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Turbulence for travel and tourism

Brexit and the resulting weakness in sterling, along with fears of terrorism, have created uncertainties in the travel and tourism sector
June 9, 2017

Would-be travellers may be feeling the pinch ahead of summer holiday plans this year. The value of sterling has fallen dramatically since the UK voted to leave the EU, and since wages have failed to keep up with price inflation, consumers' spending power isn't what it was. This squeeze on incomes could force many customers in the UK to rein in spending, leaving travel companies wondering where on the list of priorities a holiday will fall.

Earlier this year rating agency Moody's forecast that passenger growth in Britain's airline industry will slow to half the rate previously expected over the next two years due to a weak pound, coupled with economic uncertainty. While some airlines have felt the drag of sterling-denominated earnings in recent results, most have endured the turbulence so far.

The prospect of travel does not yet appear to be too bleak - at least not yet. According to the most recent monthly travel data from the Office for National Statistics (ONS), UK residents made 4.6m visits abroad during March 2017, up 5 per cent from the same time last year, and spent £3bn during their visit, 13 per cent more than the year before. On the flip side, weak sterling could help the UK by encouraging tourism since foreign tourists will see their currency go further than in years before. Overseas residents made 2.9m visits in March, up 11 per cent, and spent £1.5bn, 14 per cent more than last year, during their stay.

Companies in the travel sector could also be feeling nervous about what a Brexit deal could look like, particularly in regard to flight routes on either side of the Channel. Threats of terrorism could also affect where would-be travellers choose to visit. Many travel companies have admitted that destinations in the Middle East and Africa have become less popular as clients look for locations perceived as being safer. However, with the prevalence of 'lone wolf' attacks across the globe, confidence to venture abroad at all could shrink.

 

 

The burden of Brexit

One ramification of the Brexit vote was the fall in sterling's value. EasyJet (EZJ) and International Consolidated Airlines (IAG), owner of British Airways, both issued profit warnings after the referendum to prepare investors for a sterling-denominated earnings drag. And although currency issues will persist, a record number of passengers on easyJet flights with an all-time high load factor of 90.2 per cent has helped soften the blow as the budget airline reported a slight boost to revenue in its half year to March. Meanwhile, IAG reported an 8.6 per cent revenue increase to €2.54bn (£2.22bn) over the year to December 2016, although the exchange rate still wiped €460m off the reported figure.

On The Beach (OTB) has admitted to raising hotel prices as a result of weaker sterling, combined with wider hotel price inflation in the western Mediterranean region. But an oversupply of flights to some of the company's key locations - and thus, lower flight prices - actually meant package holiday prices stayed flat year on year.

Fellow package holiday provider Tui (TUI) recently stated that Brexit had gone from being an "emerging risk" to a "material risk" after the British government triggered Article 50 at the end of March. Lack of clarity over what a deal between the UK and EU could look like hasn't helped matters. As prime minister Theresa May reinforced her idea of a hard Brexit ahead of the general election and briefings from EU officials crushed expectations of special arrangements for the aviation industry, Tui management said the main concern would be whether airlines could maintain a similar level of access to EU airspace as it does today. The group has lobbied British and EU ministers to stress the importance of an accommodating deal for aviation and its impact on consumer choice.

EasyJet has faced these concerns head on. A plan is already under way to establish a European Air Operator Certificate - which gives the airline appropriate permissions to carry out commercial air transport operations - in another EU state by the summer. This will cost the airline about £10m over three years, but it could be well worth the money if it allows for business as usual no matter the outcome of political negotiations.

Budget airline operator Wizz Air (WIZZ) is taking a bolder approach to Brexit. It added a million seats to its UK operation in its financial year to March 2017 and is looking to do the same again this year. It's banking on the idea that more tourists will come to the UK and says it's already experienced an uptick in traffic coming from eastern Europe. So far, this strategy appears to be coming to fruition - following a capacity increase of 17.4 per cent in the 12 months to May 2017, passenger numbers are up 20.3 per cent, and the load factor by 2.1 percentage points. But the company isn't entirely immune from exchange rates: €17m was still wiped off the annual top line due to currency translations.

 

Terrorism's toll

Thomas Cook (TCG) recently reported that customer demand for Belgium was below historical levels as customer sentiment slipped on the back of the attack at the Brussels airport in March 2016. Revenue from Turkey was also down 41 per cent, resulting in an £80m loss there. Focusing on capacity control, margins and looking at ways to make the company more efficient has helped offset some terror-related losses so far. On The Beach said acts of terrorism have continued to hurt travel to Egypt and eastern Mediterranean destinations, and that customers are now booking at shorter notice and often to western Mediterranean locations. Tui similarly suffered, as demand for holidays to Turkey and north Africa fell. But the appeal of Mediterranean regions and the Caribbean helped to offset this potential sales hit at a group level.

Ryanair (RYA) has also warned that any repeat of last year's "security events" across several European cities could damage consumer confidence. But the airline has already decided to focus on flights around Europe and rein in its previously ambitious expansion plans for UK routes following the referendum instead.

 

IC VIEW

Travel companies have remained resilient so far, but it's impossible to know what an aviation deal between the UK and the EU could look like post-Brexit, nor can shareholders predict terror incidents or whether sterling will rebound. Consumer confidence is also finicky. This makes it tricky to make big calls on the sector, but for now investors could do well to prioritise budget airlines such as easyJet, Ryanair, and Wizz Air. These companies are filling planes and offer competitive pricing, which is likely to draw consumers looking for a more budget-friendly holiday this year, and benefit from European travellers coming to the UK to take advantage of their spending power on weaker sterling. Package holiday providers such as Tui and Thomas Cook may be more susceptible to the 'squeezed middle' as customers trade down to cheaper options this year.

 

Favourites

Airline-wise, we like the proactive planning of easyJet. The company is already putting plans in motion to ensure that it can operate both in the UK and Europe, even in a worst-case scenario for Brexit negotiations. Record passenger numbers and an all-time high load factor should reassure investors that business isn't bad, either. Although there aren't any dividends, we think easyJet will continue to grow as travellers look for low-cost travel options, especially on shorter flights. The shares' more reasonable rating - not to mention the income on offer here - also makes it a top pick.

Outsiders

Weighty warnings from Tui on the impact of Brexit on the business have us worried. Companies that offer full holiday packages could be more susceptible to squeezed consumer spending since they have to fill both plane seats and hotel rooms. The group reported a pre-tax loss of €311m and investors lost 62¢ per share, while dividends do not look to be on the agenda any time soon. Although the shares are trading at the lower end of their recent value, we think there could be reason for this.