Ryanair’s Season of Discontent

Madhu Unnikrishnan

February 10th, 2020

  • All along, it said not to worry. For seven straight quarters —almost two years — Ryanair’s operating margins were in steady y/y decline. Labor costs were rising sharply. Same for fuel costs, inflated by a weak euro and wrong-way hedges. Air traffic control delays were another headache. Brexit uncertainty and its impact on consumer sentiment led to “panic-pricing” by rivals. Savage fare wars in Germany and Austria caused unexpectedly big losses at Ryanair’s Lauda subsidiary.

    And the B737 MAX-200s Ryanair was eager to get never arrived, leading to pilot overstaffing, aborted growth plans, and higher costs for aircraft maintenance and depreciation. Last winter half (October through March), the airline suffered a highly unusual negative 12% operating margin. Even excluding Lauda’s losses, the figure would have been an ugly negative 6%. Fear not, however, because Ryanair continued to earn extremely high peak-season margins.

    And during last year’s calendar fourth quarter, its margins suddenly increased sharply as adverse trends reversed. Yes, just like Ryanair said they would. Q4 revenues soared 21% y/y despite just 6% more scheduled ASK capacity (Cirium). Operating costs, meanwhile, rose just 10%. Labor and fuel costs again rose by double digits, up 14% and 11%, respectively. Lauda is still losing more money than expected. But fares throughout Europe were no longer depressed. On the contrary, Ryanair’s average fares jumped 9%, alongside a huge 21% increase in ancillary revenues. Priority boarding and preferred seating were big sellers, boosted by a new digital sales platform that enables more personalized offers. Late-booking demand was notably strong around the Christmas and New Year holidays.

    Importantly, lots of industry capacity was lost due to the MAX grounding, NEO delays, and the disintegration of multiple airlines including Thomas Cook and Slovenia’s Adria. Ryanair was itself supposed to have more than 50 MAX-200s by now. Instead, it’s looking at a second straight summer with zero (see Fleet section below for more on Ryanair’s MAX situation). So growth will again be held back, following the reluctant closure of bases in Belfast, Hamburg, Las Palmas, Nuremberg, Stockholm Skavsta and Tenerife South. Lauda, on the other hand, with its Airbus CEO fleet, will continue to expand aggressively as it grows from 23 to 36 planes this summer, while enabling a fifth base in Zadar, Croatia. It wants more secondhand A320s if it can find them cheaply, though that’s becoming difficult given the MAX situation.

    In any case, Lauda intends to grow, with its eyes on establishing a base in Spain, Italy, eastern Europe or somewhere else outside of Germany and Austria. Vienna airport, as it happens, is running out of room for expansion, even as Lufthansa’s Eurowings retreats and IAG’s Level cuts back. As for its Düsseldorf and Stuttgart bases, Lauda won’t grow there until the market “settles down.” (Ryanair accuses Lufthansa of “below-cost selling.”)

    Lauda, of course, is just one of several Ryanair subsidiaries now, the others being Ryanair U.K., Malta Air, and Buzz in Poland. The company doesn’t pay much attention to their brands. But it finds this IAG-like multi-airline structure useful for lowering its tax liability (and the tax liability of its crews), improving operational flexibility, and providing its Dublin-based management with more career promotion and leadership experience opportunities. Ryanair continues to speak optimistically about its future. CEO Michael O’Leary expects more rivals to fail and consolidate. True to form, he angrily blasted away at Wizz Air’s claims of having lower costs, claiming its own CASK per passenger is 24% lower (and 44% lower than those at easyJet). Wizz Air, he said, is “clearly mathematically challenged.” O’Leary is still extremely bullish on the MAX and what the plane will ultimately do for its unit costs.

    On fuel costs, Ryanair is now 90% hedged through early 2021 after locking in recent declines in the oil market. On labor costs, the market for pilots has eased considerably without “the likes of Norwegian running around offering everybody stupid contracts, promises of long haul 787s and all the rest of it.” And the revenue environment? O’Leary said pandemics like the coronavirus actually boost demand as Europeans elect to holiday closer to home. But he declined to forecast what yields might be this quarter or this summer.

