Shares digital

Trading has been steady for tour operators, travel agents and hoteliers so far in 2008. But the advance nature of bookings may have created an illusion this part of the leisure sector will not be affected by the weakening economy and slowdown in consumer spending.

by Dan Coatsworth

House builders and banks have taken a sharp blow to the head in the past year but the damage inflicted upon the leisure sector is potentially more brutal, a slow agonising pain that may not dull until 2009 or beyond. Trading has, on the whole, been steady for tour operators, travel agents and hoteliers so far in 2008. But the advance nature of bookings may have created an illusion this part of the leisure sector will not be affected by the weakening economy and slowdown in consumer spending. A clearer picture will emerge by the new year.

The market initially took no chances and aggressively marked the sector down, with pub and restaurant companies spearheading the downturn. Analysts have also started to take the knife to earnings forecasts. Yet many stocks have staged a recovery in their shares over the past month. Momentum has picked up in stocks like TUI Travel (TT.) and Thomas Cook (TCG), and nimble investors have been able to make money from a difficult environment.

However, this sector should only be traded as a short-term play as there could be a nasty shock when trading updates emerge towards the end of the year, giving an indication of the crucial 2009 forward bookings. Anyone prepared to buy now must be ready to jump ship at the first sign of a main market operator reporting a notable downturn in trade.

Going on a summer holiday

The UK’s two biggest quoted tour operators, Thomas Cook and TUI Travel have reported robust trading for the current summer holiday season. Newspapers and television programmes may portray consumers being relegated to camping in the garden and enduring burnt sausages on the barbecue as their summer experience. But the companies who arrange holidays and run leisure activities say the pressures of food price and energy inflation, the credit crunch and dwindling economy had not fed through to the consumer’s wallet when summer bookings were made earlier in the year or even in late 2007.

The travel and leisure sector has declined by 17% since the start of 2008, compared with the broader FTSE All-Share falling by 14.9%. The sector can split into three sections, two of which are the key drivers behind the decline.

Higher oil prices have dragged down the airlines, while pub and restaurant groups have been hit by the smoking ban and then the squeeze on consumers’ disposable incomes, which has resulted from the credit crunch and rising household bills. Such woes are already well understood by the market so Shares has focused on the remaining segment of the sector which comprises the businesses which sell and arrange holidays, offer accommodation and run leisure activities.

Broker Morgan Stanley published the results of a study last month that surveyed 1,000 UK adults about leisure spending trends. It found while people were concerned about their personal finances, the higher oil prices and a weaker pound against the euro, they were still likely to maintain or increase their travel and holidays spending.

Less than a third (28%) of respondents said they were ready to reduce their expenditure on overseas breaks, and only 22% on UK holidays. Nevertheless, as Morgan Stanley rightly points out, making plans and executing them may turn out to be quite different over the next year.

‘An estimated 40% of people book their summer holidays before Christmas, so there is perhaps not the same degree of consumer gloom surrounding the current trading of holiday companies,’ says Carl Michel, chief executive of adventure holiday-to-short break specialist Holidaybreak (HBR). His company’s share price collapsed from 835p in October 2007 to 341.8p in July 2008, yet an upbeat trading statement triggered a recovery in the shares to around 468p earlier this month. A similar picture can be seen at TUI Travel, which fell from 297p in December 2007 to 169.4p in July 2008, only to quickly snap back to 239.8p by mid-August.

The upside of low expectations

The market is already expecting every tourism and leisure stock to do badly, so any upside surprise with trading has so far managed to create a significant uplift in equity valuations. The sector is proving to be surprisingly resilient. In the last major recession, holiday expenditure only fell 1.9% in 1990 and 1.4% in 1991, according to research by Landsbanki. After the tragedy of 9/11, airlines had to slash capacity to survive, and capacity again is the centre of attention among leisure operators hoping to ride through the current presumed downturn.

Thomas Cook and TUI Travel have been applauded by analysts for reducing capacity, in an effort to avoid the pressures of having to shift countless holidays at the last minute. Unlike pubs and restaurants, tour operators have a more flexible model in which to adapt to the changing leisure landscape.

The challenge now is to pass on higher fuel costs and weaker foreign exchange rates to the customer. Analysts are looking for an increase of around 5% to 7% in the price of holidays to offset most of the rising input costs. Morgan Stanley wants to see tour operators increase their brochure prices by 6% in their mainstream businesses to hit consensus forecasts next year. ‘This reflects 3% from fuel, 1% from currency and 2% from other cost inflation,’ says the bank, adding if operators cannot claw back higher fuel costs, they could be facing a 10% drop in underlying profit.

Thomas Cook has managed to increase average selling prices for the current summer season by 6%, having last week reported 86% of available holidays have been sold. This is on 10% less capacity and a 9% drop in bookings. Collins Stewart analyst Andrew Fitchie reckons Thomas Cook will have to increase average selling prices by 5% in 2009 to offset rising costs, which he describes as ‘a very challenging hurdle’.

Shares in Thomas Cook have rallied by around 36% to 236p since early July. Analyst Simon Larkin at Royal Bank of Scotland says last week’s upbeat trading statement ‘justifies this move from a level at which it was oversold’. He adds: ‘Thomas Cook now stands at 10.6 times 2008 PE, falling to 8.3 in 2009 when forecast EPS growth is driven by an incremental £65 million of synergy. We remain buyers, but we are conscious that despite good initial bookings, concerns over the consumer outlook for 2009 are unlikely to go away.’

TUI Travel’s third quarter results last week also showed a business able to absorb cost pressures by lifting selling prices. These are up 13% for 2008, 8% for the winter season and 12% for summer 2009. Sales in its mainstream markets for this summer are up 5% in the UK and 1% in Germany. Figures like these could prompt analysts to revise earnings back upwards.

No going short

Higher brochure prices will predominately hurt short-break holiday sales, according to Chris Mottershead, chief executive of Travelzest (TVZ:AIM). ‘Ryanair said it relies on custom from people who spontaneously want to travel. That frivolous spend is the first type of person to drop out of the market.’ He believes long-haul travel will remain fairly resilient as a 5% to 7% increase in the selling price seems less pronounced on what is already a major purchase for most people. He explains: ‘If you can just manage to spend £350 on a holiday, you might think twice about taking a similar break next year if the price rises to something like £425. However, if you can manage £1,500 then next year you can probably pay £1,700.’

There is already evidence short-break trips are under pressure. Airlines are cutting capacity. Ryanair (RYA) is slashing prices as a desperate measure to keep the punters rolling in. Growth has stalled in Holidaybreak’s short-break hotel packages arm, which accounts for around a third of the group’s sales. Growth has reduced from 7% at the half-year stage to 3% in July, which implies a ‘pretty flat performance since March’, according to Altium analyst Greg Feehely. The company has shrugged off any concerns, saying this is a traditionally quieter period for its London destinations before better value deals become available in the autumn.

If long-haul demand fares better than short-haul, that would suggest cruises would also remain resilient given their position in the upper ends of the pricing bracket. Having recently bought a cruise business, Travelzest claims this market is propped up by wealthy individuals who do not have financial worries from rising household costs and weaker economies.

All-Leisure Group (ALG:AIM) runs cruises to such locations as Antartica, Africa and the Red Sea.

In July, it said 95% of forecast revenues for the year to 31 October had been secured. It also said winter sales for its ocean cruises are ahead of expectation. However, it has not escaped the rising cost pressures and said only a small proportion of increased fuel costs will be recovered through surcharges. Chairman Roger Allard said it was too early to draw conclusions as to how well sales would be for the summer 2009 season.

Once at the travel destination, the day-to-day cost of being on holiday is also a factor under close consideration by consumers. Currency concerns have traditionally been focused on the dollar versus the pound for UK travellers going to the US. Other currencies are now in play. Holidaymakers travelling to countries using the euro have found they get a lot less for the pound in their pocket. In January 2007, £1 was worth ?1.53. Today it will only buy you around ?1.25, nearly 20% less for your money.

Cyprus, Paris, Majorca and Dublin are among the Eurozone casualties, according to unquoted online travel specialist Cheapflights.co.uk. Based on traffic through its website, non-Euro destinations are a hit with consumers this year, including Turkey, Bangkok and Dubai. Travelzest’s Mottershead adds Croatia and Tunisia have jumped in popularity for the same reason. ‘Accommodation can be much cheaper. For example, five-star in Egypt is the same price as your typical three-star in Euro destinations,’ he says.

The trade down

One of the biggest fears for tour operators, travel agents and hoteliers is that consumers will trade down to cheaper accommodation, such as switching from a five-star to four-star room. Nevertheless, they would still prefer this to happen than for the customer to not use their facilities at all.

Millennium & Copthorne (MLC) claims it is the beneficiary of people trading down from rivals in the luxury market to cheaper rooms that are still of high quality. ‘We have received business for budgetary reasons into our hotels, including employees of one finance company that I know normally stay at the Ritz-Carlton,’ says chief executive Richard Hartman. Whitbread’s (WTB) Premier Inn claims to be following a similar trend where its budget prices are appealing to people traditionally used to paying more for hotel rooms.

The shifting pattern of hotel occupancy could leave some hoteliers out in the cold. This will trigger a new wave of consolidation in the market. Evolution analyst Nigel Parson believes M&C could raise up to £1 billion of ‘firepower’ to facilitate buying hotel assets at the bottom of the cycle. Hartman points out M&C was originally established on this premise. ‘Our business was created on the back of a down cycle. We took advantage of other people’s disadvantages. We are ready to buy assets now but there aren’t sellers yet,’ says the M&C boss. ‘Until expectations align over what people think their assets are worth and what people are prepared to pay, then deals won’t be made. I believe you start movement from the end of the first quarter in 2009.’

For the three months to 30 June M&C reported 4.9% growth in revenue per available room, also known as the key industry metric of RevPAR. However, growth is slowing in Asia, its biggest market. The stock was overhyped in 2006 and 2007 and fell over 60% in the 14 months to July 2008 to 298.75p.

Continual leadership changes have not helped sentiment but the market seems pleased with the appointment of former InterContinental Hotels’ (IHG) director Hartman in April. Evolution’s Parson believes M&C chairman Kwek Leng Beng could bid for the 46% of the hotel group his CDL vehicle does not already own, but in the absence of such a move M&C should emerge jubilant from the current market downturn if Hartman can whip the business into shape by selling off non-core assets and improving day-to-day management.

There are more serious concerns about InterContinental Hotels. Its half-year results reported earlier this month showed a 29.1% increased in operating profit to $284 million. Weekend leisure business has weakened while midweek corporate spending remains resilient. Charles Stanley analyst Sam Hart says there is a danger corporate expenditure could weaken in the coming months ‘as businesses start to feel the full impact of the economic downturn and travel budgets begin to be cut.’

The owner of hotels in Amsterdam and London and a resort in Croatia, Park Plaza (PPH:AIM) says it continues to pick up hotel trade from consumer and business travellers with extra revenue coming from corporate conferences. It is opening one of London’s largest hotels in 2010, One Westminster Bridge. This is being financed through selling hotel rooms to investors. Unfortunately the buy-to-let mortgage market has almost dried up, forcing Park Plaza to re-evaluate the project and own the remaining rooms itself. The difficulties for consumers to fund aspirational purchases have also put pressure on other operators of buy-to-let sites including American Leisure (ALGL:AIM). It is building a timeshare complex in Florida but its inability to publish accounts for 2007 has left its shares suspended since June and the City questioning its ability to survive a weaker leisure market.

CONCLUSIONS: Tourism & Leisure

Risk to earnings forecasts: 2 (5=upside risk, 1=downside risk)

Earnings predictability: 2 (5=very high, 1=very low)

Valuation: 4 (5=cheap, 1=expensive)

Balance sheet strength: 3 (5=cash rich, 1=heavily indebted)

Cashflow: 3 (5=very strong, 1=very weak)

Over-owned? 2 (5=all brokers negative, 1=all positive)

TOTAL: 16 / 30

Stocks to buy: TUI Travel, Whitbread

Stocks to avoid: Carnival, InterContinental Hotels, Minoan, Real Hotel

Total Broker Buy Ratings on Stocks: 45

Total Broker Hold Ratings on Stocks: 12

Total Broker Sell Ratings on Stocks: 9

SHARES RATING: NEUTRAL

SPOTLIGHT

TUI Travel ahead of schedule

Prospects look bright for the travel company created by the merger of First Choice and TUI AG’s travel division

A few years ago, First Choice wanted to sell its tour operating business but was left with a limited number of potential buyers after rival Thomas Cook and MyTravel merged in February 2007. As a result, it decided to merge with the tourism division of TUI AG. The combined entity was listed as TUI Travel (TT.) in September 2007 and has become one of the few leisure stocks with clear growth potential.

The group wanted to achieve £150 million of cost synergies by 2010 from the merger. It has already increased the figure by 50% this year and made plans to deliver the benefits faster than originally planned. Around 85% of earnings before interest and tax in 2007 came from just a third of its £12.8 billion revenue stream. Of the other two-thirds, £4.3 billion was loss-making or had less than 1% margins, and £4.1 billion had margins of 1% to 3%. Before the merger, First Choice commanded margins closer to 5%. Since TUI Travel now has the same chief executive and finance director as First Choice, it is feasible the enlarged business could generate higher profit margins.

Leasing for flexibility

The sale and leaseback of 19 aircraft in June is a mirror of First Choice’s strategy of not owning assets (so it can be more flexible in adapting to supply and demand of holidays), as was the decision not to take TUI AG’s hotels as part of the merger. A German airline subsidiary is too large for TUI Travel’s needs. A deal is being fleshed out with Lufthansa to merge operations with budget airline Germanwings so it has the appropriate number of planes to suit its tour operating business. TUI Travel has reduced holiday capacity to ease pressure on having to sell last-minute breaks. It aims to have 15% fewer holidays on sale in summer 2009 in its UK business.

CONCLUSION: TUI TRAVEL (TT.) 225p

Risk to earnings forecasts: 4 (5=upside risk, 1=downside risk)

Earnings predictability: 3 (5=very high, 1=very low)

Valuation: 4 (5=cheap, 1=expensive)

Balance sheet strength: 3 (5=cash rich, 1=heavily indebted)

Cashflow: 3 (5=very strong, 1=very weak)

Over-owned? 2 (5=all brokers negative, 1=all positive)

TOTAL 19/30

RATING: BUY

TUI Travel has taken steps to strengthen its position in Russia. The market is similar to the UK 30 years ago, where people started to have spare money and showed interest in travel. Trading on a forward price/earnings ratio (PE) of 8.4, TUI Travel looks good value compared with the sector average of 12.2.

TRADES TO MAKE THIS WEEK

Budget hotels’ good service

Whitbread (WTB) £11.63 BUY

After a 34% price fall since last October the stock looks great value, since it now trades at a 10% discount to the hotels sector. Even without acquisitions, Whitbread has the market strength and expertise to maintain its earnings growth curve.

An estimated 70% of sales come from its budget hotel chain, Premier Inn, but this is set to rise further following an asset swap with pubs operator Mitchells & Butler (MAB). The latest trading update, covering the 13 weeks to 29 May, revealed an 18.3% rise in like-for-like sales at Premier Inn, helped by higher volumes after hotel expansion and customers paying more per room.

The rest of the business comes from drinks chain Costa Coffee (10% of sales) and pub restaurants (20% of sales). The latter assets are a thorn in Whitbread’s side. Operating margins around 12.4% are much less than the 33.7% from Premier Inn. This is why a deal has been struck with M&B, which wants to sell its hotel operations and buy up more pubs. Whitbread is exchanging 44 pub restaurants for 21 M&B hotels, adding 1,245 rooms to its capacity. The sites are locations where Whitbread has not been able to secure planning permission to build an adjacent Premier Inn.

The deal will enhance earnings from 2010 but could have been grander. Citigroup had suggested Whitbread could get around 100 M&B hotels and £500 million cash, for its 400-odd pubs. Whitbread has not proved immune to weaker sector conditions, since Premier Inn is seeing a slowdown in weekend and mid-week occupancy, and spend per head in pubs is down slightly. Costs are rising 3% to 6% a year. Broker UBS reckons Whitbread is capable of generating double-digit organic earnings per share growth over the next two years.

Bearing up, not prospering

Holidaybreak (HBR) 421p HOLD

Last month’s market update was not as bad as feared but there is no need to ship in any Holidaybreak shares yet. A third of earnings come from organising short-break holidays, an area that could come under pressure as consumers feel the pinch. Sales based around London events have weakened in the past four months and Holidaybreak could see 2008 earnings hurt by an estimated £4 million hit to profit from foreign exchange purchases – it is becoming more expensive to forward-purchase euros in sterling.

The forex hit should be partially offset by euros earnings benefiting from the currency strength. Last summer’s acquisition of children’s adventure holiday group PGL was wise as the brand has a loyal following among schools. Education division sales, including PGL, are up 9% for the first ten months of its financial year; 40% of next year’s targeted bookings are already secured. Camping sales nudged up 1% on 5% less capacity. Camping could become more popular as consumers seek cheaper forms of holidays, although it is too early to judge this trend as many people book well in advance. Finally, its Superbreak business has good coverage across the UK’s network of travel agents.

Low bid still puts it on the map

Travelzest (TVZ:AIM) 104.5p HOLD

Last week’s 115p-a-share cash bid boosted the shares, previously languishing near 87p all-time lows. It is hard to see management accept such a low offer as the stock traded above 175p around 18 months ago, which may explain it not soaring to the proposed offer price at once. Management is capable of building a much larger business before considering a sale.

There is good geographic spread. Former TUI UK managing director Chris Mottershead founded the £21.3 million cap in 2005. A tour operator arm provides quality holidays for over-55s. A luxury cruise business acquired in June for £6.5 million mostly sells to wealthy US customers. ‘These customer types are not troubled by money or economic problems,’ says Mottershead. Travel agents include Canadian iTravel2000, giving counter-cyclical revenue when Europe is out of season. It slipped to a £90,000 loss in the six months to April 2008 from an £800,000 profit a year earlier with sales hit by technical problems on UK sites, holiday.co.uk and flight.co.uk. Mottershead reckons Canada’s market will thrive as the currency firms and the economy is stronger than the US. In late 2007, it opened a Francophone base in Montreal, offering a growth opportunity.

Gambling on a surprise

Thomas Cook (TCG) 243.3p HOLD

The grim outlook suggests 2009 summer holidays may be close to home, but in a high-risk, high-reward scenario it is worth holding Thomas Cook in case positive trading surprises the market and protects its share price. History suggests larger operators can fare better than smaller ones in tougher markets.

Thomas Cook is the product of a merger, which should offer scope for cost synergies when some rivals struggle to stay in business. The tie-up with MyTravel in June 2007 has given Thomas Cook a new lease of life. Should holiday demand fall, Thomas Cook can reduce capacity, which it has started to do. This should help it maintain profits.

Stockbroker Landsbanki believes Thomas Cook will be able to flex its buying power to strike better deals with hoteliers – essentially getting them to share any downturn pain. It thinks travel industry supply next year will contract by more than demand and there will be less competition from low-cost airlines and ‘bed banks’. A 45% share price drop from February to July means the market priced in a potential reduction in sales volumes and the collapse of a planned merger of its German airline operation with Air Berlin. The shares have subsequently rallied.

Analysts say Thomas Cook’s challenge is to raise brochure prices by around 6% to offset cost pressures. A strong brand and respected management mean this should not be too daunting. Only the German airline operations are expected to see reduced EBITA in coming years, according to broker forecasts. Summer 2008 trading is holding up. The business is targeting £155 million merger synergies by 2009. Net debt was £265.2 million as of 30 April 2008. A prospective PE of 7.6 for the current year looks good value against the broader sector’s 12.2 PE average.

Guests checking out

InterContinental Hotels 752.5p (IHG) SELL

Last week’s interim figures saw management admit there is limited earnings visibility. RevPAR in the key US region is slowing as the American hotel market deteriorates and InterContinental would suffer worse than more diversified rivals in a marked downturn here.

Signs of further slippage in industry-wide revPAR could jeopardise consensus earnings growth forecasts of 11% for 2008 and 8% for 2009, and mean the stock is not as cheap as it looks.

A three-year target set in 2005 to add more than 60,000 rooms on a net basis was achieved in the first half of this year, six months ahead of plan. It has spent $1 billion on relaunching Holiday Inn and trading in general here has held up well.

InterContinental continues selling its hotels to become a pure hotel manager/franchiser, but tighter credit markets delay transactions, scuppering the financing of several deals. The company benefits from strong brands, good pipeline of new rooms and growth prospects in emerging markets but sentiment is likely to be mixed on the stock. A 2008 prospective PE of 14.3 is not cheap for the sector and it is hard to see what could stop uncertainties in the broader leisure sector hitting the share price.

Fuel costs flow with adverse currents

Carnival (CCL) £18.91 SELL

A 32% share price rally in the past month provided rare cheer for investors in the cruise ship operator but this is likely to be short-lived. Analysts have been slashing earnings forecasts over the past few months on worries about spiralling fuel costs and, though the price of crude is some 20% off its peak, rocks lie ahead.

Stockbroker Evolution reckons Carnival will only be able pass on two-thirds of higher costs to customers. There is also the risk customers will choose to defer or cancel trips if economic conditions do not improve, since cruises can be very expensive. The super-rich may well continue to spend, but it is the aspirants who could cut back, as rival luxury brands such as Porsche, Bang & Olufsen and Raymarine (RAY) have found to their cost. Around 85% of its costs are fixed, leaving it in a difficult position should sales volumes decrease.

TREND SPOTTING

Heading for sunnier climes

Is the gathering bullish mood a sea-change or a blip?

by Simon Griffin

There now appears to be a real possibility the sector is changing trend and about to test resistance from its descending 200-day average. If bulls can drive the market through this then expect the sector to initially target 5,168, about 12% above current levels, then possibly on to test resistance near 6,000. The risk is the rise has only been a large correction within a continuing bear trend, the moving average will hold as it supported during the long bull run to 2007, and a rotation to at least test the lows of mid-July will unfold. The cautious might wish to await a bullish moving average cross before committing.

Since the sector peaked at the end of May last year, following a bull run that saw it climb by some 250% from its base in early 2003, it has consistently underperformed the broader UK equity market. The key moving averages crossed bearishly in early August last year, giving a clear warning the rot was setting in. Relative weakness accelerated in the past twelve months during which time the sector has declined some 25% against the FTSE 100 index, lost some 40% of its value and briefly broken below both the Fibonacci 61.8% retracement of the previous bull run and the low seen in May 2005. The culmination of this move appears to have the characteristics of a spike low, typifying the sort of climactic event that itself often concludes a bear market. The subsequent bounce has taken the chart of the index up through the bear trendline on the log scale chart that has been defining the extent of upside corrections during the sharp fall over the past 15 months.

Holidaybreak (HBR)

BUY - 429p

TARGET - 620p

STOP LOSS - 400p

If the shares can hold above the lower bear channel there seems a prospect of a rise toward 500p and a move to test previous support and the falling 200-day average, with further recovery likely to target 620p and the 50% retracement of the bear trend. Significant congestion would then be encountered here.

The shares rose some four-and-a-half fold in 11 years, largely shrugging off the 2000/03 bear market and reaching 892p in mid-June last year.

The price started to slide in late summer 2007. The moving averages crossed negatively in October and the hitherto solid bull trendline gave way a month later when the shares hit 725p.

Their seeming inability to climb above the 50-day average has continued the decline. A bear channel can be drawn on the log-scale chart defining this decline. An apparent selling climax broke below the lower bear channel return line in mid-July. Volume also rose dramatically, suggesting the decline was reaching its nadir. The resulting bounce boosted the shares to a breakout of the channel top line in some ways symmetrical with the preceding downside break. Weakness could resume, though if the low found support from old highs seen around 2000 it would likely offer significant support to further tests.

Whitbread (WTB)

BUY - £11.83

TARGET - £14.50

STOP LOSS - £11.00

If bullish momentum divergence suggests bulls could maintain the recovery then further gains would target a test of £13.35, then £14.53. A return of weakness taking the shares below £10.70 would raise the possibility of new lows, forcing a reverse of position, in the expectation of falls as low as support near 718p, which dominated the chart for eight years up to 2004.

A climb by some 310% in the 2003-07 bull market was a 100% outperformance relative to the FTSE 100. The shares spent most of last year forming a top pattern on the chart. Over the past 16 months the drop in value has been some 50% at worst, but the shares have outperformed their sector by some 30%. Technically the chart’s most interesting feature is the reticence of the market to tolerate a sub-£11.70 for long. This level represents the twin peaks in 1998 and 1999, not bettered until 2006. The spike low, characteristically with raised volume, in mid-July tested support from congestion that worked through in 2005. But the shares have sharply recovered above £11.70 to test resistance from the bear trendline that has defined the decline and the coincident falling 200-day average.