Ryanair Stock Analysis – Not a Buy Yet, But a Stock to Watch

I’ve been marginally following Ryanair for a few years now. When a CEO states:

“If someone wanted to pay £5 to go to the toilet, I’d carry them myself. I would wipe their bums for a fiver.”

ryanair ceo

It means that he is dedicated to the business. Nevertheless, I always look at risk versus reward and Ryanair was always a bit too expensive for me in the past. Over the past months however, the stock is down significantly and it is time to do a deep research into the business, to see whether it is undervalued and a good investment, or the business model is not strong enough to mark it a long-term investment opportunity. We know airlines are not renowned for being the best businesses in the world but you never know, Buffett bought 4 of them a few years ago.

1 Ryanair stock price

To value Ryanair, we have to look at:

  • The current situation full of issues
  • How those issues affect the short- and long-term outlook
  • Whether Ryanair has a moat, a competitive advantage
  • Where we are in the business cycle for airlines in Europe
  • Ryanair’s stock price compared to a long-term earnings model
  • General and specific risks

The recent news on Ryanair has been mostly negative

The news has been bad over the last two years for Ryanair:

  • Unionization and strikes that led to huge staff cost increases – 28%.
  • Higher oil prices have influenced their hedging, they are 90% hedged for FY 2020 but still forecast an increase of 400 million in costs.
  • The competition has been constantly increasing and has created overcapacity in Europe, despite the bankruptcies. Germany has large overcapacity as Lufthansa is initiating a price war by selling tickets below cost with its Eurowings subsidiary.
  • Air Traffic Control is also an issue with new regulations coming up and probably higher costs due to understaffing and more traffic.
  • The recently acquired Lauda Motion subsidiary suffered losses of 140 million in the first year where the situation is still chaotic, according to the CEO.
  • The Boeing Max aircraft issue has delayed delivery of 5 aircrafts ordered.
  • There will be more airline failures this winter, thus book your trips only with good companies. On the other hand, for Ryanair, this indicates there will be a stable supply of pilots and staff.
  • Guidance is flat for profits, between 750 million and 950 million on lower prices, 8% passenger growth and strong ancillaries. If there is no Brexit. Long-term guidance says investors should expect a few down years.

All of the above shows how the airline industry is tough, something we’ll discuss in a moment.

The same issues forced Ryanair to lower prices as the average ticket sold fell from EUR 39 to 37 and consequently net income fell to 1 billion. However, the sky isn’t that dark.

Ryanair’s short term and long-term outlook

Ryanair’s CEO clearly states that the fare environment will be weak going ahead. But things are not all bad. There have been some bankruptcies in Europe over the last years which allows Ryanair to grow and get more slots. It is expected that there will be more divestments and perhaps other opportunities for Ryanair to scale as it recently did by acquiring Lauda for 50 million EUR and further investments. Now that the company is unionized and both a Boing and Airbus operator, it can participate in consolidations.

Another positive will be the delivery of newer Boing 737Max planes with 4% more seats and 16% better fuel efficiency. Over the coming years, Ryanair plans to sell its older aircrafts, 10 of the oldest will be sold for 170 million as soon as they get the new aircrafts.

From listening to the conference call, I must say the management is very opportunistic. Something you don’t hear much when listening to calls. They recently took 750 million of unsecured debt at very low rates and they prefer to lease 7 to 9-year-old planes for less than $200k per month rather than to acquire new planes. On new aircraft prices, the CEO says how the pricing is high and order books are full and how they’d rather wait for the pricing cycle to weaken. This is a very important thing to hear for Boeing or Airbus investors.

It is interesting how Ryanair switched from dividends to buybacks, perhaps again opportunistically, and how they have a new 700 million share buyback plan. That is important and we can see how the number of shares outstanding has significantly declined over the past years. Pabrai would call this an uber cannibal stock.

15 buybacks and dividends ryanari

Source: Ryanair investor relations

They know the price environment is weak, but they think share prices are low and their cost advantage is the key for the long-term. Thus, long-term, a good investment in a currently bad environment.

My question is: can somebody compete with Ryanair? For that we have to analyze the competition, their fare prices, profitability etc.

Ryanair’s competitive advantage

In whatever business you are, if you are the lowest cost operator, you will probably survive all downturns, grow market share and be a good investment.