    Brexit is no longer an immediate concern with the U.K. now out of the European Union. But the two sides must still negotiate an air service agreement for flights beyond the end of this calendar year. Another long-term concern is the airline sector’s growing exposure to environmental taxes, regulation, and consumer activism. Ryanair is taking the problem seriously, hiring a new sustainability director and loudly touting its efforts to reduce carbon emissions. Another airline acquisition, by the way, would not “be the first thing on our list,” O’Leary said, while sounding open to the possibility.

Spirit Reports Favorable Trends

  • The fourth quarter brought some welcome developments to Spirit, America’s largest ultra-low-cost carrier. The airline’s 13% operating margin was second-best among all U.S. carriers, behind only Allegiant. This was better than expected — Spirit last month revised its RASM and CASM forecasts to reflect more favorable trends. In addition, the operational messiness it experienced during the summer largely dissipated as management restored more conservative levels of pilot reserves and aircraft utilization.

    On the other hand, Spirit’s 13% operating margin was a substantial drop from the 16% it earned in the same period a year earlier. Its margin decline, in fact, was steeper than that of even Southwest and Hawaiian, the two other U.S. carriers which suffered y/y margin deterioration.

    Spirit’s revenues increased 12% y/y on 17% more ASM capacity. More worryingly, operating costs jumped 16%, even with fuel prices down. Labor costs jumped 15%, depreciation costs were up 29% and maintenance costs rose 37%. It’s seeing airport cost inflation too. It’s building a new headquarters in Fort Lauderdale. And it’s spending money to become more customer friendly, in terms of service and operational reliability.

    Is Spirit losing its cost advantage? No, executives insist, because rivals are seeing their costs rise as well. Though it’s not a MAX customer, Spirit’s A320 NEOs are arriving late due to tariff disputes and issues at Airbus and Pratt & Whitney. But it relishes the NEO’s fuel efficiency and will now start deploying them on longer-haul routes where the benefits will be even more pronounced. The delivery delays, by the way, are not disrupting 2020 expansion plans too much, but Spirit fears they might cause it problems in 2021.

    The airline remains a champion of ancillary selling, earning $58 per passenger on average last quarter, up 2% y/y. It sees more growth in this area as it refines pricing, introduces new fare bundles, benefits from a revamped website, and uses software to yield greater insights into customer behavior. Spirit is also introducing onboard Wi-Fi and will soon unveil a new loyalty plan that should drive more credit card adoption. Demand and bookings remain strong, especially during peak periods. For offpeak periods, demand is there but pricing is more competitive. Inventory controls on discount fares, it said, are looser this year than last across the industry. That implies pressure on yields.

    But at the same time, Spirit’s yields should benefit as it enters fewer new markets. In 2019, it entered Austin, Burbank, Charlotte, Indianapolis, Nashville, Raleigh-Durham, and Sacramento. That list will likely be smaller this year. Not that it’s slowing growth overall — ASMs should increase another 17% to 19% this year. But much of that growth will involve frequency additions or connecting cities it already serves. It is however adding two cities in Colombia.

    In Orlando, its busiest airport after Fort Lauderdale, Spirit is benefitting from re-timed schedules on Latin/Caribbean routes. These were a drag during much of last year. The Dominican Republic is one Caribbean market that’s weak this winter. Puerto Rico shows some weakness too, perhaps related to a recent earthquake. Now that fuel prices are plummeting, would Spirit consider growing even faster?

    Not really: “We don’t swing our fleet planning and our growth profile based on the machinations of the fuel market,” CEO Ted Christie said. Besides, the large new batch of NEOs it just ordered won’t be arriving for several years. One other note on Spirit’s network: There’s less seasonal variance this year, with schedules not quite as peaked in the summer.

    How will margins develop this quarter? The company expects a pretax figure between 6.5% and 7.5%, down from close to 9% in Q1, 2019. Full-year 2020 margin pretax should be about 12%, compared to nearly 14% in 2019.  

Korean’s Dire Straits

  • For much of the first two decades of the 2000s, Korean Air built a thriving hub in Seoul by rendering it a convenient gateway into and out of China, for both passengers and cargo. Now that China’s economy is slowing, however, the model is showing cracks. More importantly last year, the U.S.-China trade war and a slowdown in global trade more generally badly damaged Korean’s Air’s cargo business, which accounted for 24% of revenues in 2018. Last year, that dropped below 21% as cargo revenues plummeted 15%.

