Ryanair opens throttles in post-Brexit battle of low-cost carriers

When Ryanair boss Michael O'Leary promised on Tuesday to pump a million seats a month into a weak winter market and slash fares by 15 per cent, he was ramping up pressure on rivals – and on investors struggling to see an end to Europe's price wars.

Since Britain voted in June to leave the European Union, the environment for the continent’s airlines has been rapidly deteriorating, wiping a quarter off the sector’s market capitalisation and triggering a string of profit warnings.

But executives across the sector have stubbornly resisted cutting the number of tickets on offer to raise prices, telling investors that short-term profitability is a price worth paying to maintain and grow market share.

With analysts forecasting capacity increases this winter of 8 per cent – the highest in a decade – the pressure is likely to keep rising in the coming months.

"There's more supply coming on this winter and next summer and that's why the market's got very scared," said a top-30 shareholder in low-cost carrier EasyJet, speaking on condition of anonymity. "And that's just not going to change any time soon. This is a tough year and you've just got to wait it out."

Profit warning

On Tuesday, Ryanair followed rivals including EasyJet, British Airways owner IAG and Germany's Lufthansa in issuing a profit warning, saying its profit would grow 7 per cent rather than the 12 per cent previously guided.

But company shares climbed on the news as investors focused on O’Leary’s promise to ramp up capacity growth and grab market share.

“In every market we are competing with other incumbents, whether they be allegedly low-cost carriers or legacy carriers. We are taking very significant traffic away . . . and we see that continuing,” O’Leary said.

Low prices will last “two years if not more,” he warned. Ryanair, which hopes to lift its European short-haul market share to about 20 per cent by 2024 from 14 per cent now, said it would add six million seats over the six months to the end of March, up from an earlier forecast of four million.

The airline intends to add 50 aircraft in the year to July 2017, up from 36 in the previous year. O’Leary said the company may add more than 50 aircraft in 2018 and 2019.

It says its business model, which fills aircraft irrespective of ticket price to minimise passenger costs and boost spending on extras, is uniquely suited to a period of low fares.

“There’s never been a worse time to be a competitor of Ryanair,” O’Leary said.

Investors in some rival airlines fear he may have a point.

The founder of EasyJet, Stelios Haji-Ioannou, whose family remains the airline's biggest shareholder with a 34 per cent stake, believes the airline should start cutting capacity at the next available opportunity in 2018, revisiting his public opposition to EasyJet chief executive Carolyn McCall's 2013 deal to buy 135 new Airbus aircraft.

“Stelios has been very firm about this ever since 2013 that the fleet growth plan would be destructive of total shareholder value and it looks like he’s right,” his spokesman said.

Fleet growth

EasyJet’s earnings per share will fall by more than 20 per cent for the 12 months ended September 30th, a year in which it has grown its fleet by 16 aircraft, followed by a further forecast drop of 10 per cent this year, according to Reuters data, as it adds 20 aircraft. Fleet growth is anticipated to continue at a similar rate in 2018 and 2019.

McCall has said the current tough environment is the right time to take advantage of its bigger scale and lower-cost operations.

“History shows that at times like this the strongest airlines become stronger,” McCall said earlier in October.

But the collapse in fuel prices, which typically accounts for around a quarter of airline costs, has thrown a lifeline to many airline owners, and there has been precious little sign of capacity leaving the market.

Holiday airline Monarch was last week kept alive by a bailout from investors. Lufthansa agreed to lease 40 aircraft from loss-making Air Berlin, keeping capacity in the market.

Despite repeated failures in the past, Air France-KLM and Lufthansa are investing heavily in their respective low-cost arms, Transavia and Eurowings, extra capacity that is pushing down prices whether they make a profit or not.

"The problem is that at the moment the incumbents are in absolutely no mind to shrink," said Barclays analyst Oliver Sleath. "I think that investors need to be braced for a tough year or two."

EasyJet is hoping its luck will turn after a year in which Islamist militants have staged attacks in France and north Africa, key markets to which it has been much more exposed than Ryanair. It is also far more exposed to Britain, which has been hit by a steep fall in sterling since the June 23rd Brexit vote.

It sees Ryanair’s decision to pull aircraft out of the United Kingdom – its largest market, where it has cut its growth rate to 6 per cent from 15 per cent this year due to uncertainty around Brexit – as a sign of weakness.

An EasyJet source said the airline wanted to take advantage of Ryanair’s withdrawal in the UK, helping to get shareholders on board with its growth plans.

“When we update the market in November we will provide more granularity of where we are adding capacity, at places like Luton, Manchester, Berlin and Toulouse, and we believe that this will help reassure them [investors],” said the source.

Early bookings

Some analysts feel Ryanair has had some luck on its side this year. O’Leary admitted that recent decreases in the number of empty seats on aircraft had likely ended, which may deprive them of a tailwind on costs. And its high proportion of early bookings means more than half of its summer tickets had been sold before Brexit hit the value of sterling.

But overall, analysts appear more confident in Ryanair’s ability to withstand the pressure, with just one out of 20 polled recommending investors sell the company’s shares compared with five out of 25 at EasyJet.

Shares in EasyJet, half of whose passengers originate in the UK, are down 40 per cent since the Brexit referendum compared with a fall of 11 per cent at Ryanair.

The question to be answered in the coming months is whether the inevitable retrenchment will start to hurt EasyJet or Ryanair too or whether it will mainly affect their weaker, smaller rivals and less lean carriers at the higher price point.

“Taking a longer-term view, probably it’s still the case that EasyJet is in a better position than a lot of the legacy airlines,” said Jonathan Wober, chief financial analyst at Capa-Centre for Aviation.

“It’s just about getting the balance right and that really does depend on how long the overcapacity remains.” – (Reuters)