8 ryanair cost advantage

Source: Ryanair IR

Ryanair has to be compared to EasyJet as Wizz is not really a long-term competitor as it will hardly survive as an independent airline. Therefore, Ryanair’s advantage is large when it comes to cost.

Ryanair’s business model is different as it is the only company that has significant scale to operate as it does by using remote, small, ex-military airports across Europe.

9 ryanair costs competition

Source: Ryanair IR

Ryanair’s scale is incredible and they are further planning to expand in Ukraine, Israel, Bosnia & Herzegovina etc. Plus, they might take advantage of bankruptcies in the future but they are not interested in expanding in Scandinavia due to high government taxes.

10 ryanair airport coverage

Source: Ryanair IR

Given Ryanair’s business model, it actually doesn’t have much competition among customers that look for low prices.

11 market share

Source: Ryanair IR

Good market share, in a growing market as more and more people fly. Further, Ryanair’s share is even higher with cost aware customers. All smaller airports want to get Ryanair into their hub and the others are not that of an interest as unstable.

When it comes to business analysis, the best thing to do is to go to Peter Barklin from Niche Masters Fund. He has been kind to share his Global airline industry presentation with me and I’ll use some slides to better explain what Ryanair could be. If we take a look at the demand curve for the industry, Ryanair covers a huge part of the market and given its low cost, it might really have a moat.

14 ryanair cost curve

Source: Niche Masters Fund

As Ryanair has a kind of advantage due to low costs, let’s see what is going on within the European market.

What does it mean low-cost? These guys print their logo and put it on an old laptop. As long as it is functional. Got to love such managers. Source: 2019 FY Ryanair conference call.

ryanair

The European market

Consolidation will continue as many will fail. Ryanair actually hopes oil prices stay high so that they have lower competition in the future due to bankruptcies.

On fares, according to the CEO, fares in Europe are 25% when compared to North America and therefore have to rise at some point in time given that those are artificially low now.

If there is a price war, Ryanair will win due to the lowest cost. Profits might suffer for a year or two, and that is what shareholders should expect according to the CEO, but Ryanair should win.

The story is that there will be 4 to 5 big carriers in Europe and that is it, like in the US. Ryanair as the lowest cost, Lufthansa, BA AIG, Air France- KLM, with a question mark whether EasyJet will survive as an independent carrier – probably they will.

What did Buffett do when the industry consolidated and stocks were cheap? He bought them all, all four of them.

Ryanair stock price analysis, valuation and investment thesis

The market cap is currently at 11 billion EUR. Profits over the last 5 years, that have been good, were around 1 billion on average.

15 ryanari financials

Source: Morningstar Ryanair

Management has guide for profits between 700 and 900 million, let’s take 700 million over the next two years. After two years, we can assume profits to grow back to 1 billion and above, as the market consolidates. Or, we could see profits go to zero, especially if we have a recession.

However, what is a given, is that Ryanair will reach 200 million passengers per year by 2024.

16 growth

This implies growth of 25% in revenues from traffic and probably higher growth from ancillary businesses. If fares  in Europe increase by then, I would assume a 50% increase in revenues, add an acquisition and we are beyond 12 billion in revenues, perhaps even 15, depending on what is acquired. On 15 billion in revenue, with an average historic gross margin of 25%, net income could be 2 billion. If they continue with buybacks, earnings per share could be at 3 EUR and the stock price at 30, at some point in the next 5 to 7 years. That is a 16% return over the next 7 years. If it happens over 10 years, it is an 11.6% return.

If I look at earnings, it is impossible to make a model as airline earnings will always be volatile. However, I can estimate 2 years at 500 million, 2 years at 2 billion, 2 years at 1 billion and I would even add a year at zero and one at 3 billion. Thus, Ryanair will make a billion per year over the next 10 years, probably 1.5 billion. Thus, a fair price for a 15% return should be 10 EUR.

IMPORTANT STOCK PRICE NOTICE: If profits suffer for another year or two, the market will see only that. If there is a slowdown in Europe, this could get ugly. It is time to look at the sector and then be ready to strike when the situation looks like it was in the US a few years ago, when Buffett bought everything. However, there are always risks.