    Unfortunately, the passenger business isn’t exactly thriving either, wounded not just by the slowing Chinese economy but also a heated political dispute between South Korea and Japan. Trouble in Hong Kong, a heavy debt burden, and Korea’s weakening currency relative to the U.S. dollar didn’t help. As a result, Korean’s Air full-year 2019 operating margin dropped to just 2%, from 5% in 2018, 8% in 2017, and 10% in 2016.

    See the trend? During just the fourth quarter, Korean Air’s operating margin did actually increase y/y, to 4% from 1%. For that thank a sharp 12% y/y decline in operating expenses, aided by cheaper fuel. Revenues dropped just 8%. Helpfully amid its woes in neighboring China and Japan, Korean Air gets roughly half of its passenger revenues from intercontinental flying, with about 30% from North America and the other 20% from Europe. These markets held firm, with the U.S. market in particular supported by Korean’s joint venture with Delta.

    Delta is now a part-owner of Korean Air, helping it develop more sixth-freedom U.S-Asia traffic, more U.S. point-of-sale traffic, more U.S.-based corporate business, and new routes like Boston and Minneapolis (the latter operated by Delta). The other key component of Korean’s Air traffic base is the ASEAN market, which seems to be doing well enough though certainly not short of tough competition. Korean opened new routes like Manila Clark and stimulated more leisure demand to destinations like Vietnam.

    Back on longhaul, it’s trying a new route to Budapest this summer, aimed at Korean tourists. It plans more frequencies to Boston, as well as to other cities like Los Angeles, Singapore, and Delhi. It will operate more charter flights for tourists. It’s expanding business class seating on shorthaul flights. And it will work to optimize aircraft utilization and deployment.

    Make no mistake though: Korean Air is a troubled airline, and not just because of temporary market disruptions. Its fleet, for one, is overly complex, probably the result of owning an aerospace manufacturing subsidiary that works closely with both Airbus and Boeing. Indeed, Korean has ordered just about every plane on their menu: A380s, B747-8s, B737 MAXs, A321 NEOs, A220s… the only notable exceptions so far are A350s, A330 NEOs, and B777-Xs. Last year it bought 30 more B787s, including the -10 version.

    Another problem is corporate governance, crystalized by the antics of the airline’s controlling Cho family. Remember the “nut rage” incident? Family members are now battling for management control, prompting current CEO Walter Cho to pledge asset sales and other reforms.

    The bottom line is that Korean Air is nowhere close to meeting the objectives of its Vision 2023 plan. And 2020 is off to a terrible start with the coronavirus scare emanating from China. 

And Jin’s Bad Fortune

  • Jin Air was launched as a low-cost subsidiary of Korean Air, before getting partly spun off through a public share offering. Those who invested aren’t happy right now, to say the least. Jin Air reported a devastating negative 32% operating margin for the fourth quarter, with revenues plummeting 20% y/y but operating costs dropping just 3%.

    A year earlier, Jin’s Q4 operating margin was bad, but only negative 11% bad. The company’s full-year 2019 figure was negative 5%, saved from an uglier fate only by a strong first quarter. Don’t blame cargo — Jin Air barely has any exposure. The main reason for its Q4 debacle was the geopolitical dust-up between South Korea and Japan, which obliterated demand for air traffic between the two neighboring countries.

    A year ago, Jin Air was getting more than one-fifth of its revenue from Japanese routes. Last quarter they were responsible for just 8%. The disruption forced Jin to move planes from Japan to China, the ASEAN region, and the Korean domestic market, leading to excess capacity in these markets. It did however cut ASK capacity overall by 10%.    

Finnair’s Declining Margins

  • Turning from Jin Air to Finnair, the Helsinki-based carrier’s annual operating margins for the past three years unfortunately read like a rocket launch countdown: 7% in 2017, 6% in 2018, 5% last year…. can the carrier reverse the slide? It plans to slow things down in 2020, following a year in which it grew ASK capacity a bullish 11%. That made it one of Europe’s fastest-growing airlines.

    Finnair grew 11% in just the fourth quarter of 2019 as well, with more new flights to Asia and a new route to Los Angeles. More importantly, results for Q4 improved y/y, empowered by strong results on intra-European shorthaul flying. Operating margin rose to 4%, giving it a fighting chance to post a modest profit for the offpeak winter half, always a challenge in the Nordic region. Q4 revenues rose 13% y/y, outpacing a 12% increase in operating costs.

