Sectoral heterochromia

“Aviation in the evening, I can feel it coming on”

– Aviation: The Last Shadow Puppets

Professional fund managers tend to make their name by taking big sector positions. Famously Neil Woodford did very well avoiding banks, and owning tobacco companies. When I started everyone loved technology and hated mining companies. Then 10 years later this reversed, mining companies had hugely outperformed tech (caused by under investment and a commodity driven boom from China). Now technology seems to be back in fashion (Facebook, Amazon, Google etc) and companies like Lonmin have come to close to failure.
But I’m more interested in the huge disparity of returns within a sector. It’s easy to make generalisations and say “technology companies are great investments”…but not all technology stocks are. Groupon shares anyone? Snap? 
Similarly not all “banks/restaurants/films are a terrible businesses”, just because most lose money. A few companies in the unloved sectors go on to be very successful. And it’s the unlikely successes that I’m most interested in. It appeals to the contrarian in me. I like the idea of thriving in an industry where most companies struggle.  


The same goes for airlines, which is normally considered a terrible sector for investors. Sensitive to the economic cycle, high fixed costs (airplanes, staff), no control over variable costs (fuel price), that’s why most airlines are a poor investment. But some budget airlines have done really well, with their structurally lower cost operating model versus the “national flag carriers” like Iberia or Allitalia. But even within the subsector, performance varies widely. Budget airlines have very different results: Air Berlin has gone into insolvency. EasyJet is up 3x since it listed on the stockmarket. But the market leader in budget airlines is up 40x in the last couple of decades. 40x bagger that’s my kind of company.  

Looking back it’s not particularly obvious which airline was going to massively outperform.  

40x increase

Airlines are so familiar – we think that we understand them. But I realised that I don’t really understand them. Or at least, I can’t answer why the winners have done so well, and the losers have done so badly.
An online travel agent like lastminute.com was put in the technology sector, but Ryanair has been much more successful at exploiting the internet, is still in the airline sector. Even in the 1997-2000 internet bubble Ryanair outperformed the wider stockmarket, up 300% in the 3 years after it IPO’ed in May 1997. At this point Ryanair was trading on 3.5x revenue and 20x historic earnings…not exactly a bargain, but still went on to be a multibagger over the next decade and a half.
Even if you believed that the internet was going to be bad news for traditional travel agents – the best idea was not to buy shares in an online travel agent like Lastminute. Customers who previously had used high street travel agents didn’t start using online travel agents, instead they cut out the middlemen completely. They started going directly to the airline websites, compare prices and book the cheapest flights directly.

Why is it flying so high?

Ryanair and easyJet have subtly different strategies. Ryanair’s strategy is to offer the lowest fares, but to fly to secondary airports like Oslo Torp and Frankfurt Hahn. Ryanair struck deals with regional authorities across Europe, who owned these secondary airports, and received money to fly to these out of the way places.
EasyJet focused on popular destinations like Geneva (good for skiing in Chamonix) and offering good value, “no frills” prices, but not the cheapest. EasyJet also thought hard about marketing its brand, targeting catchment areas close to airports. They deliberately didn’t use TV advertising because management thought it was too unfocused – but instead got lots of free publicity with a documentary about its workers at Luton Airport, which (unbelievably) got 7.5 million viewers in the early noughties.
For me, the best way to learn about Ryanair and easyjet is to go back and read the previous years’ Annual Reports. They are fascinating to read.  One thing to notice is that Ryanair is never afraid to pick a fight, either with airport monopolies, competitors, elected politicians or regulators.  They are happy to publish the low cost fares in their reports to shareholders.

The one thing Ryanair management are quite sensitive about is the accusation that the only reason they have done well is by paying their staff less. Or that they have bad labour relations.  So they publish this table in their 2009 Annual Report.


One consequence of MIFID II is that management of companies won’t be able to rely on sell side research analysts employed by investment banks to make the investment case  for them…they will have to make their own investment case in their Annual Reports to shareholders.  I like reading these documents, I appreciate the really well written informative ones like (Ryanair, Burford, Games Workshop, even WPP) and have a quick laugh at the ones that just spout vague banalities (most large banks) before discarding them in frustration.


