Description

DISCLAIMER: The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note and disclaims any obligation to update such information. The views expressed in this note are the opinion of the Author, which may change at any time. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the below note. This note should not be construed as a recommendation to buy or sell any security. 

Investment thesis

Ryanair Holdings (“RYAN”) is the lowest cost, best capitalized, airline in Europe. That low-cost position has allowed the company to profitably grow into becoming Europe’s largest airline, while achieving attractive returns on capital in an industry famously known for destroying capital. We believe their cost position is secure, and that they are the best positioned airline to capitalize on what should be a benign supply/demand environment. At current prices, shares of RYAN represent an attractive risk reward. 

RYAN has led Europe into the age of low-cost air travel for intra-continental flights – a transition that the European population has embraced (see below). From 1987 to 1992 Europe engaged in a series of regulations that relaxed the rules governing air fare, travel, and capacity. The last of these ‘packages’ in 1992 largely removed all remaining commercial restrictions for European airlines operating in the EU; setting up the European single aviation market. This opened the door to free market competition. As it were, this gave RYAN – who was in the right place, with the right strategy, at the right time – the opportunity to disrupt the incumbent market structure by bringing inexpensive capacity into the market. The short-haul European commercial aviation market has shown itself to be extremely price sensitive. A pattern that has emerged across the globe. As long as a minimum threshold of reliability and service is met, price and convenience (i.e. shortest flight) win. 

This display of commodity-like characteristics means that the lowest cost producer wins. RYAN is, and should continue to be, the lowest cost producer in Europe. Airlines are famously bucketed into three categories: legacy/flag carriers, low cost carriers (“LCC”), and ultra low cost carriers (“ULCC”). Being a ULCC has an impact on almost every part of the company’s operations. From route selection, to the 25-minute turnarounds, the aircraft configurations, airport selection, and everything in between. An airline must know what it is. A legacy carrier can never compete with the ULCCs on price. This has forced the high-cost legacy carriers to increasingly exit the short-haul market in order to focus on the long-haul market where the ULCC model is less advantaged. 

When comparing RYAN’s cost position to peers, we tend to focus on comparing RYAN to its two closest competitors WIZZ and EZJ. To that end, RYAN’s cost advantage has expanded through the pandemic. Both the CASK and the Opex per pax (ex-fuel) differential between the company and its two competitors has widened since the pandemic (see below). While some of that increased cost advantage will prove to be temporary, we would be surprised if the cost differential goes back to pre-pandemic levels anytime soon. While they are taking on a lot of risk to get there, over the very long term (10+ years) WIZZ is the airline that might get closest to RYAN on cost. But as we will see, RYAN should still have the advantage amongst the two.

RYAN’s cost position can be attributed to both scale advantages and operating tenacity. The two main areas of cost advantages in the P&L can be found in (1) airport and handling charges, as well as (2) aircraft ownership costs. With the highest market share in most of the airports they operate in, the company can obtain better airport and handling rates than its competitors. It is difficult and very expensive to compete head-to-head with RYAN in bases where they are the incumbent. Kicking out RYAN is a bad financial decision for airports, which means that the lower airport charges are quite secure. In terms of ownership costs, being the largest European OEM customer, the only large BA customer in the continent, and a tough negotiator, has allowed RYAN to achieve better terms on new aircraft than competitors. Lastly, management is not distracted, and they have a reputation for being relentless. They know ULCCs fall from grace because they lose sight on the cost structure. At RYAN, every decision is guided by operations and costs, which has allowed them to fight cost creep. 

We believe RYAN can be conservatively valued around €22 per share, representing 45% upside from current prices. Importantly, we believe that the risk of capital impairment at current prices is very low. Our thesis is predicated on the following four points:

1. RYAN will be able to maintain its cost leadership in Europe, which should allow it to price its capacity aggressively in order to continue growing market share profitably. 

2. The capacity environment in Europe looks quite favorable over the medium term. This will make it easier for RYAN to grow profitably in what should be a constructive environment. 

3. RYAN’s entrenched position in airports, along with their aggressive competitive stance, is a strong deterrent for competitors to try to directly compete with them; adding a layer of protection should the supply/demand picture deteriorate. 

4. A long-tenured and focused management team with the industry’s best operating track record should be able to maintain the current cost advantage and place capacity intelligently. 

