In a glum moment for budget airlines, Ryanair may have the last laugh
Investors underestimate how balance-sheet strength might be a differentiating factor in what happens next
Polarising as its approach to service might be, Ryanair tends to do well when it comes to performance rankings. Yet in share price terms, the budget airline is one of Europe’s weakest this year. Investors are right to worry about rising fuel prices, but they underestimate how balance-sheet strength might be a differentiating factor in what happens next.
Without question, low-cost carriers are in the crosshairs. Ryanair’s shares have slipped 7 per cent since weaker fares led it to undershoot forecast profits on Monday, leaving it down almost a fifth this year — roughly in line with rival Wizz Air. EasyJet, the subject of takeover interest from US financial firms Apollo and Castlelake, said on Thursday that it too had lowered fares to boost demand.
In contrast, shares in big full-service rivals such as IAG and Air France-KLM are up. That makes sense, in so far as demand for premium long-haul travel should be more resilient than cheaper short-haul hops. Budget airlines can’t offset rising fuel costs with higher-margin premium products. Fuel accounts for just over a fifth of costs for European flag carriers, versus roughly a third for the no-frills crew, according to Bernstein analysts.
As well as a general trend of rising demand for premium seats, Europe’s flag carriers have benefited from passengers’ wariness of using Middle Eastern hubs. Emirates’ long-haul capacity into Europe has fallen more than a tenth this year while Qatar Airways is down a fifth, according to UBS. Meanwhile, Asia-bound seats from Europe have risen between 8 and 13 per cent, depending on the departure country, compared with overall long-haul growth of just over 5 per cent.
So far this year, all European airlines have been loath to cut capacity significantly because the summer season is when they make their money. Financial hedges have also protected against soaring energy costs, but these will gradually wear off. If fuel remains high into the latter part of the year, winter flight plans will need greater trimming.
That’s when Ryanair should come into its own. Absorbing losses will be much harder for more indebted carriers such as Wizz Air, with net debt equivalent to some five times this year’s ebitda on S&P Capital IQ estimates. Lufthansa and Air France run with net debt below twice ebitda, which, while manageable, limits their ability to aggressively grow market share by cutting prices. EasyJet, currently debt free, may be in a very different position if its private equity takeover goes ahead.
Winter season, when exuberant holidaymakers are harder to come by, is harsh for all airlines. High fuel prices will make this one even harder to bear. But what investors seem to be missing is that for those with the financial flexibility to do so, it could also be an opportunity to expand as rivals retrench.