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Why this growth star could disappoint investors in 2017

Photo: Arpingstone. Public Domain.

After a 225% rise in five years, investors in budget airline Ryanair Holdings (LSE: RYA) may be worried that challenging market conditions will wipe out some of their hard-earned gains.

Today’s third-quarter figures suggest to me that this is a valid concern. The airline said Q3profits fell by 8% to €95m, despite the number of passengers carried rising by 16% to 29m. The problem was that the average fare fell by 17% to just €33.

Ryanair is adding new routes and bases to its network despite competition from other EU airlines, which are also adding capacity. Ryanair says “downward pressure on pricing” is expected to continue over the next year. The firm expects ticket prices to fall by 15% during the first three months of 2017, compared to the same period last year.

An airline price war seems increasingly likely to me. This isn’t generally a scenario in which I’d want to invest.

However, Ryanair claims to have the lowest passenger costs of all EU airlines. The group said today that unit costs fell by 6% during the quarter, excluding fuel. By contrast, easyJet reported a 1.1% increase in costs during the same period, excluding fuel.

I believe there’s a good chance that Ryanair will be able to win market share from competitors and maintain stable profits this year. But I’m less convinced about profit growth.

The airline confirmed its full-year profit guidance of €1.30bn to €1.35bn this morning. This puts the stock on a forecast P/E of 14. That’s not excessive, but I suspect broker forecasts for 2017/18 may be trimmed after today’s downbeat update. In my view, the outlook for Ryanair shareholders seems finely balanced. I’d hold and wait for further news.

Is this growth titan a better buy?

With a market cap of £93bn, Unilever (LSE: ULVR) isn’t a hot growth stock. But the firm’s shares have risen by 61% over the last five years. That’s almost three times the 22% gain achieved by the FTSE 100.

Unilever might have done better still, but January’s fourth-quarter results disappointed the markets and caused the firm’s share price to sag. Unilever also warned of a “slow start” to 2017.

This might suggest that it’s time to take profits on Unilever, but I think this could be a mistake.

Firstly, last year’s results weren’t bad at all. The group’s core operating margin rose by 0.5% to 15.3%, while free cash flow was stable at €4.8bn. Net profit rose by 5.5% to €5.5bn.

Unilever’s shares do look fully priced, on 19 times 2017 forecast earnings. But the group’s prospective dividend yield of 3.6% is in line with the FTSE 100 average. This payout is comfortably covered by earnings and free cash flow, making it very safe. That’s not the case with some other high-profile dividend stocks.

Unilever’s earnings and dividend payout are both expected to rise by about 7% this year. Even if performance does disappoint slightly, I suspect that long-term shareholders will profit more by holding than they will by selling. This remains a very high quality business, in my opinion.

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Roland Head owns shares of Unilever. The Motley Fool UK owns shares of and has recommended Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.