Thesis 

1. RYAN will be able to maintain its cost leadership in Europe, which should allow it to price its capacity aggressively in order to continue growing market share profitably.

For airlines, there are thousands of small decisions that create tension between cost and some other benefit. Somewhat counterintuitively, as airlines get bigger, inertia seems to pull some costs higher. The desire to grow and attract more affluent customers, be in larger airports, and recruit more staff, amongst others, cause an airline to compromise. Our view is that as RYAN gets bigger, it should be successful in fighting that inertia, and be able to maintain its current cost advantage. The company’s current cost position is the result of the thousand small decisions successfully made year after year. Those decisions have created what we would consider to be a structural cost advantage. We believe the company’s operating ethos will allow it to keep making decisions that will allow it to continue enjoying that cost position. 

As we analyze the company’s cost structure and compare it to competitors, there are three areas where RYAN’s cost position is clearly and materially superior: 

• Airport, handling, and route charges.

• Depreciation + lease expenses.

• Maintenance expenses.

Following is a discussion of all three cost items. 

Airport, handling, and route charges:

Airport and handling charges consist of what they sound like. Airlines pay airports to access their facilities. While at the airport, airlines need to handle the aircraft and its passengers (either directly or through contractors) which creates expenses. For this discussion we will ignore route charges as all three airlines pay roughly the same. Both airport and handling charges are highly dependent on volumes at the airport level. While there are nuances around whether airports are public/privately owned, slots, and the market environment at the time when deals are struck, the overarching fact is that the more passengers passed through an airport, the bigger the per passenger discount an airline will receive.

As a result, an airline’s market share inside an airport is incredibly important. In an analysis we concluded in 2019, we noticed that RYAN was the market share leader in airports that together accounted for 69% of RYAN’s total capacity, the second biggest airline in airports accounting for 23% of their capacity, and the third largest in 7% of their capacity (see table below). That means that in 2019 RYAN likely enjoyed the best airport and handling rates in at least 69% of its capacity. That year the company had >60% share in 24% of its capacity and >30% share in 60% of its capacity. These are large numbers, and since we did our analysis, RYAN’s concentration has become even more pronounced. 

This level of market concentration has allowed RYAN to obtain large discounts on both airport and handling charges. We believe this position is quite secure. It is extremely difficult for the company to lose their incumbent positions. With their high load factors in the 90s% and their fast turnarounds, competent ULCCs deliver an amount of traffic into airports that no other type of airline can drive. Airports monetize passengers by selling them food, duty free, and other products at high prices. This is a material source of revenue for airports.

Kicking out an incumbent airline (by making it unacceptable for the airline to operate in the airport) with a high market share is quite risky for the airport. It takes two to three years for new airlines and routes to mature – if they mature in line with expectations. That two-to-three-year period would have an airline, or a group of airlines, slowly ramping up capacity and running on much lower load factors. One can come up with scenarios where the airport’s revenues decrease by 20%+ over at least one to two years (on a largely fixed cost structure) if they part ways with a large incumbent. Most airports are hungry for growth. Parting ways with an incumbent creates a high degree of uncertainty. There is a risk that the new capacity is not able to bring as many passengers through the airport as the incumbent did. 

As a result to the above, it requires an enormous degree of friction for a small or mid-sized airport to want to part ways with a large and productive ULCC incumbent. Then, when considering that there are only two real ULCCs in Europe, and that they both have a similar operating model, that just increases the hurdle for ruffling feathers. That is assuming that someone else will come and want to get on RYAN turf, which is not a small assumption that will be explored on thesis point three. In addition, RYAN’s market position is diversified across many airports. As long as the company operates in a satisfactory way, most of their more material airport positions are secure. 

For reference, RYAN’s current country-level market share can be found on Exhibit 1 of the Appendix.

Depreciation + lease expenses:

The above is an estimate, there is some noise in this data.

As the largest customer of narrowbody aircraft in Europe for any OEM, RYAN can extract large discounts on its aircraft purchases. RYAN is also famous for striking large deals during industry downturns, such as the deals they struck after 9/11 and during the COVID shutdowns. This has allowed the company to create capacity at the lowest costs. 

