It's understandable if investors in Ryanair Holdings (NASDAQ:RYAAY) think they have the luck of the Irish today. Despite predictions of a truly ugly quarter, the low-cost European airline managed to post a 15% increase in third-quarter revenue, and yields held steady over the prior year. While net profit was down 26%, that was still better than expected. In a time when many airlines are posting losses, restructuring through bankruptcy, or giving up entirely, Ryanair is at least still profitable.
A brutal market for air carriers is not purely an American phenomenon. Recently, European low-cost airlines such as Volare (Italy), VBird (Germany), and Air Polonia (Poland) have been driven out of business, and many of those that still survive have reduced capacity. While Ryanair management heartily patted itself on the back for a job well done, it did express ongoing caution about the next quarter.
Like its American cousin, Southwest Airlines (NYSE:LUV) (to which it constantly compares itself), Ryanair survives largely on its ability to keep costs under control. Consequently, when fuel costs rise 68% and route costs rise 22%, profit margins shrink rapidly.
Ryanair has hedged its fuel costs (at an average of $41 per barrel for oil) through the fourth quarter, which ends in March. After that, the company is unhedged, as management expects lower energy prices. This is a somewhat risky gamble, because the company has a mixed record as a prognosticator of oil prices.
Unlike many carriers, Ryanair derives a meaningful chunk of its revenue from non-flight operations like car rental. These ancillary revenues grew 24% in the third quarter and now make up 16% of the company's total revenue. Although investors have been looking for new inflight entertainment systems to drive this higher, that optimism may have been premature. According to management, initial test results of the systems have not lived up to expectations, and if consumer acceptance doesn't improve quickly, the company will not roll out the systems to its entire fleet.
Although Ryanair is still the most profitable publicly traded airline, a forward price-to-earnings ratio well above 20 seems like an ample reward for that performance. With the airline industry still facing overcapacity, brutal price wars, and high operating expenses, there could still be turbulence ahead. Though Ryanair is unquestionably an excellent company, that doesn't make the stock automatically attractive at today's prices. Besides, when cowboys like Ryanair get cautious, investors would be smart to do likewise.
Fool contributor Stephen Simpson, a chartered financial analyst, has no ownership interest in any stocks mentioned.
