City Insider - FT journalist David Stevenson on the travel industry



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It’s been a very busy couple of weeks over in the airline sector with a slew of financial numbers suggesting very mixed fortunes amongst the dominant carriers.

The least surprising numbers came from IAG which reported a pre-tax profit of €103 million (£86 million) substantially up from a €121 million loss in 2012. Crucially revenue climbed 4% to €14 billion.

Overall IAG produced a €690 million operating profit in the third quarter, the strongest three months of the year for the transnational carrier.

British Airways was yet again the star performer, but Vuelling also seems to be powering ahead with much more growth to come as the Barcelona-based discount airline opens a new base on Belgium serving 107 destinations.

Most financial press coverage tried to contrast IAG’s very positive numbers with those from Ryanair (more on those later) helped in part by Willie Walsh’s observation that the current trading environment hadn’t been “particularly unusual….I don’t think you could have achieved those sorts of results in an environment as bleak as some people would want you to believe”.

Any suggestion that he might be having a dig at O’Leary’s downbeat assessment was quickly corrected though by Walsh adding that “I don’t think O’Leary has got it wrong because he’s still producing very healthy results”. Quite.

Which brings us neatly to the airline that everyone loves to hate – Ryanair.

The second profits warning in just a few months and a declaration that Europe’s leading Low Cost Carrier would try to appear cuddlier (helped along by reserved seating and a new website) prompted the usual spate of bearish comments from the national media – “has Ryanair lost its mojo” would seem to be the underlying drum beat of gloating.

But both the hard numbers and O’Leary’s subsequent comments to analysts after the trading numbers should, I think, dispel that gloating.

Ryanair is still very much the low cost carrier to beat and Europe’s leading discount airline is still a very long way from falling into the Tesco trap (stalled growth, falling profits and increasingly successful competitors).

The top line is that Ryanair saw its first half net profits increase, reversing the decline posted in quarter one. In fact its second quarter numbers were the best yet with increased average fares and lower unit passenger costs.

Ryanair’s chief executive put it succinctly to investors, noting that the airline still produced a “relatively strong set of numbers against the backdrop of weaker pricing …Traffic was up at 2% and capacity up 1%; traffic up 2%, the load factor was up 1%… despite the fact that we have added very little capacity; revenue per customer up 2%, mainly on the back of ancillary strong performance; the ancillary’s revenue is up; 5% and profit after tax up 1%.”

And then there’s that superb balance sheet. According to O’Leary, Ryanair has “net cash of €175 million at the end of September, despite completing €177 million in buybacks during the half year”.

The challenge, of course, is that weak pricing, acknowledged by O’Leary – these results showed average fares including bags was down 2%. Yet the brutal truth is that Ryanair is still the lowest cost European airline, with costs per passenger continuing to decline to even lower levels – giving it immense firepower to undercut its competitors.

It’s worth sticking with O’Leary’s comments to analysts at this point: “We were the first airline to call the lower fare situation back at the end of August. We’re also going to be the first airline to kind of jump on that, keep taking down unit cost….. at the moment, easyJet, Norwegian, Aer Lingus, all of our indirect competitors are more than double our fares.

“Our unit cost, excluding fuel, is €29 a passenger. EasyJet’s is almost 90% more expensive; and their costs are rising faster than ours, particularly for staff and airports… You go back to the fundamentals of the Ryanair model — our load factor, active; price, passive.

“We take whatever price we get as long as we fill our planes to 82%, 83% on a year-round basis. And yet, our margins are still bigger than EasyJet. We make more money than EasyJet.”

These are compelling numbers but what’s really fascinating is what Ryanair thinks might happen in the future. With fares so soft for at least the last six months, its management should be cautious about the next few months and beyond.

Yet recent numbers indicate that load factor has risen by 1% and volumes were up in October by 6% – according to Ryanair bookings are running very, very strong. Looking at 2014 the airlines bosses expect “flat capacity out into summer 2014 … our capacity would be marginally down, but traffic would be slightly down”.

