Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

After a year marred by terrorist attacks and employee strikes, Air France-KLM and Lufthansa might have expected that falling jet fuel prices would mean a better 2016.

Falling Crude
The falling oil price should provide a boost to airlines
Source: Bloomberg data

But low-cost rival Ryanair served a warning on Tuesday that Europe's legacy carriers will be unable to reap the full benefit of that windfall.

Fuel is one of the biggest expenses for airlines -- accounting for 40 percent of Ryanair's costs -- so the benefits of cheaper fuel are real, as long as they can be retained.

Airlines hedge the bulk of their fuel costs and European carriers are forced to purchase fuel in costly dollars, limiting some of their gains.  Lufthansa and Air France have hedged a smaller proportion of their fuel costs than Ryanair, meaning they stand to benefit more from the falling cost of jet fuel. 

Fuel Costs Tank
The price of jet fuel has fallen almost 40 percent in the past year
Source: Bloomberg data

But unlike the U.S.'s oligopolistic industry, Europe's airline market remains fragmented. So Lufthansa and Air-France should be worried by Ryanair CEO Michael O'Leary's prediction on Monday that air fares could fall this year as airlines pass on some of their fuel savings to customers.

Ryanair CFO Neil Sorahan noted that because Ryanair's cost base is much lower than rivals, the company is better placed to win a price war, should one materialize.

Lagging Profitability
Europe's airline industry is far less lucrative than that of the U.S.
Source: IATA

With Ryanair and low-cost rivals all adding lots of new capacity, that seems a distinct possibility. Ryanair forecast fares would decline 6 percent in the fourth quarter (in part due to the falling pound).

Lufthansa's also aware of the risk. It expects earnings growth in 2016 but told investors this month that yields, a measure of average ticket prices, would keep falling.

Ryanair's unit costs excluding fuel are expected to drop 2 percent this fiscal year, even though the airline has been expanding into more costly primary airports, as opposed to those miles away from the passenger's final destination.

Ryanair expects passenger numbers to jump 26 percent in its fiscal fourth quarter from the year-earlier period and reach 106 million for the year ending in March, slightly more than previous guidance of 105 million.

With Ryanair expanding fast in its German home market, Lufthansa is trying to respond with a lost-cost service of its own: Eurowings. But the need to cut costs doesn't seem to have sunk in with workers, who went on strike repeatedly last year.

Air France was forced to scale back plans to expand its Transavia low-cost arm in 2014 and in October employees ripped the shirts off the backs of management over proposed job cuts, suggesting they aren't entirely convinced of the need for change either.

Ryanair's projection that its passenger numbers will increase by more than two-thirds by 2024 haven't gone unnoticed by investors, however.

Taking Off
Ryanair shares have outperformed other European legacy carriers
Source: Bloomberg data

The stock trades at more than 15 times estimated earnings for the fiscal year ending in March, three times Lufthansa's valuation. With some 350 Boeing 737s on order, Ryanair's premium could prove rich if the industry enters another cyclical downturn.

Iata noted in December that historically the airline industry profitability cycle lasts between eight and nine years from trough to trough. Ominously, the low point of the last cycle occurred in 2009.

Ryanair's balance sheet offers some protection. The company had 350 million euros ($381 million) of net cash at the end of December, and felt confident enough to announce an 800 million-euro share buyback on Monday.

Contrast that with Lufthansa, which scrapped its dividend last February and which had 9.2 billion euros in net debt and pension liabilities at the end of September.

If the airline industry again encounters turbulence, Ryanair looks better-positioned to ride it out.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net