When, on 25 November, Thomas Cook said that it needed to borrow more from banks on looser terms only a month after previously renegotiating its loans, we quickly moved our view on its shares to a 'sell'. The share price bounced strongly after the banks speedily came to the group's aid, taking only a 5 per cent claim on the company's equity. Nevertheless, we find little cause to change our stance. While the upside to the share price could be massive if a trading recovery extinguishes worries about the debt, we think the odds remain stacked against equity holders.
- Recovery potential
- Loans extended on looser terms
- Tough trading
- No chief executive
- High debt
- No dividend
First, debt remains a serious issue, despite the banks' decision to provide Cook with the extra £100m it needs over the cash-draining winter months (when it buys holiday slots for the following summer) and to loosen other loan terms to alleviate the group's immediate problems. True, most likely Cook will remain a prominent player in the holiday market, but what value the company offers for shareholders looks questionable. Besides, currently it has no chief executive in place to offer a clear plan. Broker Peel Hunt estimates that the sum of Cook's bank debt, bonds, operating lease commitments and pension liability comes to an eye-popping £2.8bn. That's 19 times the market value of the company's equity, and such massive gearing can be incredibly destructive to shareholder value when trading deteriorates.
And trading is definitely tough. Political turmoil in North Africa continues to hit the region's attractions and torrid economic conditions are hitting demand in the UK.
There are longer-term structural issues that the industry faces, too; such as the increased use of the internet by consumers to create their own holidays rather than buying packages. What's more, unlike rival Tui, which has been increasing sales of so-called 'differentiated' holidays, Cook seems to have stayed focused on mainstream packages.
| THOMAS COOK (TCG) | ||||
|---|---|---|---|---|
| ORD PRICE: | 16p | MARKET VALUE: | £140m | |
| TOUCH: | 16-17p | 12-MONTH HIGH: | 207p | LOW: 9p |
| DIVIDEND YIELD: | nil | PE RATIO: | 2 | |
| NET ASSET VALUE: | 191p | NET DEBT: | 64% | |
| Year to 30 Sep | Turnover (£bn) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2008 | 8.75 | 23.7 | 4.60 | 9.75 |
| 2009 | 9.27 | 45.1 | 0.80 | 10.75 |
| 2010 | 8.89 | 41.7 | -0.30 | 10.75 |
| 2011* | 9.15 | 190.1 | 15.8 | 3.75 |
| 2012* | 9.01 | 127.8 | 10.4 | nil |
| % change | -2 | -33 | -34 | -100 |
Normal market size: 30,000 Matched Bargain Trading Beta: 1.9 *Peel Hunt Forecasts (Profits & earnings not comparable with historic figures) | ||||
But the biggest problem Cook may face is the damage to its reputation done by the financing issues. While delayed full-year results, now scheduled for next week, may give a clue as to how consumers have reacted, summer booking figures next year will be the acid test. It is easy to imagine that punters may be scared off by the group's well-publicised problems. Meanwhile, Cook's competitors have been running large adverts to point out how financially sound they are and to ensure that consumers don't confuse their brands with Cook's. Suppliers may also ask for more assurances.
All this needs to be seen in the context of tour operators' notorious propensity to disappoint investors - if they're not being hit by an Icelandic volcanic-ash cloud, then it's the Arab spring, or something equally unpredictable. The problems are exacerbated by a low level of forward bookings. Any bolt from the blue in 2012 will be of added pain for Cook, given its precarious position.
While the current valuation of the shares against forecast EPS looks low, this should be treated with a pinch of salt. What's more, the renegotiated terms of Cook's loans means it is not allowed to pay dividends or buy back shares for the time being, so there is little share price support from this quarter. In addition, Peel Hunt reckons that Cook's enterprise value (market value of equity plus net debt) should be no more than 2.5 to 3 times cash profits. But, on that basis, Cook's shares would be worth 14p maximum and zero at worst.
