Ryanair Holdings: An exercise in de-branding Jul/Aug 2019

Ryanair has been Europe’s most successful airline post liberalisation, in terms of traffic growth, profitability, and shareholder returns as well as, it claims, punctuality and environmental responsibility. It has, of course, also succeeded in attracting a regular stream of negative publicity over customer service and personnel relations. Its new Holdings structure looks like a brave attempt to overcome Ryanair brand problems, through the management are reluctant to present this strategy in this way. More fundamentally, it also has to address negative cost and profit trends.

Results for FY 2019 were well down on the previous year. Net profit (after tax) was €885.0m (including Laudamotion losses of €139.5m), 29% below FY 2018, despite traffic growing by 9% to 142m and total revenues by 7.6%. The net profit margin of 11.5% in FY 2019 was in sharp contrast to the 19-20% margins achieved in recent years. The profit outlook for this year is flat — Ryanair has issued guidance in a wide range, €750-950m for FY 2020 net profit, implying another decline in profit margins.

Management changes

The question of succession, an issue for institutional investors, is being resolved. stors. After 25 years of being in total charge of the airline, Michael O’Leary is moving up, rather than on, to become CEO of Ryanair Holdings while Eddie Wilson has been appointed as CEO position at Ryanair DAC (Designated Activity Company, the Irish equivalent of Ltd), ie the main airline. This was a somewhat surprising move — Eddie Wilson has been in Personnel throughout his 22 years at Ryanair and held the title of Chief People Officer. He has led the many negotiations with the unions, but has not been associated with the core LCC activities at Ryanair.

COO Peter Bellew had been favourite for this role but he is leaving for easyJet, assuming that Ryanair’s lawyers, currently examining the non-compete clauses in his contract, don’t get in the way. Other leading internal candidates for CEO were CCO David O’Brien and Neil Sorahan, CFO.

David Bonderman, the Ryanair chairman for 25 years and founder of Texas Pacific Group and LCC guru, will be stepping down in 2020, having faced increasing criticism from investors, specifically for not rectifying poor labour relations at the company. Also, he will be 77 years old next year. He will be replaced by Deputy Chairman by Stan McCarthy, the former CEO of Irish agriculture and food corporation Kerry Group.

O’Leary remains committed to Ryanair, as far as one can tell from the outside, though some commentators believe that he is developing his own exit strategy. In April he signed a new five-year contract as Group CEO. He agreed to halve his basic pay to €500,000 and his annual bonus also to €500,000 in return for a major incentive: 10m share options at a strike price of €11.12 (Ryanair currently trades at €8.5 though it peaked at €18 in 2017) if the net profit of Ryanair Holdings exceeds €2bn in any year to 2024 and/or the share price of Ryanair exceeds €21. O’Leary doesn’t need the money but a bonus of €100m or so would be satisfying for his ego.

Group rationale

The question is whether Ryanair’s group strategy is likely to produce a more than doubling of its net profit in the target time period. Ryanair’s strategy has been based on simplicity and a laser-like focus on its low-cost operating model. But the evolution into a group structure has been accompanied by some statements that would normally be associated with a traditional carrier; is O’Leary’s assertion that Ryanair will emulate IAG’s multi-airline model valid?

The Ryanair Group now comprises: Ryanair DAC, Buzz (formerly Ryanair Sun), Laudamotion, Malta Air and Ryanair UK (which is a backstop in the case of a Hard Brexit, which unfortunately is looking more likely).

Malta Air

Malta Air is set for a major expansion, although it has only recently received its Maltese AOC. The CEO has just been appointed — Diarmuid O’Conghaile, for the past three year Head of Public Affairs at Ryanair. Again, to outsiders at least, a surprising move — like Eddie Wilson, O’Conghaile clearly had an important role at Ryanair, but not one associated with core LCC management. Perhaps there is a pattern here.

Six 737-800s have been or are being transferred to Malta Air, but the startling statistic is that Ryanair plans to increase the fleet to 50-60 units.

