Airlines – what happens when ROIC looks too good

So much for IATA’s prediction last year of “Normal profits are becoming normal for airlines”, or the thesis that airlines would again be able to pass on higher fuel prices to customers by charging higher fares. Someone must have forgotten to tell Ryanair, as they cut a further 10 percentage points from their current year earnings guidance (now a cumulative -20 ppts reduction) as they gird themselves for a -7% drop in average fares over H2 FY, having already trimmed the previous flat projection to a -2% decline.

Perhaps one might have appreciated the implications of too much capital chasing a too high a return expectation on future returns.  As I pointed out back in June of last year in “Normal profits are becoming normal for airlines” – be afraid!”, the doubling of airline ROIC would enable stronger players to compete away excess returns and thereby limit the industry’s ability to pass on rising fuel costs this time.

While this has been a tide that has raised and lowered returns across the sector, Ryanair can at least take some comfort that as the cost leader in the sector it ought to come out of this with an improved market share. As weaker players get bought up, it’ll probably take time to squeeze out the excess capacity that is currently capping returns and we still have to get through the Brexit debacle.  Beyond this and with prospect fuel costs now heading lower however, a sub €10 RYA is starting to look interesting.