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The model evolves Jul/Aug 2018 Download PDF

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Reluctant unionisation, high profile strikes, a steady drip of adverse news items: is the Ryanair model under terminal threat? Certainly not, is the answer from this review of the fundamentals of the airline’s financial and operational performance. However, in this financial year (to March 2019) the company will probably see a drop in profitability from the 20%-plus norm, and it may prove very difficult be recover such margins.

Over the past five years Ryanair has averaged 10% passenger growth, largely through stimulating traffic in new markets. It has pushed average load factors up to 95%, a level that would have been regarded as inconceivable a few years ago. The strategy has been based on yield neutrality — adjust price to generate the required traffic to fill the aircraft. Consequently, yield has fallen every year — from €48.20 per passenger in 2013 to €39.10 in 2018.

The proposition by Ryanair that it would somehow be acceptable for prices to slide towards zero as revenue would be generated from other sources now seems implausible. Ancillary revenue per passenger did grow by 4% to €15.50 in FY2018 but this is roughly the same level as in 2014. Substantially increasing  ancillaries on a pure short-haul network is challenging, and  has been tasked to RyanairRooms  (competing with, and other online agencies, through cutting out their 10% commissions — but customers only receive this benefit in credit for future air travel) and RyanairLabs (clever new apps and other techie stuff).

Nor is traffic growth a given. Ryanair’s target is 200m passengers by 2024, and it has always hit its targets in the past, but saturation must be reached at some point — in our analyses of Wizz and Aegean (Aviation Strategy, March and April 2018) we noted how these two very different airlines had succeeded in slowing or blocking Ryanair’s expansion in their key markets.

The exit of Monarch and AirBerlin has not done much to improve supply/demand balance as the capacity from these two carriers was rapidly backfilled by other low cost and network airlines. Ryanair darkly hints that the real market adjustment will come from Norwegian — whose “uncommercial” expansion it blames for at least exacerbating the pilot shortage, adding to its embarrassment when its crew rostering system imploded last September.

Turning to the labour situation, agreements with plots unions in the UK, Italy and now Ireland have been signed though tricky negotiations are ongoing in Spain and Germany. Ryanair has made some major concessions in its newly unionised world: 20% salary increases for pilots, making Ryanair rates better than its benchmarked rivals (Jet2 and Norwegian) according to its own assessment; rebasing of 900 pilots to preferred cities; and a new sponsorship programme for trainees.

This, along with new cabin crew agreements, will inevitably push costs up and reduce productivity (on the measure of cockpit crews per aircraft, Ryanair’s ratio has edged up from 4.3 to 5.6 over the period 2013-18). For perspective, as the pie chart shows, Ryanair’s staff costs in FY2018 still only accounted for 14% of its total costs, and we estimate that cockpit and cabin costs amounted to 11%. Ryanair management state that the total impact on non-fuel unit costs in FY2019 will be an increase of 6% (in contrast to an average 1% annual decline during 2013-18) but contend that this will be mainly a one-off cost adjustment.

In negotiating with its unions Ryanair says that it will take strikes if its fundamental model is threatened and it still has the option, though probably to a lesser extent than before, of churning aircraft among its 86 bases. Whether unionisation will cause a continuous cost escalation will basically depend on the supply/demand balance in the pilot market, which at present is very tight, driven by the expansion of the Chinese carriers and in Europe, as Ryanair complains, by the existence of airlines which really should not be in the market.

Which is why Ryanair almost seems to welcome the escalation in fuel prices as a catalyst for removing financially weak but aggressively expanding competitors (ie Norwegian), despite the fact that higher fuel prices will add about €430m to its costs in FY2019, even taking into account a 90% hedging programme. Fuel accounts for 34% of Ryanair’s cost base and, as the chart suggests, without the softening in prices from FY2014 to FY2018, Ryanair could not have been able to  achieve 20% profit margins.

The first of the 197-seat 737 MAX-8s will arrive next spring, a type described, unoriginally, by Ryanair as a “game changer” because of a promised 16% reduction in unit fuel costs.  Ryanair has succeeded in building in a critical capital cost advantage through its bulk orders from Boeing, the first in the year after 9/11 when the manufacturers were truly desperate. Presumably, Ryanair will have achieved a very deep discount on the MAX’s  list price of $117m (50%?) and will, as before, absorb most of the capex through its very strong free cashflow. Its ownership costs were 12% of total costs in FY 2018, and only 2% in cash costs (rentals and net finance charges as opposed to depreciation).

Ryanair has now increased its ownership of Vienna-based LaudaMotion to 75%. The rationale for the investment is partly to obtain the Austrian AOC and gain access to restricted airport slots in Germany, but primarily it seems that it is to boost Ryanair’s Airbus credentials. By operating A320s for the first time — and mooting a plan for rapid growth to 50 units — Ryanair’s idea is to create real competition between the manufacturers for its future business.

Unfortunately, LaudaMotion’s operating losses for this year have already been revised up from €100m to €150m — the Austrians had no fuel hedging in place — before Ryanair’s restructuring of the airline has begun and before BA’s new short haul low cost airline, Level, also starts building its network out of Vienna. Surely Ryanair hasn’t repeated the mistake it made with its only other purchase of an airline, Buzz way back in 2003, a decision made in rapid response to easyJet’s takeover of Go (which in retrospect was also a mistake).