Ryanair has had a productive relationship with Malta, going back 15 years when the Maltese government in effect subsidised Ryanair to operate to Valetta in order to boost tourism. But tourist arrivals on the small island totalled only about 2.5m last year. And the main carrier to the island is still the flag-carrier Air Malta; the Maltese Prime Minister has confidently stated that Malta Air will not have an impact on, and presumably will not be confused with Air Malta, as they serve different markets, which sounds a little hopeful.

At the Q1 results presentation Ryanair talked about potential routes to North Africa and the Middle East that could be served from Malta. But how this would work without a connecting operation at Valetta is unclear.

In reality, Ryanair’s operation to/from Malta would require only six or so full full-time aircraft. More than 40 of the aircraft will be immediately deployed in continental European markets under the Malta Air rather than the Ryanair brand. At the Q1 results presentation Ryanair referred to this obliquely, noting that German, French and Italian crew members would now pay national taxes rather than Irish taxes, which would comply with new union agreements but would apparently result in lower costs for Ryanair.

What Ryanair appears to be doing, though it is difficult for the Irish company to say it explicitly, is to disguise its brand in certain markets, particularly German speaking markets which it has found it difficult to find acceptance. In terms of seats offered Ryanair accounts for just 1% of the (large) German domestic market compared to 88% for Lufthansa/Eurowings. Ryanair is the third largest carrier in the Germany-Rest of Europe market, but its share, 12%, contrasts with 37% for Lufthansa/Eurowings. Only 10% of its revenues are generated from sales in Germany, compared to 19%, for example, in Italy.

The Malta Air colour scheme is reddish and white rather than blue and yellow at Ryanair, and the Irish harp is replaced by the Maltese cross — in other words, no sign of the owner. One question is: how do the Germans feel about Malta?

However, the basic idea is intriguing — the airline should be able to retain Ryanair standards of low-cost operating efficiency (high utilisation and load factors, seating density, rapid turn, airport churn, lean management, low capital costs, etc) and at the same time project a new image suited to customers who are unhappy with Ryanair’s reputation (whether not this perception is justified) in particular markets.

On the soft spec side of the brand, there is not going to be any significant change in onboard service (Ryanair standard is now universal intra-Europe). But there are other service elements that will have to be changed, which will likely have an impact on costs. These might include removing things that passengers really do not like, such as seat allocation charges and excessive change fees. Customer service lines will have to properly manned. The new airline may have to provide guarantees that it will sort problems out effectively in cases of cancellation or delay (even if it is the fault of air traffic controllers) — something similar to Aer Lingus’s operating approach. Customer acceptance may influence airport choice — more primary airports, for instance.

Buzz

Buzz is new name for Ryanair Sun, a charter carrier based at Warsaw Modlin airport and operating under a Polish AOC. Its fleet consists of 25 737-800 repainted from Ryanair colours to a buzzy yellow and white with a bee on the tail. (Buzz was the name of the KLM low-cost subsidiary Ryanair bought in 2003, a transaction that turned out to be a bit of a financial disaster for Ryanair.)

Chairman of Buzz is Juliusz Komorek, who is also Ryanair’s Legal Director and has been at the company for 15 years, while the CEO is Michał Kaczmarzyk. The model to date has been business-to-business, either flying sun charters or wet leasing out 737s to tour operators, though the airline will evolve into scheduled services, probably taking over all of Ryanair’s Polish operations and possibly expanding into the Czech Republic and the Baltic states.

The website is pretty basic at present, but the intention is to list both Buzz and Ryanair flights — there does not seem to be the same necessity to diverge completely from the Ryanair brand in Central Europe. And, in the short term at least, network and pricing policy will be controlled by Dublin. According to an interview with Kaczmarzyk, Buzz will establish its independence in operations and marketing. Buzz was marginally profitable in FY2019, according to Ryanair.

Laudamotion

The rationale for Ryanair’s 2018 investment in Laudamotion was partly to boost Ryanair’s Airbus credentials. By operating A320s for the first time — and announcing a plan for expanding rapidly from the current 16 units to at least 35 — Ryanair’s idea is to create real competition between the two manufacturers for its future business.

