanair UK, Laudamotion in Austria and, its latest addition after announcing the acquisition in June, Malta Air. They will all report to O’Leary, who will lead the umbrella company.
This by no means represents a step back by O’Leary, who will remain firmly in control, but it will mean the business is less reliant on him and devolve day to day errands to others. It will also inject competition internally by pitting one airline against another, which should accelerate and intensify the need for the new managers to introduce improvements.
Devolving power from Dublin and managing staff locally should hopefully improve relations with its workforce. One of the reasons its European workforce has become disgruntled is because they are employed centrally in Dublin rather than in their respective countries and that it paid all its tax centrally rather than locally. However, it setup a new subsidiary to buy Malta Air and said it would be structured so income taxes were paid locally in France, Italy and Germany – rather than in Ireland.
Ryanair chairman, David Bonderman, who has been in his role for 22 years, will also leave in the middle of next year and replaced by Stan McCarthy. Pressure has been building for Bonderman to leave since a vote in late 2018 saw nearly 30% of votes cast against his re-election to the board. The overhaul of the board shows it is listening more to disgruntled shareholders while its new structure suggests it is taking comments from unhappy staff on board.
Ryanair is also setting itself up for expansion by ‘enabling the group to look at other small-scale mergers and acquisitions (M&A) opportunities like the successful development of Lauda’. It is clear Ryanair will keep cutting fares as much as necessary to drive out its competition, and then possibly pouncing on opportunities to buy them or their assets for a better price.
The majority of airlines that are based in or are operating within the UK have taken steps to mitigate potential threats from Brexit. Wizz Air, situated in Hungary, obtained a UK licence in the middle of 2018 and easyJet, based in the UK, secured a licence in Austria to ensure flights can keep going after Brexit. Ryanair has followed suit, having secured a UK licence.
Ryanair share price: where next?
European airline shares have all come under pressure in 2019. Ryanair, Wizz Air, easyJet and IAG have lost value over the last 12 months and only Wizz Air has rebounded since the start of the year. A notable number of brokers believe Ryanair is undervalued but the stock has a Hold recommendation according to a Reuters poll.
It is also not the most favoured airline stock among brokers, with Wizz Air and IAG both earning Buy recommendations.
Reuters Poll: Broker Recommendations (July 2)
|Strong Buy||Buy||Hold||Sell||Strong Sell||Average Recommendation|
What is the investment case for Ryanair?
The seatbelt sign will remain on for the next couple of years. Costs will continue rising and fares will remain low, pressuring margins. Ryanair and others have done well to subsidise fares with ancillary services, but this model is not sustainable forever.
However, Ryanair is in a stronger position than most to weather these conditions in the short term, and possibly for massive benefits over the long term. More airlines will falter, and this will boost Ryanair by removing capacity from the market, therefore allowing for higher fares, and by presenting some acquisition opportunities that the airline can use to expand. The investment case right now is very much short-term pain for long-term gain.
However, investors should be wary of how Brexit could impact their holdings. Ryanair has been clear it is prepared to take drastic action to avoid compromising its business if the UK leaves the EU without a deal. But some will argue Ryanair has simply been more proactive than others.
Right now, considering the complications with its dual-listed stock and the fact brokers see better buying opportunities in the market, Ryanair may not be the best addition to your share portfolio. However, this turbulence has introduced some volatility that could be of interest to traders: Ryanair’s share price has swung from as low as €9.61 to as a high as €16.50 over the last 12 months.
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