Michael O’Leary receives a lot of attention, because he tends to be outspoken. He wanted to charge customers for using the toilets. He also came up with the idea of expanding Ryanair to long haul flights. Offering Eu10 tickets cheap seats, then 10-15% super premium seats at the front of the plane with champagne and blowjobs included
Meanwhile the former Chairman of easyJet Sir Stelios Haji-Ioannou sued his rival for libel, after a Ryanair advertising campaign that implied he lied about easyJet’s punctuality statistics. O’Leary responded by challenging Stelios to a running race around Trafalgar Square.

Bonderman and Rake

I think the lower profile Chairman of Ryanair is more interesting: David Bonderman. The US billionaire has been chairman of Ryanair for the last 20 years, and also founded a private equity company TPG and was on the board of Uber, until he resigned after making comments that were perceived as sexist at a board meeting. In the 1960’s Bonderman studied law at Harvard, and after completing his studies then traveled to Cairo, to study Islamic Legal Jurisprudence and Law and learnt Arabic. A Jewish lawyer in the 1960’s learning arabic jurisprudence in Cairo?  Not the most obvious path to billions of dollars – it does show intellectual curiosity and to take an interest in obscure, unpopular areas. So Bonderman is a quirky figure, he went on to be a bankruptcy lawyer then making his billions investing in unloved banks and airlines. Unpopular sectors that others dismissed. Then becoming an early investor in Uber in 2013.  He doesn’t get everything right, TPG tried to buy Bradford and Bingley, which I thought was worthless. But at least when he shows poor judgement he can walk away from the deal without losing money.
On the other hand Stelios is widely associated with founding easyJet, but actually stood down as Chairman in 2002. And later resigned from the board, complaining about the fact that the business hadn’t created much in shareholder returns.

The Chairman of easyjet after Stelios stepped down was Sir Colin Chandler then Sir Mike Rake. No doubt one of the best-connected people in the City (KPMG, BT and on the board of Barclays) an accountant who is more politically correct, good at climbing hierarchies, ticking boxes and counting beans. Not a risk taking entrepreneur though.

When Stelios and O’Leary started, they didn’t have much of a track record.  But perhaps an investor could have looked at Bonderman and Rake’s track record, and taken a view that they would rather back Bonderman than someone like Rake.

Not what I’ve come to expect

There are a couple of things that I got wrong about Ryaniar. The first is that I’m generally against businesses that compete on price: it’s not very creative. As a rule of thumb I like businesses that can raise prices because they are doing something that their customers value. Anyone can open a bar that serves the cheapest beer, or is the lowest cost hotel in the city…you have lots of customers but you just don’t make any profit margin with the prices you charge. It’s better to find the businesses that can charge premium product (whether its craft beer or a tonic water) where there is a decent margin.  
Ryanair’s strategy has been to offer the lowest fares in every market. But it has been able to do this while reporting higher margins than easyJet and other budget airlines.  Not only that but average fares at Ryanair have actually fallen, from €54 in 1999 to €41 in 2017, despite this drop in prices revenues have increased 23x and profits are up 19x over the same time period.   That’s highly unusual. None of the others (with the possible exception of Wizz) seem to be able to copy the lowest cost model.  Which is ironic because both Ryanair, easyJet and Air Berlin copied the low cost model from Southwest Airlines in the US – which was a 100 bagger in the 1970s (a time period considered to be a terrible time to be an equity investor) – but only Ryanair has copied the Southwest Airlines successfully.   

Returning the cash

The second thing I got wrong about Ryanair is that I don’t like companies that have to keep returning to the stockmarket to finance their growth. But Ryanair first came to the stockmarket with its IPO in 1996, but then came back 4 times for more money in 1998, 2000, 2001 and 2002. Companies that keep coming back to the stockmarket for more money often don’t have a viable business model. Ryanair though is different, since 2008 they have returned Eu5.4bn of cash to investors…10x the amount they raised in their early years.
“It’s the way you wing it while you’re figuring it out.”