    Frustratingly, the weak euro and hedge losses prevented Finnair from taking advantage of declines in the oil market. Its Q4 fuel bill increased 18%, never mind all the fuel-efficient A350s it now has. Labor cost inflation exceeded capacity growth too, rising 14%.

    Back on the revenue side, Finnair’s rosy results from the intra-European market has something to do with the market’s MAX-induced aircraft shortage. But even more helpful was Norwegian’s massive capacity cutting. Thomas Cook of course, disappeared, which contributed to good performance at Finnair’s tour operator division.

    Domestic performance was likewise strong, aided by leisure demand for connections to Lapland in the north. North American RASK trends were surprisingly robust, with Chicago singled out for distinction. Management also mentioned a bump in government traffic while Finland presided as EU Council president during the last half of 2019 (the rotating six-month position is now held by Croatia).

    But we’ve come too far without mentioning the centerpiece of Finnair’s business model: Asia. In fact, somewhere between one-fifth and one-quarter of Finnair’s shorthaul passengers are connecting to or from Asia, so when it’s not performing well, the entire network suffers. Well, it did perform rather well last quarter. Yes, Hong Kong was weak, though not quite as weak as feared. Yes, mainland China routes saw additional capacity, including Juneyao’s new Shanghai-Helsinki route. And yes, Finnair’s heavy exposure to Asian export economies implies a significant cargo operation, for which Q4 revenues shrank 5%.

    But Finnair’s single largest foreign market anywhere in the world is Japan, which performed well. A trans-Siberian joint venture with IAG and Japan Airlines helped. So did a weaker euro-yen exchange rate, which stimulated inbound European tourism from Japan. Other Asian markets like Korea, Thailand, Singapore, and India, the airline said, are behaving in the “usual fashion,” even now in the throes of the coronavirus scare.

    About that scare, Finnair is not terribly worried. Demand for its China flights is typically weak this time of year anyway, so cancelling them through the end of this month won’t result in any lost profits. So even factoring in refunds to customers, management feels the financial impact will be “relatively limited,” even if the cancellations extend through the entire first quarter. If the problem persists into the peak spring and summer seasons, of course, that would create more problems. One option it mentioned, if necessary, is reallocating some capacity to markets that could support it, like London.

    As it waits for the virus scare to pass, Finnair is embarking on a new business plan covering the next five years. It envisions a more modest expansion of about 3% to 5% a year in ASK terms. Other highlights include a plan to renew its narrowbody fleet, the introduction of a longhaul premium economy class, and the development of a fourth schedule bank at Helsinki airport. It appears keen on wanting a fleet with a greater ratio of narrowbodies relative to widebodies. It separately outsources regional flying to its partner Norra. It continues to expand in Japan with a new Sapporo service and upcoming flights to Tokyo Haneda.

    And after next month, the airline’s pilot contract comes up for renewal. Keep in mind that Finnair remains a government-controlled company. Its current ownership share is 56% and going anywhere below 50% would require an act of parliament. For now, that’s not terribly relevant.

    But it could be if another carrier like IAG ever decides to pursue an acquisition bid. Finnair itself would likely welcome any such interest, understanding all too well its vulnerability as a smallish airline dependent on connecting traffic to Asia. Aeroflot, interestingly, is increasingly chasing the same traffic. LOT Polish has its eyes on the market as well. 

Icelandair Reconsiders

  • On the far eastern end of the Nordic region, Icelandair chases not Europe-Asia traffic but Europe-North America traffic. But that market for the airline — transatlantic travelers connecting via Reykjavik — contracted by 21% y/y last quarter. Local passengers starting or ending their journeys in Iceland helpfully increased by double digits.

    But it wasn’t enough to prevent Icelandair from reporting a negative 11% Q4 operating margin, or negative 13% for just the mainline airline operation itself (i.e. excluding Air Iceland and the company’s hotel, aircraft leasing, and tour operator businesses). That sure beats the negative 23% figure it suffered in the same quarter a year earlier. Revenues rose 7% while operating costs fell 3%.

    Its full year margin figure (negative 3%) also marked a y/y improvement, though only a small one. Put Icelandair in the category of airlines deeply affected by the MAX grounding. Last quarter, it forced a 9% y/y reduction in ASK capacity. More importantly, the disruption has erased as estimated $100m in operating profits.

