Ryanair, today confirmed that its quarterly board meeting yesterday determined that its negotiations with Boeing for an order of up to 200 new B737-800 series aircraft for delivery during the period 2013-2016 cannot be successfully concluded prior to the end of the calendar year and have been terminated unsuccessfully.
Ryanair was hoping that in recessionary times, Boeing would be more flexible. Airbus refused to get involved in a bidding war, as it assumed it would only be used to beat down on its US rival.
Ryanair CEO Michael O'Leary said in early November that senior management changes and "internal turmoil" at Boeing had made it impossible to get important decisions from the company.
"The difficulty has just been in getting someone in Boeing to make a decision," O'Leary said. "Boeing seem to have a degree of internal turmoil."
Ryanair confirmed that the breakdown of the negotiations will not effect its plans to take delivery of 112 B737-800 aircraft during the next 3 calendar years 2010 (48), 2011 (37) and 2012 (27), which will sustain Ryanair’s strong traffic growth over the medium term. Ryanair said it will now bring forward plans to significantly reduce growth and capital expenditures, in order to maximise cash balances for distribution to shareholders during the period 2012-2015.
Michael O’Leary said today: “We regret that our prolonged negotiations with Boeing have failed to reach a mutually acceptable conclusion. While we reached agreement with Boeing on pricing for 200 aircraft deliveries during the 2013-16 period, Boeing were unwilling to incorporate some other terms and conditions from our existing agreement into this new aircraft order . Ryanair has made clear to Boeing that we will not order aircraft if we believe that either the pricing or the other contractual terms and conditions will be inferior to those which we currently enjoy, as this would not be a wise or sensible use of shareholders funds.
“We have no plans to reopen discussions with Boeing or any other aircraft manufacturers. Instead we will focus our efforts on maintaining Ryanair’s strong traffic and new route growth into 2010 and we look forward to briefing shareholders in the first quarter of the New Year with a revised strategy which will comprise much reduced capital expenditures through 2011 and 2012, thereby generating substantial surplus cash balances for distribution during the period 2012-2015. I believe it is appropriate to return these surplus funds to shareholders, if we cannot use them to purchase aircraft on terms which enable us to meet our demanding return on capital targets.
“In the meantime we will continue to work with our partners in Boeing on the 48 deliveries which Ryanair is scheduled to take in 2010 and perhaps in future there may be other opportunities for Ryanair and Boeing to work together to our mutual benefit during the period from 2013 onwards”.
Goodbody's Eamonn Hughes comments: "Firstly, on the operational side, the Ryanair model has historically been built on strong growth, which helped drive lower unit costs per pax. So, a slower growth rate will impact the airline’s ability to continue to reduce unit costs. Secondly, cutting capacity growth should lead to higher yields on two key metrics (i) easing growth in existing markets will take pressure off yields and; (ii) cutting back the introduction of new bases/routes at teaser/starter fares will also ease the strain. Finally, slower growth in the fleet and minimal development capex going forward will boost cash flow, bearing in mind the average fleet age is under 3 years (vs 10 years at Southwest, on average). Taking a first stab at this, we have moved FY11 and FY12 unit cost decreases back closer to flat and increased our yield estimates by 250bps per annum to reflect an easing yield environment because of slower growth. With lower capex, this sees our FY13 net cash build up from circa €1.7bn to €2.1bn, but the build-up is more significant after that. Balancing that though strategically will likely be smaller ultimate market shares in key markets (e.g. Spain and Italy) and some dilution to the subsequent pricing power in the long term. However, on a net basis, our models show that medium term earnings should be higher.
Secondly, from a valuation perspective, there a number of factors. Firstly, when looking at sustainable returns, higher yields are likely to lead to higher revenue utilisation. Secondly, slower growth may see the sustainable pre-tax profit margin ease from previous expectations. Finally, management has indicated that the build-up in cash could see it pay periodic dividends to shareholders, so benefits to cash generation from lower capex are returned to shareholders, broadly holding the leverage ratio flat. On a net basis, our Sustainable ROE would essentially remain unchanged at 16% (with a bias up). At the COE level, a slower growth model is likely to attract a lower beta from the market, which knocks back our COE to 9.5% (from 10%). Finally, a slower growth models implies our long term “g” is pared back from 4% to 3%. The net effect of all these adjustments is that our fair value PE remains broadly unchanged on 12.5x, though on earnings that would be higher in the short to medium term based on the yield assumptions.
Ironically, our current fair value on RYA is €3.75 per share. A slower growth, flat ROE but lower COE would actually see this circa c8% higher at €4.05, but the swings getting there may be a bit more volatile. Strategically, not doing a deal indicates a business model in transition and investors may drive up the required return they seek in the medium term to compensate for the operational risks, hence the share price may go lower in the short term (e.g. a 100bps increase in the COE would get rid of €0.35 of the premium above our current fair value). Also, a business with slower growth may see investors more focused on the near-term traditional valuation multiples (PE of 18x for FY11), which are looking stretched, particularly given where the oil price resides currently. However, tighter capacity growth should lead to a better yield dynamic in the short to medium term, so as soon as the pace of yield declines (anticipated to run at -20% this quarter) start to tick down, the market may revisit the story – we have yield declines at -15% in fiscal Q4 from -20% in Q2 & Q3 given easy comps and a final week in the quarter that straddles Easter."