At the end of 2018 Ryanair increased its share in Laudamotion to 100%, the whole transaction costing €98.5m in cash and assumed debt. For this it acquired negative net assets of-€1.1m and slots at Vienna and Dusseldorf and elsewhere which it valued at €99.6m.

Presumably the slots were very important for Ryanair. More worrying is Laudamotion’s P&L. For FY 2019 Laudamotion contributed revenues of €134.5m to the Ryanair Group but reported an operating loss of €172.9m (the net loss was less, €139m, because of deferred tax credits and other adjustments). Ryanair attributed the huge loss to start-up costs but has not provided a detailed break-down, though it has pointed unhedged fuel costs and high 737 lease rates from Lufthansa, aircraft which have now been replaced. Still for any LCC start-up, this loss figure seems extraordinary.

Andreas Gruber, the CEO, has forecast FY 2020 losses of €50-70m, which is still a loss margin of around 25-35%. Vienna is probably the most intense LCC market in Europe, with Laudamotion, Wizz, Level and Eurowings all basing aircraft there, attracted by generous incentives from the airport authority which until recently has positioned itself predominantly as the network hub for Austrian. At Vienna, Ryanair finds itself in the interesting position of having one of its units undercut on costs, probably substantially, by another LCC, Wizz.

Operating red and white livery A320s and using the name of Austria’s most famous sportsman (the late Niki Lauda) the airline is completely differentiated from Ryanair. The laudamotion.com website avoids any mention of Ryanair, other than hidden away under General Terms and Conditions section (incidentally, lauda.com which Ryanair refers to in its latest financial report leads to a totally different company). This isn’t the only brand issue for Laudamotion — the airline evolved from the original Lauda Air to Niki, a subsidiary of Air Berlin, and displayed Air Berlin’s logo on its tails, until their bankruptcy and the takeover by Lufthansa, which then offloaded the carrier to Ryanair.

What is Holdings all about?

From the review above it is apparent that Ryanair’s Group strategy is in an early evolutionary phase — nowhere close to IAG’s five-airline group. In 2020 75%-80% of Ryanair Holdings’ capacity will still be with old-fashioned Ryanair and 20-25% with the new-fangled carriers. But it also now possible to discern a coherent strategy for Ryanair Holdings — debranding Ryanair. And a clearer role for the new CEO of Holdings:

• Like Willy Walsh at IAG, Michael O’Leary’s key function as CEO of Holdings must be to manage competition between the airline units and allocate capital between them. For comparison, IAG sets a trigger of 15% anticipated RoI to justify capital for expansion at BA, Iberia, Vueling, Aer Lingus and Level.
• A specific Ryanair function will be to decide the balance between policy decisions made in Dublin and those delegated to Valetta, Vienna and Warsaw (and presumably at other European bases of other Ryanair Holdings airlines).
• Similarly, there will be questions about how much each airline is allowed to deviate from the core Ryanair low-cost operating model in order to establish its own new brand.
• Finally, there is question of closures — Ryanair has been brutal in closing non-performing routes and bases; how long will the Holdings CEO tolerate, to take the obvious example, the extent of losses at Laudamotion? A more difficult question now because of the sunk costs.

MAX situation

Ryanair and Southwest are Boeing’s most important customers for the 737 (although others — Lionair, FlyDubai, VietJet, for instance — have placed nominally larger orders for the MAX). O’Leary says that they are talking to Boeing daily, that PDPs have been frozen and compensation claims are being prepared. The first of the 197-seat 737 MAX-8s were due to arrive this spring but the forecast delivery date is now January/February 2020 (in reality no one can be sure).

The Ryanair Group’s official fleet plan is summarised in the table but will have to be adjusted for MAX delays — 58 deliveries were expected before summer 2020, now that is down to 30 aircraft. However, Ryanair is sticking to the overall numbers — a net increase of 114 aircraft between FY2019 and FY 2023 which will drive total traffic from 142m passengers in FY 2019 to a firm target of 200m in FY 2024.

