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Ryanair offers downside protection

February 23, 2011 | About:
Thesis
Ryanair is the lowest-cost European airline. This is not likely to change soon. The company sells at a modest premium to a pessimistic estimate of the replacement cost of its assets.

I use rough numbers (in this case mostly euros). I use numbers from the Ryanair website and bloomberg/businessweek. http://investing.businessweek.com/businessweek/research/stocks/financials/financials.asp?ticker=RYA:ID&dataset=cashFlow&period=A&currency=native


The company
Ryanair operates about 250 boeing 737-800s with an average age of 3.5 years. The company carries about 75m passengers annually on short routes within Europe.

The company's industry-leading profitability is driven by:

1) low operating costs

2) ancillary, high-margin revenue

1) Flying just one type of airplane offers savings on training and maintenance. Ryanair maintains a cash rich balance sheet and acquires its planes at distressed prices. The company flies its planes to second-tier airports where it can save on fees by negotiating with the local airport authority. Ryanair will open service only to airports where it can maintain its industry-leading, 25-minute turnaround, which increases the utilisation of its airplanes. Unlike Ryanair, most other european airlines of similar size, are unionized.

2) High-margin ancillary activities make up about 20% of Ryanair's revenue. Ryanair's flight attendants sell food and drinks, in-flight entertainment, calling cards, and merchandise. 99% of flights are booked directly on ryanair.com. Website visitors are open to e-commerce and responsive to offers. Ryanair leverages its web site to promote rental cars and hotels.

The company was founded in 1985 by Christopher Ryan, Liam Lonergan and Irish businessman Tony Ryan. Current CEO Michael O'Leary has been at the helm since 1991. In 1992, deregulation in Europe gave carriers from one EU country the right to operate between all EU states. This opportunity along with the competitive advantages of the company have been the drivers of rapid growth.

Ryanair was floated on the Dublin Stock Exchange in 1998. The cash was used to order the first batch of new planes; 45 new Boeing 737–800s.


The competition
Ryanair is the fourth largest operator in terms of European traffic with a market share of 5%.

Lufthansa operates 46% of European flights originating in Germany. Domestically, Lufthansa operates 3500 departures per week. Ryanair sits at 100. Lufthansa and Ryanair only compete directly at two airports in Germany: Bremen and Friedrichshafen.

Ryanair has a 1% share of domestic flights in France. Air France and its subsidiaries have 75%. For flights out of France, witin Europe, Ryanair has 3% and is the fourth player. Ryanair has no access to Charles de Gaulle, Orly or Lyon airports.

In the UK and Ireland, Ryanair is the second largest operator domestically with a 15% share of flights operated. Flybe leads and BA is third.

From the UK to Europe, Ryanair operates about 1300 weekly flights, as does BA. Easyjet leads with 1400.

Air France, BA, Lufthansa & Easyjet all have lower margins as well as higher prices due to:

  • Diverse fleets
  • Higher (worse) turnaround times
  • Less direct sales from their own websites
  • A unionized workforce (not Easyjet)
  • More expensive, less efficient and older planes.


In short, Ryanair has pricing power. It remains the low-cost provider with room to grow. The competition is consolidating fast (Iberia & BA, KLM & Air France etc. etc.). The legacy players plan to get better by growing bigger. Ryanair grows bigger by being better.


Why is this cheap ?

1) Khadaffi is being ousted; oil is rising. This is bad for airlines.

2) Ryanair told Boeing they were not ordering extra 737-800s at current prices…. too expensive.

3) The Internet is full of people claiming this is a bad company so the stock must be bad too.

4) The CEO has been at it for a while. What happens if and when he calls it a day ?

5) Ireland. (less than 10% of originating traffic.)


Specific Risk

1) Eyjafjallajökull. This volcano wreaked havoc with European air travel.

2) Oil rises much higher. If oil goes up very much more, the competitive advantages of Ryanair become less important. If fuel becomes 95% of the total cost, who cares about turnaround times, unions and cheap planes ?

3) A problem with 737-800s. If it turns out there is some problem with this specific plane, grounding them for an extended period…. Ryanair is out of options.

