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Budget airlines Ryanair, easyJet and others, stand to benefit from overcapacity

“We see tougher market conditions in the short term as positive for the stronger airlines in the long term, since this clears out weaker competitors and aids consolidation in the market,” Liberum said

Ryanair said it had to cut fares by 6% in the third quarter due to overcapacity in the market

Tough competition in the market for short-haul flights has sparked a price war between Europe's budget airlines.

Underlining the issue on Monday, Ryanair blamed “excess winter capacity” in Europe for its first quarterly loss since March 2014.

READ: Ryanair slumps to quarterly loss after cutting fares in competitive short-haul market

The airline said it cut fares by 6% in the third quarter to lure in customers.

A number of smaller rivals are struggling due to overcapacity, including Flybe, which is being taken over by a consortium of Virgin Atlantic, Stobart Group PLC (LON:STOB)  and Cyrus Capital.

READ:  Flybe flies higher after two separate moves that could lead to shareholders getting a better takeover deal

Ryanair pointed out that lower fares and higher oil prices have led to a series of airline failures in the past four months, including Primera in the UK and Spain, Small Planet and Azur in Germany, Sky Works in Switzerland, VLM in Belgium, Cobalt in Cyprus and Cello in the UK.

Others such as Wow in Iceland and Germania in Germany are seeking buyers to stay afloat.

Ryanair said it expects more airline failures in 2019 due to overcapacity in the European market.

Overcapacity could benefit 'stronger airlines' in the long run, says analyst

But analysts at Liberum reckon the overcapacity could benefit the more-established players in the long run.

“We see tougher market conditions in the short term as positive for the stronger airlines in the long term, since this clears out weaker competitors and aids consolidation in the market,” the broker said.

For instance, the collapse of Monarch and Air Berlin in 2017 led to a record number of passengers for easyJet PLC (LON:EZY) last year. easyJet snapped up Air Berlin's operations at the capital's Tegel Airport in December 2017.

Costs the main problem facing airlines

While a competitive sector is certainly driving down fare prices, analysts believe the main problem facing the sector is costs.

Ryanair’s fuel bill jumped 32% and staff costs gained 31% in the third quarter, bringing total operating costs up by 20% to €1.54bn.

Similarly, investors are worried about rising fuel costs for easyJet. The airline said in its first-quarter update last month that it expects the total fuel bill to reach £1.46bn for the year, up from £1.18bn last year.

READ: easyJet takes £15mln hit related to drone chaos at Gatwick Airport

For Wizz Air Holdings PLC (LON:WIZZ), operating costs shot up 25.6% in the third quarter to €512.7mln, driven by higher fuel costs.

READ: Wizz Air profits dented by fuel costs while full-year guidance hinges on Brexit and Easter

British Airways owner International Consolidated Airlines PLC (LON:IAG) said total expenditure in nine months to September 30 gained 4.8% to €15.7bn, mainly due to a 13.5% increase in fuel costs.  

READ: British Airways parent IAG sees annual profits €200mln up on last year

Ryanair has lowest unit costs 

But among the European airlines, Ryanair said it has the lowest unit costs and believes the “gap is widening” as it expects its investments in more fuel-efficient aircraft to pay off.

Liberum thinks Ryanair remains the “long-term winner” in the European airline industry due to its “leading market position, extensive network, low unit costs and strong balance sheet”.

“Ryanair remains on its customary and justified premium to the European airline peer group,” Liberum said, repeating a ‘buy’ recommendation for the stock.

Spotlight on Ryanair's O'Leary as he signs up for further five years as boss

Investors will be watching Michael O’Leary, who has signed on for another five years as the chief executive at Ryanair, to see how well manages competitive pressures, costs and disputes with staff over pay and conditions.

Last year, Ryanair was forced to cancel a number of flights due to strikes by pilots and cabin crew after finally agreeing to recognise unions at the end of 2017. Ryanair has since signed agreements with trade unions across Europe and hopes these will put an end to future walkouts.

“A new management structure, with O’Leary concentrating on managing costs, buying aircraft and M&A and leaving day-to-day running of the underlying airline franchises to others, will probably put some distance between him and the unions,” said AJ Bell investment director Russ Mould.

“That’s not a bad thing given he has a particularly fractious relationship with them.

“Tight management of costs, historically one of O’Leary’s and Ryanair’s strengths, will likely be fundamental to whether the next half decade proves a success, and this could require some finesse in industrial relations.” 

Quick facts: Ryanair Holdings plc

Price: 11.07 EUR

Market: LSE
Market Cap: €12.07 billion

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