The above table has the historical depreciation plus lease costs for RYAN, WIZZ, and EZJ on a per available seat basis. RYAN’s historical advantage over WIZZ is obvious and undisputable. With EZJ the advantage is still there but it requires some elaboration In conversations with industry participants, it seems likely that in the past EZJ has likely been able to achieve comparable discounts to headline prices from AIR than RYAN has gotten from BA. However, RYAN negotiates on more than just headline prices. RYAN is famous for negotiating expensive freebies with their aircraft purchases. Add-ons from BA have included free simulators, additional parts, marketing spend (yes marketing), and getting BA to send engineers that are on their payroll for things that are normally paid for by the airline. Some of these cost savings show up in maintenance expenses (which will be addressed next), while others are spread through other lines of the P&L. As a result, headline ownership numbers largely understate RYAN’s cost advantage.

As we look into the future, EZJ stops being a real contender while WIZZ is set to make some headway. EZJ’s growth ambitions have moderated, making them an increasingly smaller AIR customer. They currently only have 163 aircraft on order, whereas RYAN had 412 at the end of FY23. EZJ has also shifted part of their model and now has a larger presence at primary and secondary airports. That means fewer daily seats available per aircraft and lower load factors. WIZZ on the other hand, through its 24% owner Indigo Partners, was able to participate in a club deal where 430 A320s were purchased amongst four carriers. It is widely believed that the airlines got an attractive price for those planes. Actual prices are unknown, making comparisons somewhat unreliable, but we have seen analysis suggesting that WIZZ’s per seat cost on that order is likely comparable to RYAN’s costs on the 8200s and the MAXs. WIZZ is taking on a lot of risk with this order, they are effectively increasing their seat capacity by 4.4x over 10 years. They also have the disadvantage that they will have to fund this aircraft through some form of financing (including leases), which will add costs and restrict flexibility. However, if they pull it off, their aircraft ownership cost per seat should come closer to RYAN’s. 

Maintenance expenses:

RYAN’s consolidated numbers are higher than their B737s numbers given some issues they are facing with their small A320 fleet.

Maintenance expenses are generally bucketed within aircraft ownership costs, we separate them to give the reader better context. As mentioned a couple of paragraphs above, in their aircraft purchase negotiations, RYAN has been able to obtain meaningful concessions. Some of those concessions show up in Maintenance expenses. In addition to those concessions RYAN has a couple of other advantages that allow it to have less than half the aircraft maintenance costs than its competitors.

In general, the B737’s has a lower maintenance cost profile than the A320 family. It is easier and simpler to do the overnight checks and some of the other maintenance work on the B737. Then there is scale. RYAN’s airport-level scale allows them to have their own workforce doing maintenance work in more of their bases. That allows them to complete maintenance work more quickly and efficiently. They pay their people more than others but can do the same work with less people. When competitors use contractors the contractor has to earn a margin, and it is less willing to do the work at the same level of efficiency. All these factors combined have led industry experts to tell us that for every maintenance engineer at RYAN, WIZZ and EZJ must use 2.5-3.0 engineers.

We don’t see anything in the future that would cause a material change to the Maintenance expense differentials. WIZZ is going to get some scale but their fleet is going to get older. EZJ is likely going to stay around where it is given their more muted growth profile. RYAN is going to continue operating B737s whereas WIZZ/EZJ will continue operating AIR narrowbodies. 

2. The capacity environment in Europe looks quite favorable over the medium term. This will make it easier for RYAN to grow profitably in what should be a constructive environment. 

According to current OEM delivery schedules, we believe that available seats for European short-haul should grow at a ~6.5% CAGR to 2027 (calendar 2027 overlaps with RYAN’s FY28 over three quarters). The main drivers affecting our forecast are (1) OEM production levels and (2) average aircraft retirement age. We sensitize those inputs in the below table. Our forecast seems to be in-line to slightly conservative, when we look at several reputable forecasts. This is mostly a mechanical exercise that uses publicly stated information, assumes all purchase options are exercised, and is conservative vs history on retirement ages. Furthermore, when we layer in the current supply chain environment for the OEMs as well as the fact that airlines’ Balance Sheets are currently quite levered, we believe that there is a real possibility that we undershoot that forecast. 

As the basic laws of supply/demand would dictate, the lower the supply of seats, the more benign the pricing environment will be. In addition, a lower supply environment would make it easier for RYAN to increase its capacity under attractive terms with airports, and without having to muscle-out current incumbents. 

