Ryanair has confirmed that the price war being waged by large European airlines ultimately aimed at seeing off small short-haul competitors still has some way to run.
That is why, despite a 55% rise in profits for the first quarter, Ryanair (LON:RYA) shares have not been spared the sell-off in the European sector in recent weeks. The hit to sentiment was exacerbated on Monday after the group announced full-your net profit guidance—€1.4bn-€1.45bn—that was about €100m light of expectations.
The weak pricing environment is a negative for all airlines due to the pressure on yields which could eventually crimp profitability across the board, even for Europe’s dominant carrier. It describes: “yield visibility into H2 as zero”, sticking with guidance of a further 8% fall in fares in H2—or as much as 9%, according to comments by Ryanair’s CFO on Monday. The group also noted that a 1% rise in average fares was due to a strong April (containing Easter, unlike the year before) and some “yield stimulation” in the wake of terror attacks in the UK.
Hazards to all players from the persistence of the current soft pricing environment can’t be dismissed. Despite its leading market position, Ryanair is not immune to a confluence of competitive challenges that have entered the air passenger industry. Despite at least 31 European airlines having ceased operations since 2013, a shift away Turkey and North Africa towards the Med has ramped capacity on those routes and cheap fuel enables weaker carriers to remain in the game. With Alitalia, Air Berlin (DE:AB1), Monarch and perhaps Norwegian Air Shuttle (LON:0FGH) generally regarded as the regional operators most vulnerable to pricing pressure, though showing few indications of strategic capitulation yet, investors calculate that the cloud over the airline sector from cut-throat pricing could last well into 2018.
There’s little doubt that Ryanair’s free cash flow generation leads the industry and is specifically superior to EasyJet's (LON:EZJ) (not least due to the arch rivals being in different spots in their capex cycles). Ryanair therefore has the financial resources to compete on price at almost any yield. But the expected impact on its gross margin is forecast to be about 9 basis points in the current financial year—which also helps account for the group’s unalloyed caution for the next few quarters.
Ryanair has in short, delivered a wake-up call to the industry this morning. It is signalling that the coruscating pricing environment will have deeper consequences and last longer than the market may be factoring in. Once that reorientation is done though, we expect Ryanair’s industry leading proposition to reassert itself in its investment case and for the shares to resume their long-term lead.
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