Ryanair Tastes Red Ink

On Feb. 2, one of Europe's most profitable airlines, Ryanair (RYAAY), slipped into the red for the first time since the company went public in 1997. The Dublin-based discount airline posted losses of $130 million for the three months ending December 2008, compared with a $56 million profit during the same period the previous year.

Ryanair CEO Michael O'Leary described the results in a statement as "disappointing" and blamed a 71% increase in the price Ryanair paid for fuel during the quarter. The airline, which in the past has been criticized for refusing to hedge fuel contracts, this time around had locked in prices at a punitive rate of more than $1,100 a ton just as they began to fall to their current lows.

But the recent drop in fuel costs means Ryanair is now predicting a modest profit this year. Instead of breaking even, as the company previously anticipated, it expects a net profit of between $64 million and $102 million—despite a 20% drop in average fares, which at around $43 are already the lowest among European carriers. Ryanair also predicts a return to "significant profit" in its next financial year, ending March 2010.

Record Losses for European Carriers?

Credit a savvier fuel pricing strategy. The airline has now hedged 75% of its fuel requirements for the period from April to September 2009 (and 50% of its fuel needs from October to December) at an average price of $650 a ton—some 38% lower than the average $1,050 per ton paid in the current fiscal year. If Ryanair's average cost in fiscal year 2010 finishes at $650 per ton, the company's fuel bill will plummet by approximately $638 million the following fiscal year, O'Leary explained in a statement. He claimed that the new hedging contracts will "ensure that Ryanair returns to substantial profitability next year, when many of our competitors will be reporting losses," presumably due to factors ranging from lower demand and overcapacity to less attractive fuel contracts.

The fall in fuel prices is one bright spot in an otherwise challenging environment for the aviation industry. Citigroup (C) aviation analyst Andrew Light predicts that the fourth quarter of 2008 and the first quarter of 2009 are likely to be record loss-making quarters for European airlines, on par with the downturn caused by September 11, 2001. This year he predicts that within Europe, business travel and air cargo revenues are likely to fall by as much as 20% while passenger revenue could drop by 5%.

Just last month both British Airways (BAY.L) and Europe's largest airline, Air France-KLM (AIRF.PA), issued profit warnings. Air France-KLM, due to report its third-quarter results on Feb. 13, is expected to show an operating loss of $255 million for the quarter compared with an operating profit of $397 million during the third quarter last year. BA, which had previously expected to make a small profit, now expects a full-year loss of $212 million due to the economic downturn, fewer lucrative business travelers, and a fall in the value of the British pound.

Many analysts expect Europe's second-largest airline, Deutsche Lufthansa (LHAG.DE), also to lower its earnings estimates as demand for air travel falls. Citigroup thinks the German carrier's operating profit in 2009 will halve to $510 million. Last year Lufthansa went on a dealmaking spree, announcing plans to buy troubled Austrian Airlines and Brussels Airlines and increasing its ownership stake in Britain's No. 2 airline, BMI, to 80%.

Aer Lingus Deal Unlikely

Ryanair also had hoped to finalize its own acquisition of rival Irish airline Aer Lingus (AERL.L). But in January the Irish government refused to sell Ryanair its 25% stake in the carrier for $955 million. According to O'Leary, Ryanair is unlikely "to waste any further management time or resources making another offer for Aer Lingus, as its scale and losses will continue to render it increasingly irrelevant in Europe's airline landscape."

Analysts reckon that as more consumers trade down, budget carriers Ryanair and easyJet (EZJ.L) will emerge from the current economic turbulence before the rest of Europe's airlines. Ryanair expects passenger numbers to grow 14%, to 66 million, next year. "The longer and deeper this recession, the better it will be for the lowest-cost producers in every sector," O'Leary said. "Like Lidl, Aldi, Ikea, and McDonald's (MCD), Ryanair is the lowest-cost provider—by a distance—in the European airline industry."

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