2 Responses

  1. Andrew Latto

    Bruce, thanks that was an interesting article. I might throw in my two cents worth. I think the question you are asking is why has Ryanair performed so well? I think the answer is two-fold. Firstly the low cost carrier space has taken market share from the established carriers and is more efficient. There was an opportunity for Southwest in the United States given that is is the world’s largest economy. There was also an opportunity in the EU given the single market and the expansion of the EU. So countries can no longer protect their flag carriers in the EU due to the rules of the single market. Without the single market we would have seen Italy or Greece focus on protecting their flag carriers. It is also the case that airline travel is a growth area and price is the main determining factor for consumers. Accordingly, low cost carriers are well placed to grow and also better insulated from market downturns.

    Moving on from the sector dynamics and the question becomes why has Ryanair done much better for investors than easyJet? Both have performed well but Ryanair has generated much stronger returns. A small part of the explanation is that Ryanair buys back its shares whereas easyJet pays out dividends. The real answer is that Ryanair has had much lower costs. Given that price is the key driver for air travellers the lowest cost low cost carrier is likely to win. Of the five competitive moats a cost advantage is meant to be the weakest. This is because other companies can copy the low cost model. However, Ryanair has seemingly been able to maintain an impressive cost advantage over rivals. Wizz Air is the closest on costs but the gap is still large. As you state part of this relates to Ryanair’s focus on secondary airports.

    However, this is not the whole story. Ryanair has been aggressive in all its dealings related to costs. While most airlines in Europe by from Airbus the company played Airbus and Boeing off against each other and went with Boeing. The staff contracts for Ryanair are also meant to be fairly onerous. I think staff are officially registered in Ireland even if they live in France. Ryanair has also negotiated hard with airports that want to expand such as Stansted in London. The established players like Ryanair and easyJet also have very low financing costs when they buy planes. Newer players often turn to more expensive aircraft leasing arrangements. Being based in Ireland also gives Ryanair a very low corporate tax rate versus easyJet in the UK. As the largest low cost airline the group also has purchasing economies of scale.

    The question is whether these cost advantages are sustainable versus easyJet and other rivals. Also how much the lower cost are due to Ryanair’s focus on secondary airports. Ryanair has over the last three years sought to improve its customer service and move into primary airports. However, the latest evidence is that its cost advantage against rivals has increased (see Ryanair presentation slide 4 below).


    The cost advantage is also significant. Wizz Air is 48% higher per passenger excluding fuel and easyJet is 89% higher. This advantage supports the robustness of Ryanair’s business model as it looks to take passengers carried from 120m in 2017 to 200m in 2024 – a two-third increase over 7 years.

    Given the size of the cost advantage it seems to me that it is likely to be sustainable for sometime. This is due to 1) Ryanair’s scale and aircraft buying power 2) superior negotiating power with airports 3) very low cost of debt 4) Ireland’s low tax rate 5) large network that helps increase aircraft utilization. Clearly this thesis could be wrong and Wizz Air is trying to mimic Ryanair’s model in Eastern Europe. However, it seems to me that Ryanair’s competitors will continue to have an uphill struggle. This is not least because Ryanair can opt to compete directly on certain routes and take them out on those routes. In a legal sense it would be hard to prove this is predatory pricing due to the dynamic fare pricing model used by low cost carriers.

    Looking more closely at aircraft costs and each plane is incredibly expensive. Ryanair has provided a route for Boeing to sell short-haul aircraft in Europe. Given the scale of Ryanair’s purchasing from Boeing there is likely to be a sustainable purchase price advantage versus rivals in Europe. Ryanair is also a dependable and growing customer that Boeing will be eager to maintain.

    The key risk, in my view, is one of overcapacity or some company specific event related to Ryanair and its costs. An aircraft crash that was somehow related to costs would have a short-term impact. I think the reality is though that consumers will go back to the lowest fare company. Amazon is supposed to not be a great company in terms of taxes and how it treats employees but most of us can’t afford to shop elsewhere. The cyclical risk for Ryanair relates to overall capacity growth and the prospects for a downturn at some point. A further risk is that the EU might break up and increase national protectionism in the sector.

    Mitigating these risks is that the airline industry effectively owns slots at airports provided they use them. As airports become fuller these slots become economic moats. When Stansted reaches full capacity it is clear that Ryanair will have a strong and sustainable position there.

  2. Andrew Latto

    Bruce, Another two cents worth if I am allowed to throw it in as well. This is a fascinating topic given that we all fly on airlines. I have focused on the differing strategies of Ryanair and easyJet below.