This section will elaborate on some of the aspects that we think are likely to determine the ultimate capacity outcome and show why we think the capacity picture will be tight. Before we go there though, we should contextualize the above supply forecast with the demand picture.

Travel in Europe is still below 2019 levels and far below what long-term trends would suggest. For RYAN’s FY19, intra-Europe capacity was 1.05bn seats, while the forecast for FY24 is for less than 1.03bn. In the years prior to COVID, Europe experienced a long trend of ~5% annual demand and seat growth on intra-Europe flights. This growth is faster than overall European demand (which includes long-haul) as low priced ULCC capacity stimulates demand. There is a question of whether underlying demand grew through COVID and there needs to be a catch-up before going back to the historical trendline. If that is the case, assuming 4% annual underlying demand growth from COVID to FY28 would imply a 10% demand CAGR from FY23 to FY28. That compares quite favorable to the aforementioned 6.5% supply CAGR. We think it is aggressive to assume that we are going to have a full catch-up for the lost years, but it is within the range of reasonable possibilities. We think that annual demand growth to 2027 will probably be somewhere in the 5%-10% area. Towards the lower end of that range, we will be roughly in line with the above-projected capacity growth. Towards the higher end we will likely overshoot projected capacity growth by a meaningful amount.

Getting back to the capacity growth question. As mentioned, there is a possibility that reality undershoots our current projections. The reason for that is (1) current airlines Balance Sheets are levered making it more attractive for them to retire aircraft early and not exercise all purchase options, and (2) the current supply chain issues with the OEMs are complex and will be difficult to resolve.

Current airline Balance Sheets:

Since 2019 European airline Balance Sheets are weaker across the board, except for RYAN, who has actually improved its credit metrics over the period. RYAN is the only carrier to have maintained its credit rating, while the rest of the players are at least one notch lower than in 2019.

Listed carrier credit metrics FY2019 vs. FY2022

As the above chart shows, some of these airlines are in a precarious situation. Some airlines will likely fail, others will continue to actively cut capacity, and others will continue acting more conservatively while they shore up their Balance Sheets. We believe that there is a high probability that IAG doesn’t exercise some of their 154 options. ITA, TAP, and SAS will likely continue reducing capacity. We don’t know if EZJ will grow at all. While WIZZ will grow capacity, they are likely to keep staying out of RYAN’s markets and look to continue expanding the addressable market as they go East.

OEM supply chain issues:

AIR and BA are currently producing around 70% of eventual targets. Both AIR and BA are still below their pre-COVID production levels on the A320’s (achieved in 2019) and the B737s (achieved in 2018) and have struggled to reach production targets in the last few years. Exhibit 2 shows AIR and BA’s historical production rates and ramp up ambitions.

The aircraft supply chain is highly complex. An aircraft can have over a million parts that go into it. Each parts manufacturer or raw materials provider must be qualified by AIR or BA in a process that will typically take 1-2 years for a part that is modestly engineered. For the parts that bear the most stress, its route to the aircraft is long, with rigorous testing taking place at each stage of the process. 70-80% of the framer value added is from suppliers, with a similar proportion for the engine makers. The engine makers and the advanced casting for some of the engine parts represent the tightest and most engineered part of the supply chain, and as a result is often the source of a slowdown. Pratt & Whitney (part of RTX) produce the PW1100G Geared Turbofan engine for the A320 family, where they compete against CFM’s LEAP-1A as an option, while CFM has a monopoly on the B737 family with its LEAP-1B engine. Both Pratt & Whitney and CFM are facing supply issues.

The pandemic, along with BA’s 737 manufacturing missteps have caused a lot of issues with the supply chain. These disruptions have caused large workforce reductions within the supply chain across the board. Now there are issues getting employees back in and making them productive. Many parts of the supply chain require specialized manufacturing, which takes months to learn, and years before an employee reaches maximum productivity. Looking across some of the key companies in the supply chain, employee levels are generally 10-30% lower than pre-pandemic, and productivity 8-15% lower than pre-pandemic as measured by revenue per employee. In order to reach target production levels, assuming comparable productivity metrics (which is no small fit), the supply chain will have to grow its workforce by 43% in the next four years. Last year’s fast hiring pace produced an 11% y/y increase in total employees across key companies in the supply chain. It is likely to become increasingly more difficult to hire the marginal employee.

