ESG commentary by: Johnny Russell, portfolio manager at Nikko Asset Management
Company assessed: Ryanair
Evaluated for: A global equity fund
Background: Low-cost airlines have been taking marketshare from national flag carriers against the backdrop of a growing market. The number of air travellers globally is forecast to double to 8.2 billion in 2037 from 4.1 billion in 2017, according to the International Air Traffic Association (IATA). Europe has spawned a number of low-cost carriers and competition is intensifying. The carriers that can manage operational costs well while maintaining high safety and quality standards are arguably attractive growth investments.
Nikko’s ESG analysis is not done by a separate team, but integrated into the overall investment process, Russell said.
For the global equity fund, the team looks for companies with the highest sustainable returns, regardless of the sector. “Ideally we’re looking for companies that will grow and compound those returns.”
In 2014, the fund invested in low-cost European carrier Ryanair. Against the backdrop of increasing air passenger travel, Ryanair has been tightly focused on profitability and has seen accelerating growth and rising returns, Russell explained.
The airline has been likened to a bus and some of its European flights only cost a few pounds, which accounts for the enormous customer base. (As a reflection of scale, Ryanair is the largest seller of toasted ham-and-cheese sandwiches in Europe, Russell pointed out).
Excess capital has been invested in route expansion and has been given back to shareholders, Russell said. “Ryanair has been a growth company, growing its network aggressively. At one time it was a very fruitful investment.”
Although there were no overriding ESG concerns, the team was aware that the airline was not investing adequately in its employees. “Ryanair has one of the lowest employee and personnel costs as a percentage across the whole industry,” Russell said.
Over time, they came to understand the scale and impact of that policy. Cutting costs at the expense of employee training, wages and retention incentives impacted on employee rights, Russell said. Additionally, an airline pilot shortage exists and the burden is on airlines to retain qualified staff.
Strikes were also flaring up and the airline had to deal with strikes and a spate of flight cancellations due to a pilot shortage.
Russell said Ryanair was expanding to locations where pilots weren’t unionized. “That led us to really question the profitability of the business.”
After the Nikko team met with CEO Michael O’Leary and senior management and asked questions, “we came to the conclusion that culturally they weren’t going to address the problem.
“We don’t necessarily want to use our ultimate sanction by selling, but our return profiles were under pressure and as a result we decided it is not going to be a future quality investment”, so they made a full exit that was completed in June 2018.
He said there was no specific trigger to cash out. Rather, it was a growing concern driven by a confluence of factors: unsatisfactory investment in employees, a tight labour market and management’s unwillingness to change.
“Ironically Ryanair has one of the best carbon emission profiles of any competitors,” he said, adding that management has been investing in this area. “This [exit] was more focused on labour-management practices.”
Russell added that the team would look at Ryanair again only if they believed there was a change in company culture and management adequately addressed stakeholder issues.