For vaccine optimists, there may be no clearer way to bet on the recovery than investing in budget airlines. But much depends on whether these low-cost carriers can remain, well, low cost.
This week, Dublin-based Ryanair RYAAY 4.70% reported fourth-quarter earnings well short of analyst expectations. Last week, Southwest Airlines LUV 2.08% managed to surpass forecasts but issued gloomy guidance for the current quarter. It is still up in the air whether leisure travel can reopen in time for the high-summer season.
But investors know that, sooner or later, the exit from the pandemic will play in favor of budget airlines and against their full-service competitors. Short-haul traffic will bounce back before international flights, and corporate travelers will be fewer and more price-conscious.
The rub is that the market has already priced a lot of this in: On average, the shares of low-cost carriers are back roughly to where they were a year ago, even though their revenues are only forecast to catch up with pre-pandemic trends around 2025. To meet expectations amid heavy discounting, they will need to come out of the Covid crisis making a lot more money with fewer sales.
Which is to say, with structurally lower costs. This is their challenge.
Unit costs shot up in 2020. Even though overall expenses plummeted—aircraft have been grounded and carriers have either furloughed or dismissed a lot of their workforce—sales fell by more. Southwest and Ryanair slashed operating costs 35% and 54%, respectively, but in both cases revenues dropped more than 60% relative to 2019.
As traffic returns, sales will once again outpace costs. The question is by how much.
“With the exception of furlough arrangements, the majority of the savings are permanent,” Johan Lundgren, Chief Executive of London-based EasyJet ESYJY 2.22% told analysts last week. His plans to “reset the cost base” include renegotiating airport fees and ground-handling contracts, as well as curtailing fleet growth and bringing some aircraft maintenance in house. Ryanair instead emphasized ordering more 737 MAX jets as a driver of efficiencies, and touted a four-year extension of a low-cost deal at London’s Stansted airport.
An early clue as to whether such plans are credible will be how quickly these airlines restore unit costs to the 2019 level. Southwest expects this to happen by year-end, even at lower capacity levels than in pre-pandemic times.
Yet the Dallas-based carrier also cautioned last week that some structural costs are already creeping up, including airport expenses. This isn’t surprising given Southwest’s strategy to wrest business travel away from legacy operators at big airports—it has already made moves on Houston, Chicago and Miami.
Reinforcing main bases can deliver structural advantages, but comes with a higher price tag than focusing on profitable point-to-point routes. Before 2008, low-cost airlines championed the second strategy and their unit costs tended to fall as they offered more seats, yielding big gains in the stock market. In the past decade, however, as they increasingly pushed into denser markets, the relationship reversed. Even Ryanair’s costs were on an upward trajectory.
In the coming years, analysts seem to believe that low-cost carriers can achieve the best of both eras—controlling costs while invading new markets. Their models predict both high growth and stable unit costs, data by Visible Alpha shows. While not impossible, this will require perfect execution and very low wage bills.
For budget carriers, taking business from higher-cost airlines will be easy. The hard part is to not become like them.
Write to Jon Sindreu at jon.sindreu@wsj.com
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The Link LonkFebruary 03, 2021 at 08:48PM
https://www.wsj.com/articles/it-wont-be-easy-to-stay-low-costeven-for-low-cost-airlines-11612360117
It Won’t Be Easy to Stay Low Cost—Even for Low-Cost Airlines - The Wall Street Journal
https://news.google.com/search?q=easy&hl=en-US&gl=US&ceid=US:en
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