Compounding the labor shortage is the added pressure being felt by the engine OEMs. The engine makers develop and sell engines at a small loss/breakeven while making their margin from MRO (maintenance, repair and overhaul). In order to capture more of the maintenance business, Pratt & Whitney pre-sold service contracts with price and service guarantees. Furthermore, their engine is not performing as expected. More engines have had to be serviced at an earlier date than expected, taking up parts that would have been used for new production. Pratt & Whitney is responsible to perform on these maintenance contracts, which has been a financial disaster for them, and a source of further pressure within the supply chain. These issues should get fixed in the next few years, but for now its putting more stress on the supply chain.

---------------------------

These supply chain issues, along with the airlines’ Balance Sheets, and the current capacity baseline, set up for what should be a favorable supply/demand environment in the next few years. While most of the capacity issues should resolve themselves in the medium term, the benefits should be enjoyed by RYAN over the long term. Of course, there is a level of circularity in all this, whereby if the supply/demand environment is quite favorable, pricing will be strong. If pricing is strong, airlines will be very profitable and use the tools at their disposal to increase capacity. So there is a natural limit to how beneficial the situation can become. Our projections don’t count on a tight environment, but a tight environment improves the probability of events playing out in a way that is consistent-to-better than our projections. 

3. RYAN’s entrenched position in airports, along with their aggressive competitive stance, is a strong deterrent for competitors to try to directly compete with them; adding a layer of protection should the supply/demand picture deteriorate.

RYAN has a clear cost advantage when looking at aggregate numbers. However, in a situation where RYAN goes head-to-head against WIZZ in a new airport, both competing with their latest technology aircraft, both cost positions on that base should be largely comparable. In such a scenario RYAN will be unlikely to have a clear cost advantage. While having two low-cost providers in a large market with a handful of large high-cost players is not a bad industry structure, it is certainly worse for RYAN than being the unquestionable low-cost provider on marginal capacity. 

So, what happens in a loose supply environment where WIZZ, who is growing aggressively, and RYAN don’t have enough whitespace to stay out of each other’s way? In such a scenario, we believe RYAN is still protected. 

RYAN is quite adept at evaluating where there is room to place capacity. They believe that in their current top markets they can add enough capacity to place an additional 525 aircraft (see Exhibit 3). Not all that capacity would be in current airports, but the majority would likely be. With the current orderbook, the company will ‘only’ be adding 263 aircraft between FY23 and FY34. That means that there is likely more than enough capacity to be added in existing airports. As we saw on thesis point 1, incumbents have scale advantages on both the cost and revenue side on existing airports. That means that RYAN can likely place enough new capacity in places where they are the unquestionable cost leader on marginal capacity. 

If we venture out to new airports, the advantage isn’t as neat, but we think RYAN still wins. Their competitive stance, along with their superior funding structure, usually allows them to muscle themselves into new airports. RYAN has a reputation of being aggressive when in direct competition. With their load factor active/price passive strategy, they are known for crushing pricing in markets where there is a competitive scrimmage. Because they have the best Balance Sheet and margins in the industry, they know they can inflict more pain than can be inflicted on them. That allows them to make it difficult enough (and unprofitable enough) for competitors to incentivize them to take their capacity elsewhere. It also makes anyone think twice before getting on RYAN’s turf. 

This dynamic has caused competitors, such as WIZZ, to look to add capacity far from RYAN. That is an important reason why WIZZ has focused on going East to the Gulf and parts of the Middle East. Of course, competitors’ appetite for aggression is cyclical and highly dependent on the state of their Balance Sheet. While this can change in the future, with current Balance Sheets where they are, it is unlikely that anyone will want to start fighting RYAN for at least a few years. This should allow RYAN to increase the number of airports they operate in, as well as their market share within some of their lower share airports.

We believe RYAN has enough tools to keep growing and maintaining profitability should our assessment of the supply environment prove incorrect.

4. A long-tenured and focused management team with the industry’s best operating track record should be able to maintain the current cost advantage and place capacity intelligently.

Running a high utilization, low-cost airline is not easy. Maintaining a best-in-class cost position running an airline through continental Europe requires real operational skill and a focused group of people. We view this dynamic as a positive for RYAN because of our view that RYAN has by far the best operating team in the industry.

