FINANCE
Should Ryanair Continue Hedging its Fuel Prices?
A short recommendation I wrote at Imperial College discussing Ryanair’s hedging strategy as compared to its competitors, dated 26 March 2021.
Note: This recommendation was written in conjuction with Cameron Brown, Joshua Mills, and Thomas Butler.
1 Introduction
Hedging involves investing in derivatives to reduce the risk on other investments and Ryanair uses futures hedging extensively to stabilise fuel costs in the volatile market.
2 Advantages and Disadvantages to Hedging Fuel Prices
Advantages:
- Jet fuel price is highly uncertain and forms the largest share of Ryanair’s spending. Hedging fixes fuel prices, facilitating better forecasting of the major cash flows in the company.
- Hedging reduces the risk associated with the volatility of fuel prices enabling Ryanair to secure favourable debt premiums which are essential to a highly debt-financed business strategy.
- High spot fuel prices have to be absorbed by an airline’s customers in ticket prices. Since Ryanair aims for low prices throughout the year, hedging eliminates the risk of their tickets exceeding a threshold price.
Disadvantages:
- By fixing the fuel price, Ryanair is unable to take full advantage of low spot prices for jet fuel.
- Hedging using futures requires the contract to be upheld resulting in large losses during events where jet fuel can’t be utilised or easily stored. Ryanair lost $325m in such an incident during the COVID-19 pandemic [1].
- Choosing the optimal hedging strategy requires expertise and may need to be outsourced to a financial institution for a fee.
3 Recommendation to Ryanair
To recommend a risk management strategy to Ryanair, it’s important to consider the company's exposure to various factors. Like most airlines, Ryanair is heavily exposed to the fluctuating price of jet fuel. Fuel accounted for 37% of their total operating expenses in FY20 [2]. Ryanair is a low-cost airline with a no-fuel-surcharge policy and bold growth plans for its fleet of aircraft. All of these factors make it difficult for the airline to pass rising fuel prices onto its customers. Ryanair is headquartered in Dublin, Ireland; therefore, the company operates with EUR. This leaves the company exposed to the EUR/USD exchange rate (fuel prices, insurance and leases are designated in USD). Furthermore, U.S manufacturer Boeing is the airline’s main aircraft supplier (94% of their fleet are Boeing 737s) [2]. This leaves Ryanair vulnerable to adverse exchange rates as well as fuel price volatility. Finally, due to the ongoing pandemic, the airline is uncontrollably exposed to the current travel ban imposed by most European nations. This has led to a surge in refund requests, a mass grounding of Ryanair’s fleet and increased cleaning costs. This has had a notable impact on Ryanair’s liquidity and its obligations to debtors. The crisis has halted projects with large capital expenditure and has also begun financial restructuring. Ryanair’s gross cash dropped from GBP3.9bn at the beginning of the pandemic in March 2020 to GBP3.5bn by December 2020. The airline’s strong BBB investment rating allowed for an additional GBP1.25bn to be raised in debt in September 2020 [3]. With this recent debt-financing, Ryanair’s net debt has increased to GBP2bn, which is a historical high for the company whose net debt has often remained well below GBP1bn [2]. Despite this significant increase in debt, Ryanair remains a stronger investment than its competitors with the highest investment grade rating amongst European airlines, and the second-highest globally. Such a strong investment-grade rating signals to creditors that Ryanair may be able to weather the storm presented by the pandemic [4].
Figure 1 shows airlines with the highest amounts of hedged fuel in 2020 [1]. Most US airlines stopped hedging after merging due to their stronger financial positions [5]. Fuel costs as a percentage of expenditure typically range between 20% to 30% [6], but is at 37.5% for Ryanair [2]. Hedging is therefore necessary if costs are to be stabilised, but Ryanair needs to review its policies. Different derivative implementations are possible; Lufthansa uses range options, Air France KLM uses swaps and options, while Ryanair uses forwards. Percentage fuel hedged is also crucial, with Ryanair and EasyJet reducing it to 40% and 51% respectively for 2021 (from 90% and 71% in 2020), while IAG indicating no intention of hedging at all [7]. A conservative account of projected sales, jet fuel prices, and forex rates are obvious concerns. However, given the uncertainties, COVID-19 brings, continued adoption of futures-exclusive portfolios may cause overexposure. Other things which should be considered are potential travel restrictions, fuel storage capabilities and cost, and consumer outlook. With the uncertainties that COVID-19 brings one potential option may be to balance the price certainty of futures with the flexibility of call options. In conclusion, Ryanair’s reduction to 40% hedging of expected fuel consumption for 2021 is reasonable considering the uncertainty regarding travel between European nations this coming summer.
References
[1] Ryanair says fuel hedges will dent profit by 325 million. 2020. URL: https://www.bloomberg.com/news/articles/2020-04-03/ryanair-says-fuel-hedges-will-dent-profit-by-325-million
[2] Ryanair annual report FY20. 2020. URL: https://investor.ryanair.com/wp-content/uploads/2020/07/Ryanair-Holdings-plc-Annual-Report-FY20.pdf
[3] Ryanair Q3 Results FY21. 2021. URL: https://investor.ryanair.com/wp-content/uploads/2021/02/Ryanair-Q3-FY21-Results.pdf
[4] Ryanair bond sale as airline credit ratings fall, debt costs rise. 2020. URL: https://centreforaviation.com/analysis/reports/ryanair-bond-sale-as-credit-ratings-fall-debt-costs-rise-536993
[5] Lacking visibility, US airlines avoid hedging near-record low jet fuel prices. 2020. URL: https://www.spglobal.com/platts/en/market-insights/latest-news/oil/062920-feature-lacking-visibility-us-airlines-avoid-hedging-near-record-low-jet-fuel-prices
[6] U.S. airline fuel cost from 2004 to 2020. 2020. URL: https://www.statista.com/statistics/197689/us-airline-fuel-cost-since-2004/
[7] European airlines may quit fuel hedging after $4.66 billion in losses. 2020. URL: https://www.eurofinance.com/news/european-airlines-may-quit-fuel-hedging-after-4-66-billion-in-losses/
