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FTSE 350: Terror threats stalk tourist operators

Companies remain hopeful that demand can bounce back in spite of terrorism fears, while the falling oil price is providing a boon
January 29, 2016

Terrorist atrocities hit the tourism industry hard last year, with direct attacks on beach-going holidaymakers and tragic aircraft incidents hitting sentiment towards travel. And with the ever-present threat of Islamic State, further upheaval caused by extremist groups cannot be ruled out.

But one thing we have heard again and again from management teams - and the benchmark outperformance by airline stocks in 2015 goes some way to prove this - is that demand bounces back. People want to go on holiday and even though modern communication reduces the need to travel for the business sector, this area of the market is in rude health, with companies fighting hard to get a piece of the action.

A major factor lifting all the airlines, and which will affect the tour operators too, is the oil price. All the operators use a hedging strategy to smooth the cost of jet fuel so they won't necessarily be feeling the full effects of the precipitous falls now, but the drop in price is definitely having a positive impact on costs. Also, without an obvious catalyst for oil price rises, these companies are likely to be able to bring down the average cost of their hedged fuel as the months tick by. In recent statements, all the airlines have noted that the cost of carrying passengers has fallen, with the bulk of this being attributable to fuel.

In terms of stocks, International Consolidated Airlines Group (IAG), owner of British Airways and Iberia, performed the best out of the London-listed airlines in the FTSE 350 and there are various factors that could see the market remain upbeat about the company. In Liberum's recent consumer trends survey, BA maintained its lead in terms of business travel, although easyJet (EZJ) is closing the gap. According to analyst Gerald Khoo, the long-term trend "remains one of improvement by BA, with easyJet losing ground slowly". IAG's takeover of Aer Lingus from Ryanair (RYA) also provides scope for growth into Asia, while using the Aer Lingus fleet to maintain its strong position in Atlantic travel, as analysts at Canaccord Genuity observe.

The tour operators had an interesting year, too. Tui AG (TUI) chalked up its first year as a combined entity following the merger of the UK and German businesses. The early signs are good, but management has set itself some demanding cost-saving targets of €50m (£38m) in the year to September 2017 and has grand plans to expand some of its hotel brands.

Thomas Cook (TCG) returned to profitability under new chief executive Peter Fankhauser, who has been in the job for just over a year, but at the group since 2001. Substantial costs have been taken out of the business and there are plans to restore the dividend. Like Tui, the success of its packages and hotel brands will be a key factor, but there are encouraging initiatives, such as the boutique Casa Cook brand, aimed at young professionals. The first of these opens in May in Rhodes.

On the subject of hotels, merger and acquisition activity was under sharp focus last year. We upgraded InterContinental Hotels (IHG) to hold in May on speculation over a bid from rival Starwood Hotels & Resorts. In the end, the latter group got snapped up by Marriott in a $12.2bn (£8.5bn) deal. Responding to renewed press speculation in November, IHG told the market it was not considering a potential sale or merger. Without this catalyst, reasons for a re-rating of the shares are patchy. The increase in the number of Chinese tourists is positive, but the strong dollar could be painful for those with big US businesses. IHG's largest revenue generator is the US, so this could prove an issue for the company, although its purchase of boutique chain Kimpton could help to offset this.

Elsewhere, Merlin Entertainments (MERL) hit the headlines for the wrong reasons after an accident on one of its Alton Towers rollercoasters left two people needing leg amputations. The incident inevitably hit visitor numbers in the UK, but the company has a good global footprint and new parks alongside the opening of on-site hotels make the company an interesting prospect this year.

NAME Price (p) Market cap (£m)PE (x)DY (%)1-year changeLast IC view:
CARNIVAL       3,733                    7,076 36.22.223.6Buy, 3,620p, 21 December 2015
CINEWORLD GROUP          487                    1,291 17.33.017.4Buy, 558p, 25 August 2015
EASYJET       1,632                    6,479 11.73.41.2Buy, 1,743, 18 November 2015
ICTL.HTLS.GP.       2,274                    5,369 20.42.3-13.4Hold, 2,606p, 31 July 2015
INTL.CONS.AIRL          562                  11,364 11.21.313.4Buy, 547p, 02 August 2015
MERLIN ENTERTAINMENTS          410                    4,156 22.31.72.4Buy, 415, 01 December 2015
MILLENNIUM & CPTH.HTLS          395                    1,283 13.03.4-32.1Hold, 556p, 31 July 2015
THOMAS COOK GROUP          109                    1,666 12.20.0-14.6Buy, 104p, 25 November 2015
TUI (LON)       1,236                    7,253 26.03.39.9Hold, 1,187p, 11 December 2015
WIZZ AIR HOLDINGS       1,845                    1,040 NA0.0NAN/A
 

Favourites

The recovery story at Thomas Cook is plausible and its price tag is eye-catching, with its shares at just nine times forward earnings. We're also bullish on IAG and its recent joint venture with Latam Airline Group shows an element of management agility in spite of the size of the company. In terms of everyday leisure spend, Cineworld (CINE) should keep performing strongly thanks to a solid film slate in 2016 and the growth aspect of its central Europe business.

Outsiders

There's little to get excited about with hotel groups and the back end of 2015 wasn't kind to the share prices of either IHG or Millennium & Copthorne Hotels (MLC). For exposure to this mini-sector, it might be worth looking further down the market cap spectrum.