Starting at the top with Michael O’Leary who should largely be credited for RYAN’s success to date. O’Leary joined RYAN in 1988 as CFO and became CEO in 1994. During O’Leary’s early years, RYAN was a struggling, high-cost airline. In 1990, after spending a couple of weeks around Herb Kelleher in Texas, O’Leary led a restructuring effort to copy LUV’s low-cost model. That effort was incredibly successful, with RYAN implementing the model in a more disciplined way, leading them to the position they are currently in. O’Leary is highly aligned with long-term shareholders. He owns 44.1mm shares in the company, representing ~€704mm. He is paid a modest salary of €1.2mm and has the ability to earn a bonus that is only 50% of his base pay if certain targets are met. He also has 10mm options that only vest if the company generates €2.2bn of Net Income or the shares trade above €21 for 28 days.

Below O’Leary, there is a long-tenured bench of executives. Below the tenure of the company’s top 10 executives (excluding O’Leary), which should help provide a picture of the company’s bench.

Our perception is that RYAN is a well oiled machine. The company was, by far, the best to get through COVID – both financially and operationally. During last summer’s French ATC issues, it took them 12 hours to restart operations in the UK, whereas it took British Airways three days. The company has been spot on in their historical capacity projections, despite COVID and BA’s supply chain issues. Lately their punctuality and customer satisfaction performance has suffered a bit (as it has for the industry) given the ATC issues and other exogenous factors, but we believe controllable performance has been consistent. 

In contrast, management teams at RYAN’s competitors are much less impressive. WIZZ has had a lot of turnover within its Executive Team (the layer below Jozsef Varadi). EZJ has been run by an agent CEO since 2017 and has experienced even more dramatic turnover on the layer bellow him. The only large competitor that seems to have some stability at the top is LHA, who while it is not really run for shareholders, it is fearless in protecting their markets (explaining why RYAN only has 9% market share in Germany).

The relative differences in operating prowess have benefitted RYAN. Given the status quo, our expectation is that it should continue doing so. We gain a great deal of comfort when investing alongside O’Leary and his team. It is worth noting that O’Leary might retire in the next few years. Our understanding is that he is now a lot more hands off than he was in the past. While we believe his tenured team will take over his increasingly diminishing responsibilities without issues, a transition would create some uncertainty. Importantly, given his ownership of RYAN shares, O’Leary should be very deliberate about his transition.

While we are on management, it is important to recognize what we believe to be a shortcoming of RYAN’s management team. We don’t see their operational clarity and rigor translating to clarity and rigor on the capital allocation front. We believe any potential downside from this shortcoming is limited as the management team is quite conservative, and they have given a roadmap around their capital allocation priorities. We believe that any misuse of capital might lead to no more than an enterprise that is overcapitalized, which might lower our total return, but it is very unlikely to lead to any type of capital impairment. 

Fuel, carbon credits, and ETS

Fuel is RYAN’s single biggest input cost. In FY23 average fuel cost per passenger was €23, whereas all other costs combined were €32 per passenger. Given RYAN’s high density aircraft, their lower fleet age, and their high load factor operating model, their fuel consumption per passenger is lower than all major European airlines except for WIZZ (WIZZ has a younger and more fuel efficient fleet). Fuel presents a few challenges for airlines. Increased fuel prices are generally passed to the consumer, but higher prices have an impact on passenger demand. Differences in hedging strategies create operating noise on the cost side. In addition, as we saw during COVID, fuel hedging adds some fragility to the system. While fuel costs are generally a source of advantage for RYAN, it presents operational and financial risks.

Compounding those issues is Europe’s aggressive climate goals, and how they plan to achieve them. Airlines represent about 4% (source) of total estimated emissions in Europe, and they fall under the purview of Europe’s Emission Trading Scheme (“ETS”). For a primer on Europe’s ETS system please see here. 

RYAN’s current carbon allowances are not enough to cover their CO2 emissions, and those allowances will continue to get phased out, with no free allocations to be received by 2026. Shortage of allowances must be purchased either in the open market and/or government auctions. Carbon trading is a completely artificial market and its rules are set by politicians. As the below chart shows, emission allowances, each of which is equivalent to a tonne of CO2 (“tCO2”) of emissions, have been quite volatile with the price rising exponentially in the last six years. The increase in prices has been a result of legislation that curtailed the surplus allowances available in the market.