The MAX has been described by Ryanair as a“game changer”, mostly because of a promised 16% reduction in unit fuel costs, and the type’s introduction will be needed to counterbalance the negative unit cost trends outlined below. By FY 2024 the MAX will account for 37% of Ryanair’s total seat capacity with 737-800s down to 57%, and the remaining 6% A320s.

Ryanair is left with an invidious choice if the MAX is delayed further. It could postpone the retirals of its 737-800s — 115 are scheduled to go — but this will push up the average age of the fleet and will impact its fuel and maintenance costs. Obtaining delivery slots from Airbus in the required time period will be difficult especially if Ryanair expects the discounts that it has achieved historically at Boeing.

Incidentally, to meet the FY2024 traffic target of 200m passengers Ryanair will have to add another 60-odd units to its fleet (calculated by applying current load factor, current utilisation ratios and projected average seat capacity to the passenger target volume).

These extra aircraft would also make O’Leary’s target profit figure to trigger his big bonus more attainable. Using our adjusted fleet plan the €2bn net profit figure equates to about $3.5m per aircraft in, say, FY 2024, but Ryanair’s average profit per aircraft during 2013-19 was $2.7m, and only in one year, FY 2016, did it surpass €3.5m.

Fundamentals

There are important issues to address with Ryanair’s fundamentals. The charts and trace key revenue, cost and profit trends.

The most worrying chart for Ryanair is the first, which shows not only the marked convergence between revenue per passenger and cost per passenger but also fact that ex-fuel unit costs have been rising since FY 2017.

Over the past six years Ryanair has averaged 10% passenger growth, largely through stimulating traffic in new markets. It has pushed average load factors up to 96%, a level once regarded as inconceivable. The strategy of yield neutrality — adjusting price to generate the required traffic to fill the aircraft — has led to a fall in yield has every year — from €48.20 per passenger in 2013 to €37.10 in 2019.

But the idea 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 substantially in FY 2019, having been fairly level previously, but still only accounts for 31% of total revenue. And the reason for the increase was simply more fees for seat allocation and priority boarding. RyanairRooms (competing with Booking.com, and other online agencies) and RyanairLabs (new apps and other IT) were supposed to be important innovations but seem to have faded from the picture.

The recent efficiency gains have all been made through the load factor, which of course leaves passengers feeling cramped, while average aircraft utilisation (flight hours per day) has been declining since FY 2016, which is at least partly due to ongoing labour conflicts.

In 2017 and 2018 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. Yet conflict continues: at present, a legally blocked Irish pilots’ strike, an announced UK pilots’ strike, an upcoming cabin attendants strike in Spain, and threatened action by Spanish pilots.

Two key productivity indicators of labour efficiency — cockpit crews per aircraft and flight hours per pilot — have both been going in the wrong direction since 2015. Also, the number of employees per aircraft has moved up from 30 to 36 during 2013-19 while employment costs as a percentage of total non-fuel costs, previously steady at around 19%, jumped to 23% in FY2019.

In negotiating with its unions Ryanair has stated 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. How the splitting of Ryanair into separate airline units will affect that policy is unclear at present.

In FY 2019 higher fuel prices and capacity growth added about €525m to its costs, and another €450m is expected for FY2020. Oil prices are well down this year — currently trading at $55.7/bbl on Nymex — but Ryanair’s 90% hedging programme is based on a price of $63/bbl. Fuel accounts for 36% of Ryanair’s cost base, which emphasises the need for getting the MAX into service.

Airport charges and ground handling accounted for 16% of Ryanair’s costs in FY 2019. Its airport model — 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. It had 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 average charges per turn have been moving up over the past two years. Again, how exactly the new Ryanair airlines will negotiate with their airports is unclear.

The cost item which is clearly expanding at Ryanair is Marketing and Distribution. This is attributed to the costs of providing ancillary services and, specifically, the EU 261 Regulation, mandating compensation to passengers for flight delays. If the new-branded airlines are to shift further away from Ryanair’s austere passenger service standards, then this cost element must continue to increase.

All in all, the multi-airline, multi-brand strategy somehow seems so unRyanair, but it could work. One thing is unchanged, however — Ryanair hasn’t wasted any money on employing design consultants for the new liveries.