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Ryanair SWOT analysis – Michael O'Leary's maniacal focus on being the lowest cost producer

6-Feb-2013

Last week’s 3Q earnings report from Ryanair saw a 21% increase in net profit, with passenger numbers up 3% and average fares up 8%, partly offset by a 4% increase in ex-fuel costs per passenger. The company raised its net profit target for the year to March 2013 from its previous range of EUR490m-EUR520m to a new figure of “close to EUR540m”, 7% up on last year.

Yet again, Ryanair, now Europe’s leading short haul carrier, is performing strongly in times of economic weakness. The old days of growth at any cost have been replaced by a more measured approach to expansion, but it remains Europe’s most profitable airline through a continued, almost maniacal, focus on being the lowest cost producer in its market.

It is no exaggeration to say that Ryanair has reinvented short haul air travel in Europe. But how does Ryanair achieve its cost advantage and is it sustainable? What is the outlook for its passenger growth rates over the medium and long term and when will it place a new aircraft order? And just why does Michael O’Leary so badly want to buy Aer Lingus?

Ryanair's Strengths

Lowest cost base. Ryanair’s cost per passenger is the lowest in Europe by some margin, approximately one third lower than that of easyJet. Excluding fuel costs, the difference is even starker, with Easyjet’s cost per passenger 67% above that of Ryanair. This unit cost advantage against easyJet stems mainly from airport and handling charges. This, in turn, comes from Ryanair's use of smaller, lower cost airports with fast turnaround times, its bargaining power with airports and the impact of bag and check-in fees on lowering handling and check-in costs at airports.

Costs per passenger (EUR, ex fuel)

  Ryanair easyJet Norwegian Air Berlin Spirit Southwest
Staff 5 8 15 14 16 33
Airports &   Handling 8 18 8 26 15 22
Route Charges 6 6 13 8 - -
Aircraft O’ship  & Maint. 6 8 17 20 16 17
Sales & Marketing 2 6 12 31 4 2
Total 27 46 65 99 51 74
% vs Ryanair - +67% +137% +262% +86%

+170%

Another important source of unit cost advantage is its labour force, which is more productive and flexible (around 50% of flight crew are contractors employed only when required). It also benefits from high seat density (189 seats per aircraft, compared with easyJet’s 156 on A319s and 174 on A320s), high load factors (82% for Ryanair in the year to December 2012 versus just below 80% for AEA carriers), a point to point strategy that allows high aircraft utilisation, a young and efficient fleet, lean overheads and a lack of legacy pension costs.

Ryanair’s focus on having the lowest costs in the market is the key to its success and drives every major decision, including the choice of airports in its network; the introduction of bag and check-in charges (aimed at lowering costs by reducing check-in and baggage handling fees paid to suppliers); and even making major aircraft orders (Ryanair walked away from a very good deal with Boeing in 2010 because the deal was not quite good enough). It is unlikely that another carrier will match Ryanair’s cost base, given its scale and first mover advantage in many of its markets.

Lowest fares. As a direct follow-on from having the lowest cost base, Ryanair also has the lowest average fares in European short haul markets, 37% below those of easyJet. A combination of competitor capacity restraint, slower growth from Ryanair (including capacity cuts over the winter) and competitor fuel surcharges has allowed Ryanair to raise its average fares over recent years, while still retaining a significant price discount.

Network. With more than 1,500 routes across 28 countries in Europe and North Africa, 178 airports (of which 57 are ‘bases’, where Ryanair bases aircraft and crew), Ryanair has the largest short haul network of any carrier in Europe. 

Ryanair is number one by passenger numbers, with almost 80m in 2012 (the Lufthansa group flew 82m in 2012, but this figure included all of its subsidiaries), a market share of around 12%. The chart below ranks capacity within Europe by seat numbers in February 2013 and puts Lufthansa just ahead, but load factor differences and Ryanair's greater focus on the summer schedule put it ahead by passenger numbers on a full year basis.

Top 10 Airlines (3-Jun-2013 to 9-Jun-2013, Europe to Europe, System traffic), ranked by Seats

Fleet. Ryanair has a fleet consisting of a single aircraft type, the Boeing 737-800. The average age of its 305 aircraft is around 4 years, similar to easyJet, but considerably younger than the 9-11 years that is typical for European flag carriers. This gives advantages in terms of fuel efficiency, maintenance costs and customer perception.

Ryanair took delivery of its final aircraft under its existing Boeing contract last year and does not currently expect to place a significant order with any manufacturer that will see new deliveries for the next four to five years. This will inevitably mean that its average fleet age will grow, but it will remain lower than most of its competitors for some years. Moreover, its existing fleet should give sufficient capacity to grow at rates of 3%-5% for the next four or five years.