    As you state the strategies of Ryanair and easyJet have differed. Ryanair has gone for secondary airports while easyJet has gone for primary airports. EasyJet has the largest network of primary airports in Europe. Ryanair is the largest airline carrier in Europe.

    The question becomes which of these strategies has been most effective for investors. EasyJet is better placed to compete directly with the flag carriers as it operates from many of the same airports. EasyJet also benefits from inbuilt demand given its focus on primary airports. However, both EasyJet and Ryanair would never fly from Heathrow.

    The question comes back to the nature of demand for air travel. Much of it is leisure driven and sensitive to price. Much of it is also not driven by location but by price. If a flight to Lisbon is £250 return and a flight to Copenhagen is £90 return then a weekend break to Copenhagen may be on the agenda.

    Holidaymakers from London looking for a beach holiday are likely to be drawn to the lowest cost destination. A package holiday in Greece is similar to one in Spain for many people i.e. a beach and a hotel.

    Many websites, for example, allow consumers to find the cheapest place to travel to on certain dates. Leisure travel is by its very nature flexible and in search of a destination that offers value.

    A flight is only a means to an end for most consumers. In other words, given say a £500 budget most consumers would opt to spend on the hotel rather than the flight. Short-haul flights are only around 3 hours at most.

    Given this backdrop it appears that the strategy of Ryanair is subject to a greater growth tailwind. They are offering the product that leisure travel customers want: the lowest flight costs possible.

    In the airline industry the high fixed costs make filling aircraft the name of the game. Ryanair is best placed to do this if it attracts the large segment of the market that is price sensitive.

    Clearly Ryanair is able to negotiate discounts with the secondary airpots and pass these onto customers. EasyJet is not able to negotiate discounts with primary airports given that they are capacity constrained.

    A further growth driver for secondary airports is that prices at primary airports will continue to increase. With capacity full at many primary airports the airlines will increase prices over time.

    The disadvantage of secondary airports is the location if the object is a city break. However, the price differential can be substantial. If a direct flight to Barcelona is £250 but a flight to Girona is £90 then a bus ride from Girona to Barcelona may be worth it.

    It is also worth nothing that there is limited capacity for easyJet to grow at primary airports. However, Ryanair has substantial capacity to grow at secondary airports. Stansted still has capacity for growth (Ryanair’s home in London) while Gatwick is nearly full (easyJet’s home in London).

    So on balance the focus of Ryanair on secondary airports has allowed it to grow more profitably than easyJet. On face value these airports are worse for consumers but the fare advantage can more than offset that.

    Ryanair therefore has lower costs and offers a product that the majority of consumers want i.e. the lowest fares. It is best able to attract consumers given its low fares and has more scope to grow given the focus on secondary airports.

    Secondary airports are also better served to meet the demand for package holidays that aren’t focused on the city breaks. Beach holidays are the most important segment of the leisure travel sector. These are not sensitive to location given that a coach picks passengers up from the airport in any event.

    Arriving at Girona airport, for example, and you will see all the package holiday company coaches ready to pick up passengers. The overall cost of a holiday is expensive and secondary airports can help keep the cost relatively low.

    Ryanair can make or break a secondary airport and as such it has significant negotiating power. Given the spending power of tourists it can make sense for regions to subsidise their airports and support Ryanair.

    The backdrop is that Ryanair has been able to grow rapidly and on a very profitable basis. Opening a new route with say €20 fares will draw in demand and rapidly make it profitable.

    EasyJet’s focus on primary airports means that it focuses on a higher end consumer base. This includes business passengers where cost is not the only factor. EasyJet has to offer higher fares and is therefore less able to attract price sensitive leisure passengers.

    On balance, then, Ryanair has pursued a more profitable and faster growth strategy. Customers are focused on cost and the location of the airport is less important for beach holiday customers. Beach holidays are the main driver of leisure travel rather than city breaks.

    Against this backdrop Ryanair has been better able to profitably capture the opportunity for growth in leisure travel in Europe. Secondary airports are much mocked but low prices are what consumers want.

    There is also more scope for Ryanair to stimulate demand in new areas if it offers low prices. The difference between a €200 flight to a primary airport and a €50 flight to a secondary airport is enough to make most people consider somewhere new.