The European Aviation Sector: Up, Up and Away

Suzanne Berkery

06.12.2023

The European Aviation Sector: Up, Up and Away

The European aviation sector has seen a rapid increase in mergers and acquisitions (M&A), with the trend likely to continue as larger airlines consolidate and seek to increase their competitive edge. Consolidation is not a new theme in this sector.

 

One of the most prominent mergers in the European aviation sector was between Aer Lingus and British Airways. In 2015, the two airlines combined to form the International Airlines Group (IAG).

 

In the same year, Air France and KLM combined to form Air France-KLM. Both mergers allowed the newly formed companies to reduce operating costs, increase efficiency and increase competitive edge.

 

In 2018, Lufthansa Group acquired a majority stake in Brussels Airlines. This acquisition gave the German airline increased access to the Belgian market, allowing it to strengthen its presence in the region.

 

2019 saw the acquisition of LaudaMotion, Austria’s number one low fares Airline, by Ryanair. The acquisition allowed Ryanair to benefit from LaudaMotion’s existing fleet of aircraft, which it used to expand its operations in the region.

 

The European aviation sector is undergoing another period of rapid consolidation following the pandemic. This trend is likely to continue as airlines seek to increase their competitive edge and reduce their operating costs. This could have far-reaching implications for the industry, and it is likely that we will see more mergers and acquisitions in the near future.

 

Many newer and smaller rivals are starting to falter while the five largest European airlines are increasing their share of the market. This is partly because the Big Five – Lufthansa, Ryanair, International Consolidated Airlines Group (IAG), easyJet and Air France-KLM – have leveraged their superior scale, which is only growing amid a wave of consolidation.

 

Meanwhile, smaller firms continue to falter. At least 14 European airlines have collapsed since the start of 2018 including the likes of WOW in Iceland, VLM in Belgium, Cobalt Air of Cyprus, Primera Air in Latvia or Swiss airline SkyWork.

 

Flybe the troubled airline once considered Europe’s largest regional carrier was rescued in 2019 by a consortium including Virgin Atlantic and renamed Virgin Connect, by March 2020 the airline had collapsed. Hopes of its return were raised when Thyme Opco bought it in April 2021 but by January 2023 the administrators were called in.

 

It seems being swallowed up by a competitor is the only way many of the small-to-medium sized carriers operating in Europe will survive.

 

The European market is still highly fragmented with Air Advisor reporting an estimated 105 Airlines operating in Europe. Statista report that the Top 5 European airlines have collectively secured just over 50% of the market while in the US the Top 4 (American Airlines. Delta, Southwest and United Airlines) represent closer to 70%.

 

The chief executive officer (CEO) of Ryanair, Michael O’Leary, has said the market will continue to consolidate under the Big Five for the foreseeable future and that sentiment has been echoed by many of his peers.

 

The global aerospace & defence industry grew from $795.9 billion in 2022 to $855.6 billion in 2023 at a CAGR of 7.5% as reported by the Business Research Company. The industry has improved fuel efficiency by around 39% from 2005 to 2019 to achieve decarbonized aviation with net-zero emissions by 2050, according to McKinsey analysis. Commercial aerospace revenues are projected to grow at 14% YoY in 2023, reaching pre-pandemic levels by 2024. Despite risks such as an economic slowdown, occurrence of a new COVID variant, elevated jet fuel prices and geopolitical tensions, the ongoing recovery in the aerospace sector is expected to drive a 21% YoY increase in Revenue per Kilometre (RPK) in 2023. The IATA forecasts a $5 billion airline profitability in 2023, reversing the $7 billion loss in 2022.

 

Ryanair has a clear advantage over its peers with an impressive unit cost per seat of €31 in Q1 and the gap continues to widen. Wizz Air its closest competitor on cost is still 50% higher at €47 and IAG’s costs are a staggering 426% higher at €166.

 

During the five years prior to the pandemic, Ryanair traded at an average PE multiple of 13.85x and an EV/EBITDA multiple of 8.5x. The airline has emerged from this difficult period with its competitive position strengthened and a clear vision of its growth prospects over the next decade. As a result, with the shares currently trading at 10.1x FY24 EPS and an EV/EBITDA multiple of 5.7x. Price Target €22.75 Yield 0.00%.

 

Deutsche Lufthansa Group expects demand to remain high for the rest of the year, especially in the premium classes, mainly driven by private travellers. Demand for business travel is also increasing, and Lufthansa expects it to recover to up to 70% of pre-crisis levels by the end of the year. Price target €11.11 Yield 0.00%.

 

International Consolidated Airlines Group (IAG) key markets are improving with the London-North America market much healthier following the exit of Norwegian Air Shuttle’s competition at disruptive prices, while Europe-South America is consolidating further. Its recent acquisition of Air Europa is being viewed as extremely attractive. Price Target 219.85p Yield 0.00%.

 

Subject to approvals and conditions, Air France-KLM(AF-KLM) will take up to a maximum 19.9% noncontrolling stake in the share capital of the reorganised Scandinavian Airlines (SAS) and potentially, a controlling stake in the future. Another example of the industry consolidation in Europe. Price Target €18.94 Yield 0.00%.

 

EasyJet announced in its recent trading and business update for FY 2023 that it expects its group headline pretax profit to be in the range of 440 million pounds sterling to 460 million pounds for the 12 months ended Sept. 30. It also announced a medium-term plan envisaging, a pretax profit target of GBP1 billion by 2026, orders of 157 Airbus airplanes worth $20 billion and returns to dividend payments at the full-year 2024 Price Target £6.19 Yield 0.00%.

 

Our preferred airline is currently Ryanair. Given the tenor of management’s presentation at the company’s recent Capital Market’s Day (CMD), there is good potential that a lengthy period of sustainable growth is on the cards for Europe’s largest airline, which will be partly driven by management’s aim for a 25% increase in Profit After Tax generated per passenger by FY34. Furthermore, given the strength of Ryanair’s balance sheet (Net Cash), it was unsurprising to see management commit to returning a significant sum of cash to shareholders. Pre-pandemic the airline had an active share buyback policy, however, looking forward, management has strongly indicated that its preference is for dividends. We estimate this payout to be €365m in FY24 (which could prove conservative), representing a yield of c 2% on the current share price.