A Rough Flight for Discount Airlines

European travelers stand to enjoy fares as low as $20 this summer as several low-cost carriers drop prices to fill seats

by Kerry Capell

This summer promises to be turbulent for European discount airlines. Stiff competition, weaker market conditions, and increased capacity are taking their toll on budget carriers, long viewed as the darlings of the European aviation industry.

On May 9, Britain's easyJet, Europe's second-largest discounter, conceded its load factor, or percentage of seats filled, had fallen to 83.1% in April from 86.4% a year earlier. The news follows recent similar revelations from British Airways (BAB), Dublin-based Ryanair (RYAAY), and Germany's Air Berlin. EasyJet CEO Andy Harrison said in a statement that to reverse the trend the company will lower prices on summer flights "to sustain high load factors in weaker market conditions."

Earlier that day, archrival Ryanair announced its biggest fare sale ever, offering 10 million seats from $20, including taxes. The move should drive down prices across Europe and boost demand, says Ryanair CEO Michael O'Leary.

Ups and Downs

Fares aren't the only thing falling. The share prices of European short-haul airlines have taken a battering in recent weeks. Fearing sluggish demand in the summer—normally the discounters' busiest and most lucrative period—investors in easyJet, Ryanair, and British Airways have driven down their shares by 17%, 8.5%, and 5%, respectively, during the four weeks ending May 10.

It seems Europe's discount airlines are in danger of becoming victims of their own success. Ryanair, for instance, morphed from a near-bankrupt basket case in the 1980s to Europe's most profitable airline. With an expected passenger load this year of 50 million, it is now Europe's largest carrier.

A similar story is unfolding at easyJet, the budget carrier founded a dozen years ago by Greek entrepreneur Stelios Haji-Ioannou. It has grown from two leased Boeing 737-200s to a 130-plane fleet flying 292 routes to 75 airports in 20 European countries. The success of these pioneers has inspired a slew of copycats across Europe, where low-cost carriers now account for about 25% of the airline market, a fivefold increase from the beginning of the decade.

Full Flight

But years of strong profits have encouraged discounters to buy more planes and fly more routes, flooding the market with capacity and putting fares under pressure. EasyJet alone has taken delivery of one new Airbus A319 every 12 days since September, 2003. With 104 Airbus planes on order, the carrier expects to increase capacity by 15% in the fiscal year ending Sept. 30.

Meanwhile, Ryanair has seen 21% growth in capacity this year, taking delivery of 27 Boeing 737-800s for a fleet total of 138. By the first half of 2008, Ryanair plans to increase its fleet to 170. "This increased capacity will make it even more difficult for low-cost carriers to navigate the increasingly competitive pricing environment," says Yan Derocles, aviation analyst at Oddo Securities in Paris.

Cost Takeoff

The airlines place part of the blame for their current troubles on tax hikes in Britain and rising airport charges across Europe. In February, Britain doubled air passenger duties on short-haul economy fares to $20 per departing passenger, citing the need to curb carbon emissions.

Passenger charges at British airports also are rising. Fees at London Stansted, Ryanair's biggest base and one of easyJet's London hubs, have increased by 50%, to $4 a passenger.

The pricing environment may be a lot tougher, but both easyJet and Ryanair are on track to post strong full-year results. On May 9, easyJet's Harrison, who stepped into the top job in 2005, claimed the company was still expecting 40% growth in pretax profits for the fiscal year ending in September.

For the six months leading to March, easyJet narrowed pretax losses by 58%, to $34 million from $80 million a year ago. Meanwhile, revenue rose 14%, to $1.4 billion, thanks in large part to an increase in the money the airline makes from ancillary services, such as car hire and insurance. It even charges passengers up to $15 for priority boarding.

The discounters' ability to find ever more creative ways to get passengers to spend money is one reason why many analysts reckon the current turmoil won't dent full-year profits. "Stronger growth in ancillary revenues and better cost management" is likely to offset the current pricing weakness, says Oddo's Derocles.

Indeed, the gloomy summer forecast hasn't curbed the budget carriers' ambitious growth plans. Ryanair's O'Leary told an industry conference on May 10 that he plans to double his number of passengers to 100 million and the number of bases he serves to 40 within five years. This summer may be choppy, but the long-term flight path still looks clear.