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