Airport choices. As noted above, Ryanair derives a significant cost advantage from its choice of airports. Focusing on low cost, uncongested airports that enable it to deliver a 25 minute turnaround, helps to create Ryanair’s competitive edge. In many cases, Ryanair has opened up regions of Europe where previously there was little demand for air travel, stimulating traffic through its very low fares and creating monopolistic markets for itself, since other carriers would not be able to match its fares. While it is true that some of Ryanair’s airports are not convenient for the major city that Ryanair claims they serve (eg Frankfurt Hahn), this is perhaps missing the point. By flying to such airports, Ryanair has often tapped a whole new market in regions that previously had no convenient connection to the rest of Europe.

Moreover, after Ryanair’s initially almost exclusive focus on secondary and tertiary airports, recent years have seen primary airports offer it attractive deals and secure its presence (eg Madrid, Barcelona, Manchester, Edinburgh). This latter development has been stimulated by competitor capacity cuts, meaning Ryanair is one of a very small number of airlines that can offer growth, and Ryanair’s own more restrained capacity growth (single digit growth over the past two to three years, after strong double digit growth over the previous 15 years), which has allowed it to play airports off against each other.

Fast turnaround times. Ryanair’s 25 minute turnaround times are attractive to passengers and allow the airline to maximise aircraft utilisation. Focusing on short turnaround times has also helped to create a positive feedback loop of cost control, since it contributed to decisions about reducing check-in and baggage handling costs.

Ancillary revenues. Ryanair derives 20% of its revenues from ancillary products and services, such as travel insurance, car hire, hotels, surface transport and in-flight sales. It also records excess bag charges under ancillary revenues. While the proportion of its sales from ancillaries has fallen a little from a peak of 22% in 2010/11, it remains high by industry standards and Ryanair was one of the pioneers in developing this area to such a high level.

Management focus. Ryanair’s key source of competitive advantage is its low cost base and management is aggressively focused on this. CEO Michael O’Leary could even be said to be maniacally obsessed with low costs, famously once encouraging staff to steal pens from hotels and banks in order to minimise Ryanair’s stationery costs.

Innovation. It would be no exaggeration to say that Ryanair has reinvented short haul air travel in Europe. While the conversion of what was a small regional airline focusing on Dublin-London was originally based on the Southwest Airlines model in the mid 1990s, Ryanair has pushed the low cost concept further through a series of innovations. These have included taking advantage of EU aviation liberalisation by setting up bases across Europe; abandoning free catering; moving away entirely from travel agents to internet sales; removing check-in desks; installing non-reclining seats; putting advertising on boarding passes and overhead bins; persuading passengers not to check in hold baggage (only around one quarter of its passengers now do this).

While others, most notably easyJet, were also pioneers in some of these areas, Ryanair has gone further more often than any competitor in commoditising and popularising short haul European air travel. And, while it may sound contradictory, Ryanair has also adopted a form of innovation in not following many of its peers into hybridising in search of higher yields and wider markets.

Financial performance. Another area in which Ryanair has been innovative is in its financial performance. Since its IPO in 1997, Ryanair has only once failed to cover its cost of capital. That was in 2008/09, when there was a combination of a very sharp rise in fuel prices – and Ryanair made a conspicuous mistake in reducing its hedging programme – and a heavy fall in average fares.

This track record of strong returns through the cycle, together with strong cash generation and a strong balance sheet, have allowed the airline to return EUR1.5billion to shareholders through buy-backs and special dividends over the past five years, making it very rare among airline companies.

Ryanair's Weaknesses

Seasonality of earnings. As for the industry in general, Ryanair’s earnings are highly seasonal, with its profits increasingly relying on a strong summer, in particular its 2Q (July to September), to offset a loss-making winter (October to March). This pattern of seasonality has become more pronounced since 2008/09, since when it has consistently made losses in at least one of the winter quarters, by contrast to the previous ten years of profits in all four quarters. This seasonality helps to explain Ryanair’s decision to ground 80 aircraft over the current winter period.

Ryanair’s quarterly operating profit (EUR, mill): 1Q2000/01 to 3Q2012/13

Low frequencies. Ryanair tends to offer lower frequencies on its routes than its competitors and often has departures at very inconvenient times (to keep costs and turnaround times down). While this arguably may not be a significant weakness on leisure routes, and has even helped to allow Ryanair in its ‘land grab’ of airports and routes, it is certainly a disadvantage in attracting higher yielding business passengers and some leisure passengers.

Secondary airports. As noted above, Ryanair’s airport choices are mainly an advantage, but, where it has labelled an airport as serving a major city, while the airport is in fact many miles away (eg Frankfurt Hahn, Milan Bergamo Barcelona Girona), this has often deterred passengers in the past. This problem has receded as travellers have become accustomed to Ryanair’s labelling and as Ryanair has moved into more primary airports.

Brand/Media perception. Ryanair is frequently featured in surveys as having one of the weakest brands in European aviation or even in any consumer business. Public perception of Ryanair is often that it is mean, uncaring and money-grabbing. As the airline matures and consolidates its position as Europe’s leading short haul carrier, this perception could start to have an adverse impact on sales (although this does not appear to be the case yet). Indeed, Mr O'Leary almost seems to make a virtue of this feature of the brand - as a distinctively recognisable low price airline.

EU sensitivity. CEO Michael O'Leary makes much of his suggestion that the European Commission and other EU bodies take delight in targetting Ryanair, both in verbal attacks and in singling out the airline - and its airports - for selectively harsh treatment. Necessarily the EU rebuts any such allegations, but the high profile and aggressive tone he adopts towards the Brussels bureaucrats ("the last innovative idea in Brussels came in 1922... Brussels is the Evil Empire" etc) can do little to endear them to Ryanair's innovations, particularly where EU parliamentarians are fuelled by electorate complaints.

Ryanair Opportunities

Market growth and market share gains. Although notoriously cyclical and currently going through a sluggish phase, the European aviation sector remains a growth industry in the medium to long term, by common consensus.

Ryanair, as the market leader in European short haul and the lowest cost producer, is well placed to participate in this growth. Moreover, given current capacity cuts from most of its legacy carrier competitors, it looks set to enjoy market share gains too. Ryanair targets reaching 120m passengers annually over the next decade, equivalent to 4%-5% p/a and this looks very achievable (dependent on a suitably priced aircraft order during that time).

Ryanair passenger numbers (mill) FY2001 to FY2013f* and 2022 target**, and passenger growth rates

Further aircraft order. Although Ryanair walked away from a deal with Boeing for up to 200 aircraft in 2010, communication between the two remains open and Ryanair has said an order might be placed late in 2013 or early in 2014, for deliveries commencing probably around 2017. Ryanair is not talking to Airbus, but Chinese manufacturer COMAC could develop a 199 seat variant of its C919 aircraft by around 2018 or 2019 and could then be a credible alternative to Boeing. Its existing fleet, with the possible, opportunistic, addition of small numbers of additional aircraft through leasing deals, could sustain growth rates of 3%-5% until around 2017.

Ryanair, with significant cash and no immediate need to make an order, is in a strong position and will only do a deal if the price is right and contributes to a lowering of its unit costs.

Better deal at Stansted with MAG. Ryanair has welcomed the purchase of Stansted Airport by Manchester Airport Group (MAG), with whom it is also a partner at Manchester, East Midlands and Bournemouth. Ryanair accounts for around three quarters of seat capacity at Stansted, which has seen passenger numbers fall from 24m in 2007 to 17m in 2012, mainly due to Ryanair’s capacity cuts there as a result of airport charge increases and the rising UK Air Passenger Duty. If MAG reverses the charge increases, Ryanair could return to growth at Stansted at a rate of around 1m pax p/a by absorbing some of its spare fleet capacity and churning capacity on other airports and routes.

See related report: MAG-led consortium's purchase of Stansted Airport could point the direction for the future

Economic outlook. Ryanair has tended to produce its strongest financial results in times of economic weakness through a combination of increased price sensitivity from passengers and capacity cuts from many competitors. The current outlook for continued economic austerity across much of Europe could provide a favourable backdrop for continued market share gains.

Ryanair's Threats

External events. Air travel, regardless of the carrier, is vulnerable to geopolitical events and natural phenomena such as earthquakes and volcanic ash disruption. Ryanair’s relatively focused geographic exposure arguably mitigates this exposure relative to airlines with a more global network. With a hitherto unblemished record when it comes to fatal accidents, public perception could be adversely affected if Ryanair were to be involved in a major crash.

Loss of competitor capacity discipline. Ryanair is currently benefiting from a more disciplined and rational approach to capacity growth in its markets than has often been the case in the past. Any loss of this discipline among competitors could threaten the benign yield environment that Ryanair is enjoying.

Airport and navigation charge increases. Ryanair is seeing increases in airport charges in Spain’s AENA airports and ATC increases in Italy and these were responsible for the recently reported ex fuel unit cost increases.