In calendar year 2022 RYAN emitted 13.6mm tCO2, and for FY23 the company spent €425mm (~4% of revenues) purchasing carbon credits (inclusive of free allowances). Should the company have had to purchase carbon credits for all their 2022 emissions at current spot prices, the bill would have amounted to €1.2bn (~10% of revenues). Every €10 change in ETS carbon prices translates to a €136mm change in carbon costs on FY23 volumes. 

Substantially all intra-European flights are exposed to the ETS trading system. This means that this will be a cost that will end up being borne by the consumer. The most fuel efficient, high-density airlines should benefit as they will have to pay lower carbon costs per passenger. As Exhibit 4 shows, RYAN is the second lowest polluting (per passenger) airline in Europe (after WIZZ). This means that, from a relative perspective, RYAN stands to largely benefit from this increased cost. However, the increased ticket prices that will come from this change could have a negative impact on overall demand. We calculate that once the free allowances are gone, the added cost per passenger for RYAN will be between €3.5 and €5.0 depending on the price per tCO2. 

RYAN is the second most efficient airline – not the first. WIZZ is the most fuel efficient. We expect that by FY28 RYAN’s CO2 gram per km per passenger will be ~58, whereas WIZZ will be at ~43 (26% lower). Assuming a cost per allowance of €100, RYAN’s carbon cost per passenger will be €7.1 (vs FY23 at €2.5), whereas WIZZ’s would be at €5.3 on a like-for-like basis. That represents a €1.8 per passenger cost advantage for WIZZ assuming no offsets such as SAF. This is an area to keep an eye on, and while €1.8 is not material enough to change the relative cost dynamics, it is something to watch. Furthermore, it is important to note that this comparison uses average fleet for both companies. If we were to compare new aircraft for both companies, fuel consumption and CO2 emission per passenger is quite similar. By FY28 36% of RYAN’s aircraft will consist of the B737-8200s and the B737-MAX-10s which are more fuel efficient. The company can choose to place those aircraft in areas where they compete with WIZZ. In addition, in FY29 RYAN will start selling off their older B737-NGs, which are their least fuel efficient aircraft. This will help relative comparisons from FY29 onwards. 

Valuation

The below valuation is on the Ordinary Shares. As of this writing, the ADRs traded at a 17% premium to the Ordinary Shares. 

We value RYAN on a DCF basis. We do an explicit projection with all KPIs to FY28, and then extrapolate to FY35 with assumptions only on the main drivers. Then we use  a 12.5x exit multiple (10% discount rate, 2% terminal growth). Were we to value the company on our projections to FY28, we would need to apply a 13.8x exit multiple to FY28 in order to get the same valuation as in our FY35 projections. Given that we spend a lot more energy projecting to FY28, this section will focus on our projections to that year:

• Revenues:

  • Capacity: available seats to increase from 181.3mm in FY23 to 248.6mm in FY28 representing a 6.5% CAGR and roughly in-line with management estimates.

  • Load factor: 93% load factor, which is 1%-2% conservative compared to history, and slightly lower than management estimates.

  • Pricing: we assume a 3.8% CAGR in Booked passenger fare to FY28, which is lower than inflation plus the increase in carbon costs. This is despite the benign supply/demand environment we expect to see in the medium term. In addition, we assume a 3% pricing CAGR for ancillary revenues. 

• Opex:

  • Ex-fuel costs: increase at a 3% CAGR from €31.5 per passenger in FY23 to €35.6 in FY28. Mainly driven by an increase in staff costs. 

  • Fuel and carbon costs: increases by €4.0 from €23.9 per passenger in FY23 to €27.9 in FY28. The increase is a result of €4.6 per passenger increase in carbon costs, and consistent fuel prices, slightly offset by more fuel efficient aircraft.

• EBT: per passenger EBT reaches €12.3, which compares to the below historicals (blue bars). Total EBT compounds at a 14.6% CAGR.

• Capital allocation: we assume most capital goes to paydown debt and for aircraft acquisition costs. We assume that the company will stop retaining capital once they reach a net cash position of €2bn, with excess cash being used to mostly pay dividends, but also do some share repurchases. 

