AN INVESTOR'S VIEW:Both Ryanair and EasyJet surprised the market recently as each company warned that yields - the key measure of revenue - are running lower than expected.

Ryanair advised the market that June yields may fall by 5-10 per cent, and at the same time it announced the sale of one million free seats in British market to stimulate demand.

About the same time, EasyJet announced that it too was facing a weaker than expected yield environment.

Reasons put forward by EasyJet were a rapid 18 per cent growth rate in its seat capacity, a doubling in British air passenger duty from £5 to £10 and continued intense competition with European capacity growing despite tight aircraft supply.

The company also pointed to Air Berlin's comments that short-term bookings for southbound flights in April were affected by warm weather in northern Europe.

The reaction to this news in the stock market was swift, with the share prices of both low-cost carriers falling sharply. Over the past month Ryanair's share price is down approximately 15 per cent and EasyJet's is down by over 20 per cent.

However, both shares had a very strong run in 2006 and Ryanair had also been performing very well so far this year, so its share price remains in positive territory for the year to date despite the recent fall.

For long-term followers of the low-cost carriers, recent events will bring back memories of 2004 when profit warnings led to prolonged share price weakness. The expected fall-off in yields in 2004 was 25-30 per cent, far higher than the current environment.

In 2004 Ryanair, was developing its fleet at a very rapid pace and simply could not expand its market fast enough to fill the additional seats.

From its end-December 2003 level of 330 cents, the shares slid to below 200 cents in late 2004. From thereon the share price recovered in 2005 and rose to new highs in 2006 as the company successfully managed its way through capacity increases and higher oil prices.

Conditions in 2007 are very different to those pertaining in 2004. The European and global airline industry is enjoying favourable market conditions reflected in improved profitability across the industry.

Flag carriers such as British Airways and Iberia have recently announced results that showed higher revenues and profits. In Europe, the low-cost carriers continue to gain market share at the expense of the flag carriers. The European economy is now growing strongly and seems set to perform well over the coming two years.

Improved economic conditions across Europe, including most Eastern European economies, should underpin the medium-term demand for air travel.

The flipside of strong global growth is ongoing upward pressure on oil prices. Energy prices have experienced a renewed surge recently, with Brent crude touching $70 a barrel in recent days and it is now up 18 per cent since the beginning of the year.

While Ryanair does have fuel hedges in place, any sustained rise in the oil price will feed through to higher costs.

The response of the incumbent airlines to higher oil prices has been to impose fuel surcharges. Ryanair does not apply surcharges, but the effective increase in fares applied by other airlines has enabled Ryanair to increase its average fares in such circumstances.

However, if the yield environment for the low-cost carriers remains soft throughout the summer, it may prove to be very difficult for Ryanair and EasyJet to recoup higher oil costs through higher average fares.

Turning to stock market valuations, Ryanair is trading on a prospective price/earnings (p/e) ratio of just over 16, which is close to the average for the global low-cost sector. This is justifiably much higher than the average p/e of 11 for European Network Airlines, which includes BA, Air France and Iberia among others.

Arguably, Ryanair's pre-eminent position as Europe's largest and lowest-cost airline justifies a higher than average market rating.

However, Croesus is of the view that the uncertainty created by the current softer yield environment, together with higher oil prices, will cast a shadow for some months.

Until clearer visibility emerges regarding yields, the Ryanair share price is likely to mark time and to establish a trading range at about current levels over the summer months.