One of the 473568 other risks I haven’t thought of yet.


Asset value

Ryanair owns 200 737-800s with an average age of 3.5 years (the remaining 50 are leased).

From the Q3 report: Four Boeing 737-800 aircraft and two spare engines were disposed of, generating sales proceeds of €93.3m.

From the H1 report: three Boeing 737-800 aircraft were disposed of, generating sales delivery proceeds of €65.6m.

That’s € 22m for planes built in 01/02. The current fleet is on average 3.5 years old. It’s worth say 30m * 200 = 6 B. The accountant says book value of PP&E is € 4.5B. The reason Book value understates market value is because book value reflects the low price Ryanair paid (and locked in !) at a time when Boeing had trouble selling anything. I believe they got a 50% discount.

This estimate is pessimistic:
  • Ryanair has made forward payments for some 70 planes yet to be delivered.
  • 200 lowballs the number of planes owned.
  • All transactions I have found for 737-800’s less than 4 years old are over $ 40m => € 30m
  • I assign zero value to other PP&E such as spare parts and hangars.


We conclude book value of PP&E understates the market value of the planes by at least € 1.5B. So the replacement value of Ryanair assets net of liabilities is at least € 3B of total book value + 1.5 = € 4.5B

Again, book value of PP&E includes payments for 70 planes yet to be delivered. My estimate of replacement value does not include the value of these paper planes with an average age of -1 years ! Ryanair is expanding its fleet to 300 737-800s by 2013.


Earnings power

Ryanair spends about € 850m per annum on capex; most of it is spent expanding the fleet. Southwest (LUV) spends less than that maintaining a fleet of 737s three times the size and twice the age. If we take what Southwest spends and adjust for fleet size, the maintenance component of capex for Ryanair is € 250m. What they spend on growth is therefore about 850-250 = 600m. Owner earnings of Ryanair is about 700m of cash from ops -250m of maintenance capex = € 450m.

It's worth noting the estimate of maintenance capex is a bit more than D&A. That makes sense.

Not bad for a company currently selling for € 5B with € 2.2B of excess cash on the balance sheet. Ryanair has demonstrated it is able and willing to return cash to shareholders. € 850m in 2010 !


Final thoughts

  • The ADRs in the US are equal to five ordinary shares. It seems to me that at $ 29 the ADRs are expensive compared to the London shares at € 3.4
  • Ryanair is mentioned in the latest edition of Security Analysis.



Links

http://www.ryanair.com/doc/investor/2011/q3_2011_doc.pdf

http://www.routesonline.com/news/36/the-hub/63627/ryanairas-place-in-the-european-market/

http://www.slideshare.net/The_E_group/Ryanair-Study-version 7

http://www.planespotters.net/Airline/Ryanair


Disclosure

No position in any of the companies mentioned.

Any and all questions and comments welcome as usual.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

Visit batbeer2's Website


Rating: 4.0/5 (21 votes)

Comments

batbeer2
Batbeer2 premium member - 3 years ago
FY report is out, shares are down. Probably because there's volcanic activity on Iceland again.

"The Group generated cash from operating activities of €786.3m which partially funded capital expenditure of €897.2m and the payment of a €500.0m dividend. Capital expenditure largely consists of advance aircraft payments for future aircraft deliveries and the delivery of 44 new Boeing 737-800 aircraft in the year."

1) How's that for an estimate of owner earnings ?

2) Ryanair pays less than € 25m for the latest 737-800..... value of PP&E is understated.

3) This profitable, € 5B company is sitting on € 2B of excess cash.

Here's the report: http://www.ryanair.com/doc/investor/2011/q4_2011_doc.pdf

batbeer2
Batbeer2 premium member - 1 year ago
Analysts are currently optimistic about the future of this company.

http://www.independent.ie/business/irish/davy-raises-ryanairs-target-share-price-to-7-on-back-of-boeing-deal-29144588.html

After two years and > 80% appreciation, the thesis (based on liquidation value) no longer holds. The stock is now into growth territory. FWIW, I believe that is where it should be.

I'll keep tracking this one just in case some scare causes the price to drop below liquidation value once more. If that happens, I''l do an update.

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