Airport charges and ground handling costs accounted for 17% of Ryanair’s costs in FY 2018. Its airport model — trading guaranteed traffic growth for discounted per passenger costs — has been put under pressure as it has encountered EU legal challenges to alleged subsidisation at regional airports and as it has moved more and more into primary airports. However, since FY2016 it has contained its per sector airport costs, largely because of the growth deal it struck with MAG, the owners of its largest base at London Stansted. But it is very difficult to see where the next deal of this magnitude could come from — unless it seriously expands into long-haul from one its main bases.

Ryanair has completed an agreement with Aer Lingus to connect passengers at Dublin which should become operational before the end of this year when IT systems are harmonised. Additional revenue to Ryanair will come from fees paid by Aer Lingus for the passengers it feeds to the IAG carrier. With 95% load factors Ryanair will be displacing its own point to point passengers, presumably the lowest yielding ones, when it starts connecting to Aer Lingus, rather than generating new traffic.

As an indication of changing times, the cost item which is clearly expanding at Ryanair is Marketing. Distribution and Other. One might have expected Ryanair to claim that this was due to its “Always Getting Better” initiatives, but it doesn’t: it puts the blame on “Right to Care”, the EU 261 regulation, mandating compensation to passengers for flight delays.

Still, Ryanair is evolving: Michael O’Leary himself says he can envisage a future IAG-type structure for the company with regionally-focused airlines (LaudaMotion, Ryanair Sun, the Polish charter, etc) plus the RyanairLabs experiments, just maybe a long-haul operation.

The airline’s image is intimately bound up with O’Leary’s carefully cultivated persona, and there has been no indication of CEO succession planning. Yet at some point in the not too distant fortune Michael O’Leary might be tempted to use his fortune to indulge full time his horse racing obsession. Nauseatingly however, he has already made a second fortune through his ownership of Classic-winning horses.

Current 2018 On order On Option Additions Disposals Fleet 2024
737-800 443 15 15 -83 375
737MAX 8 135 75 210 210
Total 443 150 75 225 -83 585
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 -500 0 500 1,000 1,500 2,000 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 1,000 2,000 3,000 4,000 5,000 6,000 7,000 Operating profit Net profit Revenues Operating profit Net profit Revenues
Pax growth, Yield decline, Ancillaries stable
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 0 20 40 60 80 100 120 140 2013 2014 2015 2016 2017 2018 0 10 20 30 40 50 60 Passengers (millions) €/pax Pax Volume Scheduled Revenue Ancillary Pax Volume Scheduled Revenue Ancillary
Load Factor at Maximum, Utilisation slips
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 80% 82% 84% 86% 88% 90% 92% 94% 96% 2013 2014 2015 2016 2017 2018 8.2 8.4 8.6 8.8 9.0 9.2 9.4 Pax load factor (seats sold) Flight hours per day Pax Load Factor Aircraft\nUtilisation Pax Load Factor Aircraft Utilisation
Total Costs FY 2018
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 gnuplot_plot_1 gnuplot_plot_2 Fuel Airport and Handling gnuplot_plot_3 En Route Cockpit and Cabin Crew Other Staff Marketing/Distribution Maintenance Rentals Net Finance Depreciation gnuplot_plot_4 gnuplot_plot_5 34% 17% 13% 11% 3% 7% 3% 1% 1% 10% EUR5,540m
Positive impact from fuel price decline
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2013 2014 2015 2016 2017 2018 1.00 1.20 1.40 1.60 1.80 2.00 2.20 2.40 2.60 €bn €/US Gallon Total Fuel Cost Fuel Cost per US Gallon Total Fuel Cost Fuel Cost per US Gallon
Creep in relative staff costs
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 20 25 30 35 40 2013 2014 2015 2016 2017 2018 15% 16% 17% 18% 19% 20% 21% Total Staff per Aircraft Staff Costs as % of Non-Fuel Costs Total Staff per Aircraft Staff Costs as % of Non-Fuel Costs
Crews per aircraft increase
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 0 1 2 3 4 5 6 7 2013 2014 2015 2016 2017 2018 700 750 800 850 900 Cockpit Crews\nper Aircraft Annual Flight Hours\nper Pilot gnuplot_plot_3 Cockpit Crews per Aircraft Annual Flight Hours per Pilot IAA Max hours
Airport Unit Costs Contained
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 900 950 1,000 1,050 1,100 1,150 1,200 1,250 1,300 1,350 1,400 2013 2014 2015 2016 2017 2018 € per sector Airport and Handling En Route Charges Airport and Handling En Route Charges
Marketing, Distribution and Other costs rise sharply
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 100,000 120,000 140,000 160,000 180,000 200,000 220,000 2013 2014 2015 2016 2017 2018 2.00 2.20 2.40 2.60 2.80 3.00 3.20 3.40 No of pax €/pax Pax Per Manager/\nAdministrator Marketing/Distribution/\nOther Costs per Pax Pax Per Manager/ Administrator Marketing/Distribution/ Other Costs per Pax
gnuplot Produced by GNUPLOT 5.2 patchlevel 4 5 6 7 8 9 10 12 14 16 18 20 2013 2014 2015 2016 2017 2018 € (logscale) Ryanair

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