Buccaneering Ryanair to become a different beast

‘Heavy chop’ is a term used by air traffic controllers and commercial pilots to describe severe turbulence. To manage it belt tightening and calm decision-making are necessary.

Ryanair, Europe’s most successful airline, has just entered an area of ‘heavy chop’ and underestimating its consequences would be a grave mistake.

Once Ryanair said it would recognise trade unions, which it did last week, its share price fell by 15% and wiped €2.5 billion off the stock market value of the company. That was not a knee-jerk reaction by small shareholders but instead was a fundamental decision to divest by some institutional asset managers because of the potential consequences of union recognition.

So, what are those consequences? There are three layers to that answer. The first relates to how Ryanair’s share price trades on the stock exchange. The second is connected to how profit forecasts for the airline will evolve and the third layer assesses what implications union recognition has for the management and culture of Ryanair.

Investors value companies using a metric known as the price earnings ratio (PER) which is the share price divided by the profit per share. Companies that investors believe can generate high profit margins and returns on capital attract higher PERs than those with lower margins.

For more than 20 years investors have traded Ryanair shares at a significant premium to all other airlines in Europe because it had a business model which was hyper efficient and flexible, allowing continued growth as it expanded across Europe.

Part of its formula relied on the flexibility to expand and contract unfettered in whatever geography it chose. In the fast moving airline industry that flexibility was a key element in sustained growth. With union recognition some investors question the ability of the company to grow as fast and as profitably in future and, accordingly, will pay a lower PER for the shares.

Financial forecasts are comprised of estimated revenues and costs. Union recognition, and the earlier decision to raise pilot pay amid a rostering failure, has an impact on Ryanair’s costs. It would be natural to have analysts paring their estimates of future profits as they build in the effect of higher-than-anticipated labour costs on the business. This, too, can drag on a share price.

The third issue relates to culture and management. Ryanair has been a buccaneering dogfighter in the European airline industry for decades. Its combative approach to regulators, airports, aircraft manufacturers and labour laid the foundations for industry low air fares that created a revolution in air travel. If the business is now moving away from that approach investors are debating if this will change the way it is managed and how that could alter the company’s performance.

Whatever way you analyse this Ryanair will continue to be a major airline in Europe. It continues, even with organised labour, to have the lowest per passenger costs in the European market. Its share of short-haul air travel leaves a lot of headroom to grow, despite passenger volumes of over 120 million, and an order for competitively priced new jets will fuel that expansion.

In that process it may transition from the highly dynamic business it has been to something more nuanced, a journey its peer in the US — Southwest Airlines — has already undertaken.

Southwest shares trade at a PER broadly similar to that of Ryanair after last week’s share price decline, it grows more slowly and delivers lower after tax margins. It, however, is a behemoth in the American airline industry, has a strong balance sheet and is valued at $38bn (€32.2bn) on the stock market. This image, perhaps, is where Ryanair will settle in investors and consumers minds.

Joe Gill is director of corporate broking with Goodbody Stockbrokers. His views are personal.