    That’s almost as much as it earned during each of 2015 and 2016, the last two years in which Icelandair earned strong margins. It’s been a rough going since, especially while Norwegian, Primera, and Iceland’s own Wow Air were recklessly expanding across the Atlantic. The latter two are gone now, in Wow Air’s case after failing to secure a merger with Icelandair. Norwegian is greatly shrinking. But the market remains competitive.

    The MAX was supposed to be accounting for about 27% of Icelandair’s total capacity by now. Partial compensation from Boeing, included in the airline’s passenger revenue, mitigates the impact only somewhat. Fortunately, fuel prices are pretty low, easing the pain from having to rely on its aging B757s much longer than anticipated. This year, Icelandair plans to cut ASKs another 8%, recognizing that it likely won’t get its MAXs flying again before autumn at the earliest.

    In the meantime, it’s focused on improving operations, optimizing crew utilization, reaping the benefits of a new revenue management system, developing a new bank of flights at Reykjavik airport, and building on big improvements in on-time performance last quarter. It’s even opening a new route to Barcelona, having closed some loss-making U.S. routes (i.e. San Francisco and Kansas City). Intriguingly, it also bought a 36% stake in Cape Verde Airlines, a carrier endowed with a hub well positioned for future U.S.-Africa demand.

    In 2020, Icelandair hopes for a return to profitability, eyeing a 3% to 5% operating margin. It warns however, that forecasting is increasingly difficult with travelers booking closer to departure. One more uncertainty is another restive Icelandic volcano that could erupt and disrupt air travel. Longer term, the airline is evaluating whether to stick with the MAX or turn to the NEO.   

IATA: 2020 Off to a Grim Start

  • Global airline passenger traffic (measured in RPKs) grew last year, but much more slowly than in the previous year, IATA data show. RPKs grew in 2019 by 4% over 2018, a much slower pace than 2018’s 7% growth and the first time since the financial crisis that RPKs have not risen by an average of 5.5% annually.

    Most regions of the world saw traffic rise by about 4% last year, except for the Middle East, where traffic grew by a more anemic 2%. Some highlights from IATA’s data are that airlines in China reported traffic rising by 8%, the slowest pace since the financial crisis. India’s airlines reported RPK growth of only 5%, down from the double-digit growth that characterized the industry since 2008, mainly due to the demise of Jet Airways and the slowing Indian economy.

    In most regions, slower economic growth, falling business confidence, and geopolitical tensions caused demand to fall.

    This year is off to a grim start, with the coronavirus outbreak in China crippling that country’s air travel and dampening demand for travel to East Asia in general.◄

Q4 2019 Earnings Scoreboard: U.S. Airlines

Q4 Winners (by operating margin, all figures exclude special items)

  • Allegiant: 20%
  • Spirit: 13%
  • Delta: 12%

Q4 Losers (by operating margin, all figures exclude special items)

  • American: 8%
  • United: 9%
  • Hawaiian: 9%
RevenuesOp Profit (Exluding Special Items)Net ProfitNet Profit (Excluding Special Items)Op Margin (Excluding Special Items)Pretax MarginNet Margin (Excluding special items)ASM/Ks
Alaska $2.228b$252m$181m$181m11.3%10.9%8.12%4%

Source: Cirium

  • Delta scooping up business as its three largest rivals deal with MAX headaches; Atlanta the jewel in its crown
  • American hobbled by labor frustrations in addition to its MAX woes; helped though by better Latin conditions
  • United affected by China exposure and weakness in Germany but otherwise enjoying robust demand conditions
  • Southwest most affected by the MAX affair but just about everything else is going right
  • Alaska recovering from period of uncharacteristcally banal margins; addressed trasncon troubles
  • JetBlue always seems to lag other LCCs on margins; Latin/Carib. markets under competitive pressure
  • Spirit showing some uncomfortable non-fuel cost creep even; margins falling but still high
  • Hawaiian unsurprisingly affected by Southwest’s offensive; Japan still strong despite ANA’s A380 offensive
  • Allegiant proving that it can be every bit as profitable with A319s and A320s as it was with MD-80s

Madhu Unnikrishnan

February 10th, 2020