With oil prices so low, this would be a great time to own an airline—if anyone wanted to fly. That's the case for Ryanair Holdings PLC (RYAAY, Financial), the low-cost airline with the biggest market share in Europe and the United Kingdom.
This Dublin, Ireland-based carrier finds itself on the Undervalued Predictable list at GuruFocus in part because a lack of demand for air travel has pushed down its share price, and because it has a strong earnings history. Presumably, those earnings will continue to enrich shareholders once the current crisis has abated, or will they?
Does the company have the resources and management strength to survive an unexpected down cycle? Let’s start with a look at the share price over the past 10 years:
After making a nice recovery coming out of the 2008 financial crisis, Ryanair began losing altitude in 2018. Why? Apparently, there was no shortage of problems, including some that were self-inflicted:
- Higher fuel costs.
- Rising wages; in December 2017, the company recognized a pilot’s union and began increasing their wages. That drove labor costs up 34% in the second quarter of 2018.
- Strikes by regional air traffic controllers that caused it to cancel more than 2,500 flights in the first quarter of 2018. Ryanair refused to provide cash compensation to passengers and got even more criticism from its customers and the public.
It is a company with an appalling customer service history. The BBC reported in January 2019 that Ryanair had been named the United Kingdom’s “worst short-haul airline” for the sixth year running. Passengers did not like its boarding processes, its seat comfort, its food and drink offerings or the cabin environment.
Making matters worse is a CEO, Michael O’Leary, who seems to delight in provoking controversy, perhaps in the belief that even bad publicity is good publicity. At one time, perhaps thinking out loud, he speculated that the airline might begin charging passengers for using plane toilets, an idea that brought on a critical backlash, and one from which O’Leary promptly retreated.
Despite all that negative news, passengers throughout Europe keep flocking to the airline. In response to the polling that found it to be the worst airline for six years in a row, the company claimed its passenger numbers had increased by 80% in those same six years. The BBC also quoted an airline consultant as saying, “the airline had endured a 'tough year' but still generates 'huge amounts of cash.'"
Not long afterward, free cash flow dropped off significantly, as shown in this 10-year chart:
For a broader test of Ryanair’s quantitative worth, we will examine it using the lens of the Macpherson model, a set of criteria used by Thomas Macpherson, the manager of Nintai Investments and a contributor to GuruFocus. It tests for a moat, financial strength, profitability and a discounted share price.
Moat
To test for a competitive advantage, which leads to strong, sustainable margins and higher earnings, the model tests for a median 10-year return of 15% on capital and tangible equity.
- Return on capital: median is 22.67%, well above the 15% required.
- Return on tangible equity: again, the median is above 15%, at 18.41%.
The ROC for 2019 was 17.17%, below the 10-year average, and more than triple the company’s weighted average cost of capital at 5.27%.
We should note here that enjoying a competitive advantage, which Ryanair does, is quite remarkable given the intensity of competition in the airline industry.
Financial strength
Like most companies that use leverage, Ryanair gets a fail on both criteria for financial strength; a cash-to-debt ratio of at least 100 and a GuruFocus financial strength rating of at least 9 out of 10:
Still, it is no danger of going bankrupt; as the table shows, its interest coverage ratio is more than 22 times. Regarding interest coverage, GuruFocus explained: “Ben Graham requires that a company has minimum interest coverage of 5 with the companies he invested. If the interest coverage is less than 2, the company is burdened by debt.”
Profitability
With a strong moat, Ryanair posts strong earnings and high profitability:
As noted in the moat section, high profitability is a surprise for a player in the airline industry, which is better known for destroying capital. As with Southwest Airlines (LUV, Financial), there is profitability in keeping costs down for customers.
Valuation
An examination of Ryanair’s discounted cash flow points us to a seeming contradiction. When we bring up the DCF, we see it does not have a margin of safety (in fact, it has a small, negative margin) because the valuation is below the market price:
What we see here is the earnings-based DCF. But GuruFocus also offers a free cash flow-based DCF and the latter appears to determine whether a stock makes it through the Undervalued Predictable screener. For Ryanair, the free cash flow-based valuation is $81, a fair or intrinsic value that is well above the market price of $56.78. By that measure, Ryanair does belong on the screener list.
Overall, the airline passed tests for a moat and profitability but failed on financial strength and valuation.
Ownership
Eleven of the gurus followed by GuruFocus have holdings in Ryanair. David Herro (Trades, Portfolio) of the Oakmark International Fund has the largest holding, with nearly 11 million shares at the end of 2019. Sarah Ketterer (Trades, Portfolio) of Causeway Capital Management and Jim Simons (Trades, Portfolio) of Renaissance Technologies also held more than a million shares each.
In his letter to Oakmark shareholders published Jan. 9, Herro was optimistic about the company’s longer-term prospects. While his remarks were published before passengers stopped flying, his thoughts are encouraging for the longer term.
Institutional investors owned 26% of the company’s outstanding shares at the end of the first quarter, while its filings show no insider investments.
Covid-19 response
On April 3, Ryanair released a statement explaining that 99% of its flights had been canceled and withdrew its guidance for 2020.
It also noted, “Ryanair has one of the strongest balance sheets in the industry, with year-end cash equivalents of €3.8bn and 327 (77%) of the Group’s owned fleet unencumbered and debt free. The Ryanair Group has already implemented a series of measures to cut operating costs, improve liquidity and cash flows.”
Conclusion
Ryanair is something of a round peg in a square hole, an airline that usually makes money rather than blowing it up. I was surprised to find a major airline with a serious competitive advantage.
Yet, it’s also a company with some issues, including its current share price that provides a negative margin of safety. And, with an airline that has an uncertain future, investors would certainly want a meaningful margin of safety.
This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
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