In­vestors don’t need to adopt the brace po­si­tion on air­lines just yet

The Daily Telegraph - Business - - Business Comment - GARRY WHITE Garry White is chief in­vest­ment com­men­ta­tor at Wealth Man­ager Charles Stan­ley

When it was re­cently sug­gested that pi­lot­less planes could take to the skies by 2025, it was easy to imag­ine Ryanair chief Michael O’Leary jump­ing for joy. This new tech­nol­ogy could see his cur­rent rota problems dis­ap­pear – and there is no chance that ro­bots will feel the need to unionise or strike. But it will take many years for this new tech­nol­ogy to be per­fected – and there are some ques­tion marks over whether pas­sen­gers would be keen to climb aboard a re­mote­con­trolled jet any­way. Right now, there’s no easy so­lu­tion to the mess Ryanair has cre­ated. It will have to work through th­ese problems, pay its pi­lots more and deal with the PR fall­out. De­spite tur­bu­lence in re­cent months, air­lines in gen­eral have ac­tu­ally been pretty good in­vest­ments over the last few years – but it ap­pears that the peren­nial problems in the in­dus­try have now started to re­turn.

Not only was Ryanair forced to can­cel more than 20,000 flights be­cause of a lack of crew, but three Euro­pean air­lines have failed in the last six months – Monarch, Al­i­talia and Air Ber­lin. Monarch was the UK’s big­gest-ever air­line col­lapse. Al­i­talia and Air Ber­lin were also ca­su­al­ties in a cut-throat price war caused by an ex­cess of flights in Europe, as the low oil price prompted air­lines to in­crease ca­pac­ity. The col­lapse of Al­i­talia and Air Ber­lin has been a prob­lem for Mid­dle East­ern air­line Eti­had, as it has stakes in both and may now have to re­think its strat­egy of tak­ing po­si­tions in strug­gling air­lines.

All this neg­a­tiv­ity came af­ter the sec­tor ap­peared to be in the throes of a re­nais­sance. Fi­nan­cial per­for­mance in the sec­tor has im­proved so much that War­ren Buf­fett, re­garded as one of the most suc­cess­ful in­vestors of all time, did an about-turn on the sec­tor and his Berk­shire Hath­away in­vest­ment ve­hi­cle has been pil­ing into US car­ri­ers.

“It’s true that the air­lines had a bad 20th cen­tury,” Mr Buf­fett said in Fe­bru­ary, as he talked about his in­vest­ments in Amer­i­can Air­lines, United Con­ti­nen­tal, Delta and South­west. He es­ti­mated that the in­dus­try saw al­most 100 air­line bank­rupt­cies in the last cen­tury. “It’s been a dis­as­ter for cap­i­tal,” he added.

In­deed, things are look­ing OK across the At­lantic. This week, air­line shares ral­lied af­ter Amer­i­can said third-quar­ter unit rev­enue was ahead of guid­ance de­spite a loss of $75m (£57m) due to hur­ri­canes Har­vey, Irma and Maria. United also said that third- quar­ter unit rev­enue is likely to de­cline less than the mar­ket had feared.

The real prob­lem child is Europe. Here, air­lines have been ramp­ing up the num­ber of flights, and new play­ers such as Nor­we­gian have been ex­pand­ing rapidly. This has cre­ated a glut of sup­ply, with short-haul ca­pac­ity in Europe dur­ing the fourth quar­ter ex­pected to ex­pand by a whop­ping 8.2pc. But de­spite the cur­rent ca­pac­ity is­sues, the air­line in­dus­try is likely to grow sig­nif­i­cantly over time.

The ma­jor play­ers with deep pock­ets are hop­ing to grab mar­ket share over the medium term, so in­vest­ing in new air­craft and routes makes sense. Low mar­gins op­er­a­tions are fine for the larger play­ers, as smaller air­lines don’t have the same economies of scale.

Size is the main ad­van­tage for Ryanair and easy­Jet. They have strong bal­ance sheets and are highly cash gen­er­a­tive so can man­age their cost base bet­ter.

The fact they also have a large num­bers of slots at cer­tain air­ports gives them sig­nif­i­cant ne­go­ti­at­ing power when it comes to the pric­ing of take-off and land­ing rights, as well as in bag­gage han­dling.

The wide range of des­ti­na­tions is also a good hedge against in­ci­dents such as ter­ror­ist at­tacks, which dampen de­mand to cer­tain re­gions. In­deed, this was a ma­jor is­sue for Monarch, with An­drew Swaffield, its chief ex­ec­u­tive, say­ing the root cause of the problems was a slump in de­mand for its routes to Egypt, Tu­nisia and Turkey.

Be­cause of their size, easy­Jet and Ryanair are likely to emerge from the price war stronger. Ryanair’s woes are also an op­por­tu­nity for easy­Jet, although the Ir­ish-based car­rier is likely, as usual, to re­cover from the cur­rent scan­dal.

Ryanair makes more than 2,000 flights a day, so the can­cel­la­tions re­flect just a frac­tion of its to­tal flights and less than 1pc of its cus­tomers. The num­ber of pas­sen­gers im­pacted is now said to be 715,000. Last year, Ryanair be­came the first air­line to carry more than 100m cus­tomers in a year, so the changes are hit­ting less than 0.7pc of its jour­neys.

UK-based air­lines also have to face the con­se­quences of Brexit. Tak­ing ques­tions from Par­lia­ment’s Trea­sury com­mit­tee on Wed­nes­day, Chan­cel­lor Philip Ham­mond said it’s “the­o­ret­i­cally con­ceiv­able” that all planes would be grounded when the UK leaves the EU but also said: “I don’t think any­body se­ri­ously be­lieves that is where we will get to.”

He noted that such a sce­nario was not in the in­ter­ests of Europe ei­ther. EU sta­tis­tics agency Euro­stat re­vealed this week that the UK had the most air pas­sen­gers in Europe last year – a quar­ter of the to­tal – at 249m. It was fol­lowed by Ger­many, Spain, France and Italy. The to­tal num­ber of air travel pas­sen­gers in the EU in­creased by 5.9pc. An agree­ment on this front is highly likely.

So, ac­tu­ally, War­ren Buf­fett ap­pears to be quite right. The fu­ture of ma­jor air­lines, even in Europe, looks quite sunny, de­spite the cur­rent in­dus­try prob­lem with ca­pac­ity.

‘It’s true that the air­lines had a bad 20th cen­tury. It’s been a dis­as­ter for cap­i­tal’

The fu­ture of ma­jor air­lines, even in Europe, looks quite sunny, de­spite the in­dus­try’s cur­rent prob­lem with ca­pac­ity

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