Air travel taxes. Due to price elasticity, increases in air travel taxes reduce demand. In general, these taxes represent a higher percentage of the price of a short haul ticket than a long haul ticket, making Ryanair potentially vulnerable to recent increases in air taxes in countries such as the UK. For this reason, Ryanair says it will reduce its exposure to the UK market.

Fuel price and currency movements. The price of jet fuel, which accounts for around 45% of Ryanair’s costs, is highly volatile. In addition, a high proportion of Ryanair’s costs, but no revenues, are in US dollars, making it vulnerable to a strengthening of the dollar against the pound and the euro. To mitigate these risks, Ryanair systematically hedges its fuel price and currency exposures.

Ryanair’s jet fuel prices paid and hedging details by quarter FY12 to FY14

Cost/Tonne  

FY  12 Actual price

FY   13 Actual price/hedge price
(% hedged)

%   y-o-y

FY14   hedge price
(% hedged)

%   y-o-y

Q1  

USD820  

USD998  

+22%  

USD970   (90%)

-2%

Q2  

USD830  

USD985  

+19%  

USD965   (85%)

-3%

Q3  

USD840  

USD1,022  

+22%  

USD995   (85%)

-3%

Q4  

USD990  

USD1,005   (90%)

+2%  

-

-

Loss of management focus. Given Ryanair’s strong track record of profitable growth in almost all conditions, probably the most significant threat to its continued success is a loss of management focus. This could potentially come from a distraction deflecting the management team from ‘sticking to their knitting’ or possibly from any change at the top.

Ryanair’s current (third) attempt to acquire Aer Lingus could provide just such an unwanted distraction. Ryanair has offered what it calls “radical and unprecedented” remedies to the EU competition authorities in an attempt to gain approval for the deal. These “involve two upfront buyers [believed to be Flybe and British Airways] each basing aircraft in Ireland to takeover and operate a substantial part of Aer Lingus’ existing route network and short-haul business”.

Given that the proposed Flybe deal would reportedly see Ryanair pay Flybe EUR100m and lead to Aer Lingus losing 40% of its short haul routes to Flybe, while leaving Ryanair with Aer Lingus’ long haul routes (in which it has no interest), the logic for pursuing this acquisition is not obvious. Even with these remedies, it is not certain that EU approval will be achieved.

Moreover, given also that the Irish government, owner of a 25% stake in Aer Lingus, has repeatedly (since Ryanair’s first bid in 2006) stated its opposition to selling to Ryanair, it is not clear why Ryanair keeps trying. Aer Lingus could arguably provide Ryanair with more growth options and access to airports that it would not enter itself, but this would be limited by the proposed remedies and the necessary restructuring of the Aer Lingus rump would be a distraction. It is tempting to view the Aer Lingus bid as a vanity project, with little in the way of obvious benefit to Ryanair shareholders.

The possible departure of Michael O’Leary could also be a threat if it were to lead to management losing its focus. He has often said that he may retire “in the next three years”, but this always seems to be a rolling period and he has not shown any recent signs of being on his way out. He may want to stay until he sees a resolution to the Aer Lingus situation, a new aircraft order and a new low cost terminal at Dublin airport.

If he were to leave, he has capable deputies in the form of COO Michael Cawley and CFO Howard Millar, who have been with the airline for 16 years and 20 years respectively, although there is no confirmation (otherwise) that they will be there for the long run. His departure could also be an opportunity to recruit an outsider, which might help to create a more professional brand.

Ryanair has the low cost winning formula; so is Aer Lingus for Michael O’Leary’s epitaph?

Ryanair’s key strength is its low cost base. This allows it to have the lowest average fares in the market and this should continue to attract growing numbers, albeit at slower rates than in its rip-roaring past, and its target to reach 120m pax p/a over the next decade (growth of 4%-5% p/a) should be achievable.

There is certainly scope for Ryanair to improve its brand and media perception, which ranks among the worst in Europe, but low fares are likely to continue to over-ride this weakness. Its strong balance sheet and cash generation, together with spare capacity within its existing fleet, put it in a strong negotiating position with aircraft manufacturers, with whom it will only place an order when it chooses and only if the price is right.

All this achievable without Aer Lingus, the pursuit of which may say more about Michael O’Leary having an eye on his epitaph than it does about any compelling logic for Ryanair and its shareholders.

That said, if Ryanair were to succeed in acquiring the 70% of Aer Lingus that it does not already own, this would cost it less than EUR500m, compared with its own cash pile of EUR3.2bn and its market capitalisation of more than EUR8bn. An expensive mistake, but a survivable one.


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