|Shares Out. (in M):||296||P/E||21.4x||16.0x|
|Market Cap (in $M):||8,986||P/FCF||negative||66.5x|
|Net Debt (in $M):||395||EBIT||475||635|
I hate two things about this idea. First, it is obviously an airline. I don’t blame anyone for turning the page right now. As Warren Buffett said in his 2007 letter to shareholders, “Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.” Second, the company just raised its guidance for the year just ended on March 31 (Fiscal 2010) and the stock spiked 11% in reaction.
So why read on? And is Ryanair really an eating sardine and not a trading sardine? I believe the company in fact does have a durable competitive advantage—one even greater than its model, Southwest Airlines--as its costs are significantly lower. Just as importantly, the company is transitioning away from a high-growth model (unit growth averaging about 20% annually over the last 5 years). As a consequence, as I will show below, yields should rise as a greater percentage of routes flown transition from a heavily discounted start-up phase to more profitable levels. Equally important, Ryanair should start to generate a ton of cash by Fiscal 2012, which now is next year. Management has already discussed shifting to a strategy of cash maximization and distributing the cash.
Interestingly, I think that a set of stockholders looks at this move away from rapid growth as a negative. This helps create the current opportunity. And, of course, there is no guarantee that management can pull off the transition successfully. (Although they seem pretty aware of its importance. Here is CEO Michael O’Leary at the November analysts’ presentation: “The graveyard is full of people who keep growing for the sake of bloody growing and couldn’t stop growing.”) After a year of discussions with Boeing, Ryanair announced in December that they had broken off talks for a huge new aircraft order that would have begun in 2013. O’Leary has stated publicly that any resumption of talks would have to be on “materially better terms” than those being negotiated last year. It is possible that talks could resume or the company could begin negotiations with Airbus. I think I would prefer a no or slow growth strategy, but I am willing to bet on O’Leary. He owns over 4% of Ryanair and has a history of making pretty smart decisions. Also, it is worth noting that David Bonderman from TPG is Chairman of the Board and also a significant shareholder.
Management has a longstanding goal of earning EU800 million by Fiscal 2013. My guess is that is a little aggressive, but certainly achievable. In my crude model, the company would earn about EU710 million, or $3.25/ADR. But I also think Ryanair will issue a large special dividend, conceivably EU1 billion ($4.55/share) or more, in calendar 2011 or 2012. You can pick your own multiple, but 14X trailing seems pretty reasonable to me for an unlevered company with very good financial returns and a pretty good competitive moat. That would produce an annualized return of close to 20%/year for the next three years and I think you would still like what you own looking forward from there.
In a nutshell, “Pile it high and sell it cheap” and “Lowest cost always wins.” Amazingly, Ryanair has lowered the cost/passenger ex-fuel by 42% since 2000—passing these savings on to customers. The company is highly promotional—selling large number of seats at absurdly low prices. A quick look at the website shows London-Bologna, among many other alternatives, starting at 6GBP. In fact, the Ryanair average fare is over 40% less than that of EasyJet, the other major European low-cost carrier. Like Southwest, the route structure is entirely point-to-point, so crews can stay at home every night. Use of secondary airports drives very favorable landing agreements (especially in the current environment, as numerous competitors are closing or merging) and rapid aircraft turnaround time: Ryanair expects 25 minutes between landing and takeoff. Boeing 737-800s are exclusively used, and, by all accounts, the company has been an extremely shrewd acquirer of planes. O’Leary in June of last year: “We are taking in these very cheap aircraft with very low cost financing, locking away an unbeatable cost basis here for the next five or seven years.” Management roughly targets an 80% load factor and prices to achieve it.
Current Business Conditions
The double whammy of spiking oil prices in 2008 followed directly by a steep European recession wounded Ryanair, although the company stayed in the black on an operating basis in F09 and will be more profitable in the year just ending (just released guidance has EPS of at least $1.40. Yields are starting to stabilize year over year (versus down over 20% in early 2009)—hence the profit surprise in the March quarter. Importantly, the balance sheet is extremely strong: Net debt is less than $400MM and most of the aircraft are owned. Competitors are in generally horrible shape, which should redound to Ryanair’s advantage in the years ahead.
The Case for Higher Yields
As noted above, management targets load factors of about 80%, a strategy they refer to as, “Load Factor Active—Yield Passive.” But yields are not simply driven by macroeconomic forces. Years of very rapid expansion have been accompanied by flights to many new airports and new routes between existing airports (by this summer Ryanair will have over 1000 routes.) Pricing is better on fully mature routes than relatively new routes and, in turn, better on those than brand new routes, where discounts are particularly steep. The slower growth forecast over the next three years will lead to the route structure inherently becoming more mature and thus inherently bearing higher yields. Penelope Butcher at Morgan Stanley forecasts that this fact alone should produce yield increases of 4-6%/year over the next 2-3 years. Yields were EU44 in Fiscal 2007 and should come in at EU34-35 in the year just ended.
F07 42.5 32
F08 50,9 20
F09 58.6 15
F10 66.3 13
F11 73 10
F12 80 10
F13 85 6
Currently net debt is under $400MM. Despite the aggressive capital spending program and subpar profitability over the last two years, Ryanair has actually generated cash, before share repurchases, over the last four years taken as a whole. Going forward, the company should become hugely cash generative, especially in F12 and beyond. Gross CapEx peaked in the year just ended at EU1200 and is forecast to decline sharply, barring a new plane order, over the next few years:
In F12 and F13 combined, Ryanair should generate over EU1000, and possibly over EU1500, in free cash—over a 10% FCF yield by F13—three years from now. At that point, the aircraft fleet will have an average life of less than 5 years and the oldest plane will be roughly 10 years old, as the company has adroitly sold off older planes during strong markets in recent years. In a no growth strategy beyond F13, the fleet could age for at least five more years before Ryanair would have to embark upon a replacement cycle. Hence, free cash generation would be meaningfully higher than whatever earnings level one chooses to model. Though management has repurchased stock in the past (and, in hindsight, at not such great prices in 2007), they now appear much more interested in periodic special dividends every 2-3 years as a means to reward shareholders,
1. 1. European economy unwinds (again). While this might actually be great long-term for the company in terms of its competitive standing, it is hard to imagine the stock doing well in the short-intermediate term.
2. A large new plane order with Boeing or Airbus. There is definitely some chance of this. I’m not even sure it would be bad for the stock as a lot of growth investors would view it as guaranteeing another 5-10 years of strong unit growth. And, as I said above, I would give management the benefit of the doubt.
Note: Throughout I used an exchange rate of $1.35/Euro. There are 5 ordinary shares/ADR. The ADR is quite liquid.
1. Yields go positive over the next few quarters.
2. A large special dividend comes to be seen as increasingly likely. More investors come to understand the enormous cash generation ability of the company in the not too distant future.