The result is the following abbreviated income statement. Note that our FY24 projections are below consensus estimates. Market consensus is for a sharp increase in ticket prices in FY24. While this consensus estimate seems reasonable (even likely), we don't feel comfortable underwriting it, and are much more focused on earnings power in the out years.   

Risks

In addition to the carbon credit costs risk previously discussed, below four more risks and their respective mitigants.

• A unionized workforce bargaining for and getting large concessions: RYAN’s field workforce is largely unionized, with pilots being the highest earning/largest cost item. We have recently seen US airlines make some large wage concessions to unionized employees. European airline unions might get inspired by the results their US counterparts are achieving and decide to push for higher wages and other concessions. Union negotiations are idiosyncratic which means a wider range of outcomes. Lastly, WIZZ doesn’t have a unionized workforce.

  • Mitigant: While there is uncertainty here, we believe that RYAN is in a good position with their unionized workforce. RYAN’s philosophy is to work their employees hard but compensate them for it and pay above market. A mid-career captain might earn ~€126k at RYAN, whereas they would earn about 10% less at WIZZ and EZJ. A starting captain earns €63k at RYAN vs €45k at EZJ. In addition, RYAN gives pilots the ability to earn more, they give KPI payments and extra allowances. Pilots generally fly 900 hours a year. RYAN’s pilots get to those hours in about 10 months. Once pilots reach their quota RYAN lets them do whatever they want, they can take a two month vacation, relax at home, or earn extra income (both within and outside RYAN). This is very uncommon and a big perk. Pilots at competing airlines get asked to do other tasks (not of their choosing) once they reach their yearly quotas. RYAN also has a best-in-class training program, which is an effective tool for attracting young pilots. Our understanding is that being trained by RYAN is seen quite favorably within the industry, which makes it an attractive brand to have in a pilot’s resume.

  • It is difficult to be forced to pay more when you are the highest payer, give a bunch of perks, and have a strong pipeline of people coming through the door. Lastly, the company is as tough a negotiator as it gets, so it would be difficult to come up with a scenario where they get taken advantage of (relative to peers). Obviously, this is an area we keep a close eye on.

• Geopolitical tensions in Europe can take demand out of the system: The geopolitical environment in Europe is tense. The Russia-Ukraine conflict reduced the industry’s TAM, causing a few airlines to relocate capacity elsewhere. While Ukraine is a relatively small country, an expansion of the conflict could lead to more commercial airspace closures, which could have negative ramifications for the industry and the airlines forced to relocate capacity. 

  • Mitigant: This is a known unknown, we think the probability of this happening is low but it is a risk we are monitoring. Short of a full-blown situation in the continent, an expansion of the conflict would cause pain but should be manageable. 

• Pandemic or some other natural event that would make it difficult for people to fly: At the risk of falling prey to recency bias, airlines need for the population to have the ability to move freely. Anything restricting movement poses a risk to demand.

  • Mitigant: While COVID was difficult for RYAN, we believe that over the long term COVID will prove to have been a positive for the company’s intrinsic value. Negative shocks to the industry accelerate the natural process whereby the most competitively adept become stronger, and the weak become weaker. With the highest margins and the strongest Balance Sheet, RYAN stands to benefit (albeit with some short term pain) from events that take capacity out of the market. 

• A strong pricing environment can make the industry more competitive: Here we are making explicit a point that was previously discussed implicitly. A strong pricing environment can bring excess profitability into the industry. Increased profitability means competitors’ Balance Sheets improve quickly. Strong Balance Sheets and excess profitability tend to translate into a more aggressive competitive stance. In the past competitors have shown a willingness to be irrational when capital is cheap and plentiful, which might mean decreased profits for many years.

  • Mitigant: As explained in the write-up, we believe that there are constraints in the supply chain for new aircraft that would make the probability of an oversupply environment remote. Furthermore, while an oversupply environment would be negative for RYAN’s profitability, their cost position will allow them to still be profitable in an environment where other airlines are unprofitable. 

Appendix

Exhibit 1: RYAN’s country market share as of 9/6/23

Exhibit 2: AIR and BA historic production and targets

Exhibit 3: RYAN’s estimate of current and possible market share in existing countries.

Exhibit 4: CO2 emissions per passenger kilometer.

Catalyst

Earnings.