Following last Friday’s awful US jobs report, I think there’s little doubt that America is in the grip of a recession. At times like this, it’s critical to shift away from cyclical stocks (such as miners and commodities) that have had a good run, and instead consider stocks where price is a key differentiator.
That’s why shares in Ryanair – or the “Tesco of air travel”, as I call it – look attractive. Let me explain.
Ryanair (RYA), rated a BUY by Goldman Sachs
If, like me, you’re a price-conscious consumer, then you want to pay the cheapest fare for family holidays – and that often means flying with Ryanair. The airline is Europe’s largest low-cost carrier (with an 8% market share) and prides itself on offering unbeatable fares without fuel surcharges on short-haul routes to regional airports in and around major cities.
This simple strategy, ruthlessly executed by CEO Michael O’Leary, has proved extremely successful and led to annual passenger growth of 29% over the past decade to 50 million now. Meanwhile, the competition, especially the national flag carriers, is in disarray, losing money and being forced to withdraw services as oil prices soar. For instance, Alitalia is currently losing around e1m a day, while British Airways has shot itself in the foot (again) with the Heathrow Terminal 5 debacle.
Ryanair is also broadening its revenue streams, introducing add-on services (such as on-board mobile calls), which now account for nearly 20% of turnover. In addition, the firm is cutting costs, announcing a pay freeze for senior management and the closure of a telesales operation, while gaining price concessions at Manchester and Birmingham airports after British Airways downsized its UK flight schedule. Finally, logic suggests oil prices should eventually soften in a global slowdown. If this occurs, then Ryanair’s strong results should continue, because fuel accounts for about 36% of its operating costs.
The City expects revenues and underlying earnings per share (EPS) of e2.67bn and e0.31 for the year ending March 2008, and e3.20bn and e0.26 respectively in 2008/2009. That puts the shares on attractive p/e ratios of 10.0 and 11.5 for the next two years – attractive for such a quality stock with a strong balance sheet (net debt investment opportunity set only e18m). The board is aiming to double profits over the next five years by growing passenger traffic to 83 million by 2012.
So what are the possible curve-balls? The biggest risk is the short-term impact on profitability of both higher fuel costs, which are unhedged from April onwards, and landing charges. But even if these trends did not reverse, I suspect fares would rise to offset this shortfall.
If the recession becomes so tough that some people stop travelling, this would hit Ryanair’s 81% load factors (the percentage of seats filled per flight). There are also industry-related risks, such as sterling’s weakness against the euro, political pressures for green taxes, pilot strikes, terrorism and accidents.
But with such a compelling price advantage over its rivals, I believe Ryanair is well-positioned not only to weather a slump, but to fly through in a much stronger position. As Michael O’Leary puts it: “Ryanair has the lowest cost base in Europe… and even in a recession will continue to be substantially profitable. Despite the possibility of a fall in profits next year, our airline continues to deliver the industry’s highest margins and will remain enormously cash-generative, with a very strong balance sheet.”
Recommendation: Long-term BUY at e2.83
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments