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Heavenly peace

30 January 2015

Irish low-cost airline Ryanair has withstood turbulent conditions to emerge in good shape – and is a favourite of fund manager EdgePoint.

Picking undervalued quality businesses and holding them until the market realises their potential is easier said than done. But, for long-term investors, one of the attractions of this deceptively simple approach is its focus on stock fundamentals and value. And, in periods of market uncertainty, it requires investors to overlook the drama of short-term turbulence and keep an eye on long-term horizons.

Geoff MacDonald of EdgePoint sums up the approach as “identifying a business that can grow in the future irrespective of what happens in the global economy – within a band of reason – and not paying for that growth today”. It is a way of investing that the co-manager of the St. James’s Place Global Equity fund says hinges on “being at peace” with uncertainty – and selecting businesses that can succeed even if the future is tougher than everyone hopes.

Irish charm

Irish low-cost airline Ryanair is a mainstay of EdgePoint’s global equity portfolio, and displays the facets that the contrarian Canadian investment manager wants in its portfolio. “Most people have been pre-conditioned to believe airlines are a terrible business, and in almost all cases they’re right to believe that,” explains MacDonald. “However, Ryanair seems to be an exception to that rule.”

In fact, Ryanair has had to contend with a steady stream of market and global economic headwinds during the six years in which EdgePoint has held the stock. MacDonald points out that these developments could not have been forecast, and “realising that you can’t predict the future frees up your mind to focus on more meaningful endeavours, like how to prepare for uncertainty”. Moreover, the airline’s resilience demonstrates the robustness of another of the manager’s core tenets: ignore short-term market turbulence.

For example, Ryanair weathered the sharp rise of oil prices from $45 a barrel for Brent crude in 2009 to over $120 a barrel in 2011, where it hovered until recent falls. Now, with a barrel of oil falling by around 60% since the middle of last year to below $50 a barrel, the airline is enjoying cheaper fuel costs; and a corresponding 45% rise in its share price since June.

Turbulent years

Over the same period, Europe suffered two recessions and deflationary pressures; while Russian policy has added to geopolitical tensions. Greece, Spain, Portugal and Italy – all Ryanair destinations and markets – flirted with bankruptcy (with the jury still out on what the Greek anti-austerity victory will hold for Europe). The Irish airline witnessed the collapse of tourism in key markets, a financial crisis and high levels of unemployment in its homeland.

Airlines are also at the mercy of bad weather, as closures at airports in recent days in the UK have again demonstrated. In 2014, Ryanair’s European-centred operations were snarled up by one of the worst winters in a century that engulfed the UK and the continent, closing airports from London to Barcelona for extended periods. (The Icelandic volcano eruption and resulting ash cloud shut down European airspace for a prolonged period in 2010.)

Yet, in spite of these challenges, Ryanair increased the number of passengers it carries from 58 million per year in 2008 to close to 90 million per year today, while increasing its pre-tax profits more than six-fold over the last six years. Over this period its share price increased from approximately €3.00 to over €9.50 and it has paid a special dividend of €0.68. 1

Above the fray

All of this validates EdgePoint’s belief that Ryanair could grow almost irrespective of what happens in the economy. “We were not being asked to pay for that growth at €3.00 a share,” adds MacDonald. “The simplified version of our thesis was that Ryanair’s focus on being a low-cost operator would allow it to grow even if the economy stunk.”

But it was Ryanair’s business costs relative to its market competition that gave the Canadian investment managers the confidence to back Europe’s largest airline. “Ryanair’s cost of operation per passenger was, and continues to be, about 50% lower than its closest competitor,” he adds. As such, Ryanair could offer fares below its competitors’ costs and still make healthy profits.

“Our research also led us to believe Ryanair would continue to build on its low-cost position, increasing the value of its business,” he explains. “We have to make decisions about the future when the future is uncertain. Ryanair demonstrates that it is possible to identify businesses that can grow no matter how the economic backdrop pans out.”

The opinions expressed are those of Geoff MacDonald and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

 1 EdgePoint commentary Q4-2014, January 2014

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