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Are these UK airline stocks set for market domination?

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The UK airline market looks like it’s moving toward consolidation. This process happened in the United States around 10 years ago, endowing the victors with larger market shares and profit margins 60% higher than their European counterparts. With the hostile environment burning a hole in company valuations, now could be the time to invest in the next market leader. I believe these three UK stocks are worth consideration: Ryanair (LSE:RYA), easyJet (LSE:EZJ) and Dart Group (LSE:DTG).

Dart Group, the holding company that mainly constitutes of Jet2, is considerably smaller than its competitors. It has grown rapidly, tripling revenues over five years. However, it still carries 9 times fewer passengers than its closest rival easyJet. These airlines differentiate on customer experience and price. Jet2, with a host of awards, sits at one end and, with an average fare of €39, Ryanair sits at the other. When it boils down to it, Ryanair and easyJet are substitutable investments, both mature businesses with customer growth in the range of 7%-10%. Jet2 brings higher growth (45% last year) and, with it, greater risk. 

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Financial metrics

In the context of a highly competitive market, profitability is king. The top end is getting cut throughout the market: easyJet estimates there will likely be a 10%+ drop in fares through 2019, closer to 5% for Ryanair. Jet2 has the furthest to fall, knocking 15% off its prices in 2018 alone. So how much lower can fares go before profits disappear?  Reflective of a rough year, easyJet’s profit margin for 2018 was 3.2% (8.6%), Jet2’s came in at 7% (4.2%) and Ryanair 14% (18%). In brackets are the companies’ five-year averages. These tell a slightly different story – throwing doubt over Jet2’s margin and suggesting easyJet’s is set to improve. The bottom line remains the same, however – Ryanair stands to gain from a competitive environment where price rules.

Debt has the final word. A long enduring price war, rising fuel prices and increasing costs from disruption (e.g. drones) should make investors think twice about high leverage. Dart Group has the largest problem, characterised by a debt/EBITDA ratio of 3.2x and an interest coverage close to 7. Ryanair’s ratio is 1.8x and easyJet has net cash. High leverage should be expected from Dart Group, with rapid growth and a lot to prove. In a different industry, with low supply, it would be a different story. As it is, the company’s larger competitors sit in a stronger position to capitalise on a price war.

The best investment?

Many investors point towards easyJet’s consistent dividend, with a forward yield of 6.4%, as a winning metric. However, with a payout ratio over 100% and faltering revenues, this may be a thing of the past. In comparison, Ryanair regularly buys back shares – last year’s yield was 5.8%. Again, as a growth stock, Jet2’s low yield of 1% is expected.

Personally, too many parallels exist between Jet2 and the plethora of airlines that have recently gone bust. The real winners from this market squeeze will more likely be the big players. Ryanair holds a distinct place in the market, with its high margins, low costs and low fares. Comparable on other metrics, I back Ryanair, not easyJet, for market domination.

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Neither Sam nor The Motley Fool UK have a position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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