Headed by Michael O’Leary, Ryanair has long been an innovator in the airline sector. Last week it announced plans to allow a web check-in service, while also charging up to €7 a bag for luggage placed in the hold. This should allow the airline to reduce the number of check-in staff and baggage handlers, so reducing its overheads. It believes the move will reduce fares and speed passengers through departure gates.
Ryanair last month announced plans to base five new aircraft at Dublin airport and launch 18 new routes to continental Europe, ending a long-running stand-off with the Dublin Airport Authority. It expects to carry 1.5m new passengers on the routes.
The experts below have been selected for their skills in a number of investment areas. They, or the funds they manage, may hold shares in the companies or sectors discussed.
Joe Gill, research director, Goodbody Stockbrokers
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RYANAIR’S determination to use low prices as a magnet for passengers was underscored last week. Its new web check-in initiative facilitates another round of fare reductions, while allowing easier transit through airports for day and short-stay travellers. The old mantra of lower fares, rising passenger volumes and stable margins lives on.
Those who believe in long-term business models should own Ryanair shares. Its proven cost disciplines will lift passenger volumes from 35m to about 70m over the next six years.
The tricky part is finding an attractive entry price. Ryanair’s share price is up more than 100% in the past 14 months. We take a cautious view on short-term prospects for one reason only — oil prices.
After March, Ryanair fuel hedging unwinds, while spot jet fuel prices are 33% above last year’s levels. That creates a substantial cost headwind for a carrier determined to expand volumes by another 25% over the next year. While Ryanair will continue to generate the highest industry margins despite high oil prices, the debate over the next few weeks will centre on momentum.
Airline share prices tend to be exaggerated by profit momentum. Positive upward revisions in forecasts expand valuation multiples. Flat or contracting revisions have the opposite effect. To deliver solid earnings growth in the year to the end of March 2007, Ryanair will need relief on fuel costs or steady yields. The latter could arrive courtesy of another round of fuel surcharges from the European flag carriers. The former would surely occur if Iranian worries in the oil market abate. In the absence of either, airline share prices could struggle in the short term.
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If there is short-term weakness, use it as an access point to a winning business model. We expect Ryanair’s share of European short-haul air travel to grow from about 6% to 11% over the next six years. As it does, industry-high margins and prodigious cash flows will inevitably be reflected in a strong share price. Those who worry about the model maturing should examine Southwest in America. It now carries 90m passengers, but continues to generate double-digit earnings growth. It also has an unbroken 30-year record of consecutive profits. We think Ryanair has a better financial model.
Judgment: buy
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Kevin McConnell, head of equity research, Bloxham Stockbrokers
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RYANAIR has seen spectacular growth in both group size and passenger numbers over the past 10 years. In building a strategically unassailable position as the leading European low-cost airline, the company has fought and mostly subdued the challenge of European rivals. Yet the staggering momentum that has driven Ryanair’s success remains intact, with low-cost, short-haul leisure and commuter travel continuing to expand its European route market share.
The airline will offer a record 300 routes in the coming year, serving 22 European countries, with 80 routes being added during the summer. It expects to carry 35m passengers in the year to March, a 27% year-on-year increase.
Much of the low-cost competition that threatened Ryanair after January 2004’s profit warning has left the market, although competition remains stiff in key commuter routes, where traditional incumbents continue to fight for low-cost passengers. Ryanair is now benefiting from the rapidly growing eastern European commuter market, following EU enlargement.
Aside from the many positives behind the Ryanair story, the critical unknown that it continues to face is the impact of high oil prices, which accounts for more than 25% of its annual costs. Offsetting higher oil prices with higher yields will be the big challenge for the coming year.
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The announcement during the week that the group will move to web check-in for hand luggage and begin charging for checked-in luggage is a bold new concept in European air travel. The reduction in airport and baggage handling charges from these initiatives will facilitate a 9% cut in fares from March onwards, with increased passenger volumes expected to render the changes revenue-neutral.
Ryanair’s share price has risen by 38% in the past 12 months, bringing it to a valuation of about 20 times next year’s earnings. With profit growth expected at 20% for the coming year, Ryanair’s valuation remains robust, although fluctuations in the oil price could affect short-term sentiment. Further out, the summer benefit from the football World Cup in Germany will provide a temporary uplift to prospects.
Judgment: long-term buy
THE FIRM AT A GLANCE
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Share price: €8.06
Market cap: €6.2 billion
Year end: March 2006
EPS forecast: 38.7c
Dividend forecast: 0.0
Leading shareholders: FMR Corp 14.4%, Gilder Gagnon 9.2%, Wellington Mgt 9%, Capital Group 5%, Michael O’Leary 4.6%