Ryanair investing risks

A plane crash – that would be a huge blow. Then the EU commission might get involved due to too much power the company might have. There is the Brexit, a probable EU recession over the next few years, EURO risks as the currency and the continent are fragile, from an economic, demographic and political side. So, plenty of risks there and the company doesn’t really have a margin of safety. Therefore, I would look at this only at business returns above 20%. At 1 billion, the stock price should be around 5 and around 7.5 EUR for 1.5 billion in earnings.

To keep on the watch list, it will also be a good indication for the European economy.

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Thor Industries Stock Analysis

Over the past months I have received more than 10 emails from various investors about how Thor Industries is a great, cheap, value investment.

1 stock price tho

Source: CNN Money – THO

The first emails started coming in when the stock price fell from above $150 to around $120. Since then, the stock fell another 50% to the current $60. Ouch.

In this article I want to talk about this because it is an excellent example of how many value investors get trapped.

How value investors get trapped?

We have:

  • An extremely cyclical industry that makes the fundamentals look amazing at cycle peak

You would look and see amazing growth selling for a PE ratio of just 15 or lower as it was the case during 2018 when the earnings were $8.14 and the stock price was between $150 and $100.

2 thor fundamentals

Source: Morningstar

However, then reality struck. Earnings halved, revenues declined and the company took a lot of debt to buy an European RV produces at cycle peak.

They did make $1.6 billion in operating cash flows in the last 10 years, but they also spent $927 billion on acquisitions not including the last acquisition.

cash flows

The acquisition and positive RV environment in the US allowed for nice growth. Investors usually look at the past and think the same story will continue, but it doesn’t have to be so. In a highly cyclical industry things change fast. The company’s last quarter shows a loss and if there are more troubles or costs from the recent acquisition, the decline in sales continues, we could see negative earnings for 2019 which would not make this look like a bargain anymore.

3 second quarter

I think the same story happened with TATA Motors, when many saw it as cheap with a PE ratio of 7 and a high dividend yield.

4 tata motorst stock

The long term chart of TATA is similar to Thor’s. The only difference is that the exuberance with THO was much shorter.

5 thor stock price

On the chart, many just look at the drop from $150 to $60 and invest on the hope it will go back there. If you look at a chart when you invest, please also look that the stock was trading around $50 from 2014 to 2016 which doesn’t make it look like a bargain. I get probably 10 emails per week about how this stock is cheap because it fell 50%, nobody sees that it went up 200% prior to that. Another trap unexperienced value investors fall into.

Is Thor a good investment now?

I recently listened to an interview with Howard Marks and he put is very simply. When investing you have to look at where we are in the cycle now. Nobody can predict the future but you can see where we are now.

The first thing is to look at inventories, and those are high with dealers.

6 inventory correction

Let’s take a look at the industry.

8 industry

Even if there is no sign of a recession, just the small increase in interest rates will lower sales by 20%. If there is an economic slowdown or if interest rates increase further, I would expect sales to drop another 20% per year for a few years. Interest rates increased from 4% to 5% and already sales dropped.

7 interest rates

Source: FRED

Plus, an RV is really a luxury purchase, one that can be postponed easily and when the market contracts there is also a lot of inventory to be dealt with. RV dealers go bust, fire sales can make the environment very tough. From 2006 to 2009 sales dropped 60% for the industry. I think we are now in 2007 for the RV cycle, the peak has passed and the growth turned into a decline. Those who wanted an RV, probably bought one in the last 5 years as the conditions were perfect, long lasting economic growth, low interest rates on investments, high stock levels, a lot of money etc. It is really a discretionary purchase.

Then, they made a big acquisition in Europe at cycle peak too. The environment isn’t growing, there is a lot of competition from glamping or from mobile homes crated by the camping sites and I don’t see a positive for RV in Europe in the long term.

9 europe

For example, German tourists used to buy an RV and go to Croatia for the summer. However, now, RV space is replaced with small homes already there. It is more convenient, similar experience and you don’t have to do a thing.

10 camps

On the bigger picture you can see how more than half of the camping site has been closed with these kind of homes.

11 camsp

So, we are in a place where the trends in the industry in the US are negative but probably still above cycle average. The average in the US will be around 300k units sold, still 40% down from where we are now.

In Europe the average will be 160k and declining but we are now at 200k. Forget about growth in Europe.

In the US, the management discusses 77 million households camping and how they should all buy an RV.

12 promise

But they forget that 500k units per year sold quickly brings you to 5 million that saturates the market soon as not all campers want to own an RV.

Plus, consumer confidence is usually at its peak in the late part of the cycle. When it declines, RV sales erode.

13 consumer confidence

When RV sales erode you need to have strong financials and no debt. THO didn’t have any up till the Hymer acquisition.

14 debt

Now the company has about $3 billion in debt which should cost them $150 million in interest per year. If I take 2015 as the average cycle year, the cash flows have been $200 million which makes it just $50 million now.

15 average cycle

Conclusion

I don’t see growth in Europe as the market is changing fast. Trust me, Europe is not the place to go around with large RVs and travel.

The debt is a certainty, there is high risk of firing back and then things get ugly as those are getting now.

What would be an average cycle price value? Let’s say $3 to $5 per share in free cash flows leading to a valuation between $30 and $50 from a value perspective. Want to buy it with a margin of safety? Then we are looking at a price below $20. Am I crazy? It was trading there in 2011, 2009 and 2003.

The conclusion – look at the long term average in the cycle for the company, this will give you a good indication o the value and the investment potential with a margin of safety. Remember, where are we in the cycle now?

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To Buy or to Sell Stocks with Crash Coming? Doesn’t Matter for Value Investors – Buy Value

I received this very interesting comment from a subscriber as I bought my 5th stock for my lump sum portfolio which is now 50% invested. So, I invested 50% of my portfolio over the last 3 months that might surprise people scared of the upcoming crash or recession.

stock market crash

I have 3 points to answer this question:

  • I can’t predict the future, nobody can

Nobody knows what will happen with the market, we have the last two crashes in our mind that were close to 50%, but that doesn’t mean it will happen again. Nobody, and I mean nobody knows.

  • A recession is always around the corner

There are recession predictions for 2019 and 2020, but the same could had been said in 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, and especially 2010 and 2009. There are many out there that have been waiting on the side-lines since 2009 or they just got in in the last few years. No need to mention the missed opportunities.

For example, my largest position in January 2018 was Nevsun Resources.

3 nevsun

In January 2018 there were fears about China slowing down leading to a copper crisis etc., fears of a recession and market crash over the next two years with Ray Dalio saying there is a 70% chance for an U.S. recession. I would have been better in cash than investing in a copper miner, right?

Well, all depends on value, if you find it, even if a recession happens, your returns are delayed by a year to 3. The point is that if you buy value, you will survive those bad years and get ahead after the crash. So, I, as a selective investor, simply buy when I see value and when I am happy owning the business. It has rewarded me very well in the past no matter the possible crashes. And yes, I lost money in 2008, but it is not comparable to what I made from 2009 onward and from 2002 to 2008.

Index fund investors

For those who invest in index funds, just invest on a monthly basis, just dollar cost average and forget about stocks, don’t even think about it, you will get your returns whatever they will be, own your home, invest in another property, diversify and you will be well off. Your wealth doesn’t depend on the market, but mostly on you and you not doing stupid things like most did, I.e. selling in 2009 march.

3) Highest possible return long-term

I know if there is a recession my portfolio will get hit, but I also know that the highest possible return I will get is when I buy value when I see it. So, in good years I will have great returns, in a bad year, I don’t know how I will do. There is a nice passage in the book Margin of safety by Seth Klarman discussing how when you buy value, real value, it often offers downside protection as it is already depressed in price and the price can’t go much lower. All my current 5 stocks trade below book value, mostly tangible book value, have high earnings yield and potential. So whatever happens, I am a happy owner, owning assets and that gives me a margin of safety.

To explain in an easy way what margin of safety investing is, I’ll make the next video article apple.

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ADM – A dividend stock to own for the long term

Contents

ADM company overview

Investment strategy

A few notes from the last conference call

My personal opinion

I analysed Bunge, as it seems like the cheaper stock between the two, but ADM looks like a better business.

ADM company overview

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Source: ADM investor presentation

Unlike Bunge, they grow by acquiring smaller players and including them into their business model and possibly scaling the smaller acquisition.

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Source: ADM investor presentation

Operating profits are stable.

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Source: ADM investor presentation

And earnings per share too.

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Source: ADM investor presentation

The return on capital is 300 basis points (3%) higher than Bunge’s and 200 basis points above their cost of capital.

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Source: ADM investor presentation

They plan to increase the dividend pay-out ratio by 30% in the medium-term range.

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Source: ADM investor presentation

The increased dividend payout should lead to constantly higher dividend yields. Thus, what is now 3.24%, could quickly become 5%. 

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Source: ADM investor presentation

The last dividend is their 349th consecutive quarterly payment and an uninterrupted record of 87 years.

Net debt is smaller than Bunge’s and the available liquidity allows for flexibility. 

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Source: ADM investor presentation

Investment strategy

If ADM continues to grow as it did in the past given that it has the foundations to do so, plus the acquisition potential, I would assume its operating profits could reach $5 billion per year over the next 10 years.

pastedGraphic_8.png

Source: ADM investor presentation

This also means that distributions to shareholders would be 50% higher than in the last 10 years where the dividends paid out were $5.5 billion and buybacks $6.1 billion. Thus, over the next 10 years, allowing for the normal cyclicality in the food sector, I would say ADM could return at least $15 billion to shareholders. That implies a 6.5% dividend and buyback yield. 

Also, if profits increase 50%, we could estimate the stock price to increase accordingly. So, in 10 years the stock price will probably reach $60 at some point. This adds another 4.1% yearly yield and makes ADM a probably double digit investment over the long term. 

If food prices increase significantly, processing margins improve, there could be exuberant periods like it was the case in 2007, 2014 and 2018.

pastedGraphic_9.png

The total shareholders equity is $18 billion on a $23 billion market cap giving some margin of safety, but the accumulated depreciation is $15 billion. We could assume that some things can still be used even if the accounting value is zero. The replacing value could be much higher than the $10 billion carried on the balance sheet. 

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Source: ADM Morningstar

There is also the 24.9% stake in Wilmar, a $15 billion company traded in Singapore. The value there is $3.75 billion. 

A few notes from the last conference call

The plan is to save $1 billion from efficiency improvements and digitalization. I remember when I worked for Dow Chemical, there were all these little projects and I can tell you those improved small efficiencies cumulate over time. I see Dow did manage to improve margins over the last decade, the plan is that ADM could save $1 billion.

They expect higher interest payments as they are investing now for the long term, something Bunge can’t do as it has to deal with its issues which makes it another advantage for ADM.

In 2019 they will complete the acquisition of a French animal feed business, Neovia for $1.8 billion in cash. Neovia’s target was to reach $230 million of EBITDA by 2025, perhaps they will reach it sooner now.

ADM is a growth story with more than $7 billion in growth investments over the last five years including key investment like WILD for Taste ($3 billion), Biopolis for Health & Wellness, Neovia for Animal Nutrition, Algar in South America and Chamtor in Western Europe as well as other bolt-on additions and organic investments

My personal opinion

I target an investing business return of 15%. ADM’s average earnings and cash flows point to a 10% investing return so I have to be patient and put this on the watch list. You never know what can happen, but around $30, this might be a very interesting investment. For now, it looks like a good one. 

Also, as ADM’s CEO said, low interest rates allow for high investments that leads to high competition and food oversupply, consequently leading to low margins for processors. ADM is doing fine in this environment, if the environment changes over the next 10 years, ADM might do even better so something to keep in mind. We have been having 5 years now of bumper crops thanks to good weather globally. 

On $3.4 billion in operating profits, $1 billion in capex and about $350 million in interest expense I get to cash flows of around $2 billion. On a $23 billion market cap, that is a 9% return. Given the possible future growth of 4% per year as demand for food grows, I would look at this and compare to my other holdings at 12%. So, ADM’s market cap should be around $16.5 billion for me. That is another 30% down to $30 for the stock price. It is highly unlikely that it ever gets that low, but you never know. Let’s put this on the watch list. If you are happy with the exposure to food, like 10% per year, ADM looks like a stable and shareholder rewarding option. 

Less aggressive investors could wait for opportunities below $40 but anything below $45 seems like a good buy for 98% of investors. 

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Source: ADM investor presentation

Earnings per share are $3.19, we can assume growth of 4% over the long term and a terminal value at a PE ratio of 12.

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If the stock price drops to $30, we would have a 7% return from the stock which would bring this to 11%. 

So, cash flow return is 9%, stock plus dividend return around 7%. Thus, in line almost.

I am analysing the food sector and I must say, ADM looks better than Bunge, also better than Ingredion as it offers more stability thanks to scale. 

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