CTAIRA's Chris Tarry explains how the ripples from a Ryanair profit warning affect the European airline industry
A recent trading update from Ryanair’s management is of particular interest, for what it says and perhaps more intriguingly, the way the share price reacted and its impact on other airlines.
Key phrases in the statement released on 4 September were that there would be “no upgrade in full-year guidance”. Also that management expects the full-year outcome for the period to 31 March 2014 to be at the “lower end “of its currently guided net profit range of €570-600 million ($756- 796 million)”.
There was a comment that if fares and yields continued to weaken over the winter then there “can be no guarantee that the full year outcome may not finish at, or slightly below, the lower end of this range”.
As a starting point, it is worth looking back to what management said when it announced the full year results for FY2013 and at this time gave the guidance for FY2014 where they expected net profit to be in the range of €570-600 million. At that time management also suggested that profit growth was “subject to winter yield out turns”. At the time the first quarter results were announced on 29 July, management underlined its caution citing tough market conditions.
In the light of the profit warning, it appears that yield concerns are being realised, which in part are a reflection of the underlying market, but are also an outcome of what might be described as “own efforts”.
The message was clear that Ryanair would respond “aggressively with pricing and promotions” against a background of traffic weakness at the expected fare levels. In this way it is a traditional response, focusing first on volume, then value.
If in May 2014 Ryanair’s management reports results that are close to the bottom end of the current range, then the outcome will be broadly similar to that of the previous financial year (to March 31st 2013) when reported net profit was €569 million. Reaction to the profit warning was immediate and the share price fell some 13% and closed at €5.87 compared with a closing price the previous day of €6.77. At the time of writing it is €6.27.
Although management had given its guidance and also highlighted one of the key factors that would determine whether that outcome would be realised, most in the market were expecting not only that the outcome for FY2014 would be at the top end of the range, but would be closer to €650 million – some 8% outside the range.
Airline shares are for trading and Ryanair’s profit warning not only gave rise to a trading opportunity, it also underpinned the view of market short termism.
This gives rise to the question of who experienced what might be described as the “rendezvous with reality”.
In this respect, it seems that management has been entirely consistent in its view not least in terms of what the risk factors were. As a result, it is possible to suggest that some in the market might have been hearing but may not have been listening.
The fact that this was only what one commentator called a “mild profit warning” did not really seem to matter.
The main reasons for the greater caution on the part of Ryanair’s management were increased price competition and some capacity increases in the UK, Scandinavia, Spain and Ireland; the effects of austerity and weak economic conditions; and weaker sterling/euro exchange rates. Unsurprisingly, there was some collateral share price damage, but perhaps surprisingly not to the same extent in a number of cases.
If anything, Ryanair’s latest experience again highlights that no matter how low your costs might be that it is revenue that is the key determinant of performance and any weakness here has an immediate effect – the same can of course be said in respect of fuel. Beyond this, the key issues appear to be those that we have reflected on in these columns in the past, in particular that the rules of economics do in fact apply to the airline industry. In this case that the relationships between supply, demand and the necessary price level.
Looking ahead, although generally there is more optimism over economic prospects in Europe much of which is from a low base. There are indications that US investors are significant buyers of shares of European companies on perhaps a longer time horizon than the next quarterly set of results. For at least some airlines, the actions of their competitors in respect of capacity deployment are only likely to be of benefit to potential travellers.
While the share price reaction to Ryanair’s profit warning reflected frustrated expectations of market observers as much as anything, those with more cash in both absolute and relative terms will always be in a stronger position. Ryanair is therefore better placed than most if not all of its competitors when the going gets tough. With this in mind, it will be interesting to see how the current and winter quarter develops for some of the airlines in Europe – particularly in respect of cash generation and cash balances – let alone in respect of the number and timing of trading updates.