The concentrated stock-specific nature of the Irish equity market was brought sharply into focus last week when Ryanair's share price slumped by 30 per cent due to a shock profit warning and indications that the European Commission's ruling on the Charleroi airport deal would be negative for the company.
The contraction in Ryanair's market capitalisation amounted to about €1.5 billion and single-handedly pulled the year-to-date performance of the ISEQ index back towards the European average.
However, even with a market capitalisation of €3.5 billion, Ryanair is still significantly bigger than its arch-rival EasyJet.
The ferocity of the initial stock market reaction to the Ryanair profit warning does certainly highlight just how fickle investor sentiment can be. In part the scale of the market reaction reflects Ryanair's successful track record of uninterrupted revenue and profit growth. The company had become one of the darlings of investors and analysts as it executed a highly successful growth strategy through good and bad times. The airline turned the economic recession following the September 11th terrorist attacks to its advantage by ordering new aircraft on extremely favourable terms. This fleet expansion enabled the company to open new routes throughout Europe.
Another key element in Ryanair's low cost/low fares strategy is to focus on establishing services from Europe's underused secondary airports. It is in this context that the European Commission's ruling on Ryanair's deal at Charleroi airport has such significance. Any immediate negative financial impact on Ryanair is not the key issue. The crucial question is whether the Commission's ruling will permanently damage Ryanair's (and other airlines') ability to open routes throughout Europe on a cost-efficient basis. Given the obvious benefits to particular regions of utilising previously unused airports, it is difficult to envisage wholesale turning the clock back. Furthermore, the expansion of low-cost air travel throughout Europe is clearly something that is in the wider interests of the entire Continent.
From an investment viewpoint, the Charleroi controversy has been distracting attention away from the factors that led to the recent profit warning. It would seem that the company has suffered a sudden fall off in yields as it has cut airfares to fill seats on its expanding route network.
Yields for its fourth quarter are now expected to decline by 25-30 per cent and stockbrokers are forecasting earnings per share of 29 cents compared with prior estimates of 34 cents.
On its own a stalling in growth for one quarter would not be sufficient reason to knock 30 per cent off the share price. The key issue is whether this weaker pricing environment persists into the busier summer months. Ryanair has guided the market to expect that yields will be under pressure going into the next fiscal year. Unfortunately, the range of possible outcomes is very wide and therefore there is now a high degree of uncertainty regarding the next six to nine months.
Although Ryanair has been a highly successful growth stock, a closer inspection of its share price history reveals that most of the growth occurred before 2002. In December 2000 the shares were trading at just over €5, but by December 2001 they had risen to €7.
But over the past two years the share price has effectively been rangebound and has spent most of the time trading with a range of €6 to €7. Throughout this period sales grew rapidly - in the year to end-March 2003 sales grew to €579 million compared with €429 million for 2002. This annual percentage sales growth of 35 per cent was expected to be maintained for at least another year before settling down into annual growth in the 15-20 per cent range. Despite this highly impressive growth, the share price had stalled for some time before its recent slump.
It does now seem that Ryanair overstretched itself in trying to expand so quickly. The recent profit warning signals the firm was caught off-guard by the onset of a more adverse market environment. With additional capacity continuing to come onstream, Ryanair is finding it increasingly difficult to fill all these new seats, even at negligible airfares. It is this downward lurch in load factors, rather than the Charleroi ruling, that is at the heart of the recent share price turbulence.
For Ryanair shareholders the short-term prospects for the share price are likely to remain uncertain. But Ryanair's long-term pre-eminent position in European low-cost air travel still looks unassailable.
The company has a strong balance sheet, generates strong cashflows and is therefore capable of continuing to expand for the foreseeable future. Current turbulence reflects a pause, and possibly a prolonged pause, in Ryanair's profit growth, but it does not herald an end to the phenomenal growth in European low-cost air travel.