For me the $64 billion question is what happens next year when Ryanair starts to take delivery of those 175 new Boeings. Will the weak pricing environment still be around or is Ryanair’s high profile attempt to improve its image, booking process and revenue flows the sensible next step to firming up prices in 2014?

Looking in detail at Ryanair’s plans (see box) I suspect that 2013 might just prove to be one of those blip years where the airline’s normal double digit growth rate pauses before picking up again.







Trends to watch ?


 


Looking through Ryanair’s results and subsequent investor presentations a number of key dynamics start to emerge for the coming year – all with much wider travel sector implications.


 


For this observer the really interesting insight is that Ryanair expects fuel and dollar costs to until 2015 which could add as much as €100 million to its bottom line.  If they’re right that could be great news for the rest of the travel sector – most analysts are now predicting sharply lower oil prices and only today I saw one technical analysis which suggested that WTI crude could fall as low as $95 a barrel.


 


I’d also be watching the Italian travel market particularly carefully where Alitalia is taking capacity out of its short-haul routes. Ryanair could make a major move in this market, sparking a big price war.


 


The travel sector should also keep an eye for any further aircraft groundings by Ryanair and route cancellations. The airline is already expecting between 70 and 80 aircraft to be grounded in the next few months but this could easily hit 100 or more.


 


Last but by no means least, Ryanair itself also seems to be watching activity at fast growing Vueling. According to O’Leary “Vueling’s growth has been actually simply straight transfer from Iberia to Vueling, as gradually IAG use Vueling as the means for getting Iberia’s cost base down”.


 


Yet  the chance of a much bigger nastier price war erupting between Ryanair and Vueling is growing  by the day, especially as IAG’s finances become much more sound.


 


 


Has Flybe finally turned the corner?


Perhaps the most interesting story of the last few weeks has been reversal of fortunes for regional airline Flybe – now shorn of its old owners, the Walker family via Rosedale Aviation holdings which sold its entire 48% stake last week.


The absolutely fascinating story here is that the shares have now nearly doubled over the last six months, and even rebounded within hours of the Walker family share disposal to close at around 98p.


The market seems to be buying into Saad Hammad’s transformation story. Talking to institutional investors they seem to think that Flybe has finally turned a corner, cleared out the old management and shareholders and is about to rebuild the business.


I suspect they are probably right and there was a great deal to applaud in these numbers.  Although scheduled airline seat sales were flat in the UK, revenue (from its own managed routes) was up 20%, passenger growth increased 4.3% and revenue per seat also shot up. Crucially investors were cheered by clear evidence that Hammad is taking a knife to that notorious cost base, with cost per passenger seat falling below £40 (non-fuel costs fell 40%).


Add in the fact that Flybe Finland is now profitable, net debt was down to £34 million and overall profits at this halfway stage jumped into the black at £13.8 million and the picture does seem to be radically improved.


But – and it’s a big but – there are still some really big challenges lurking out there that could still destroy Flybe’s niche business centred around connectivity.


The elephant in the room has to be that cost level and even after these heroic achievements  Flybe’s cost per passenger is still the highest in the whole European sector above even the likes of full service operations such as SAS and Lufthansa.


That’s not helped by the fact that aircraft utilisation is still 50% below the levels seen at Easyjet and Ryanair, pilot utilisation is also poor and that at least 28 out of Flybe’s 158 routes are not even covering direct operating costs and crew costs while more than half are not covering these costs plus accounting capital costs.


Hammad has still got much to do and with just a shade under £20 million in free cash to do the job. My money is on a rights issue within the next year and a further fall in the price of the shares.


Oh yes, and even deeper trading relationships with partners such as Thomas Cook at the big regional hubs. Flybe has to still to prove that serving smaller regional airports is a fundamentally profitable business.