Weather, strikes and terrorism have blighted the airline sector, with low-cost carrier easyJet (EZJ) hit particularly hard. Its shares dropped 42 per cent in 2016. But the group has pledged to double-down on its dominant UK position as rivals Ryanair (RYA) and eastern-Europe focused Wizz Air (WIZZ) curb their enthusiasm for Blighty and expand their presence elsewhere. For investors worried about the impact of Brexit on easyJet, chief executive Carolyn McCall said a secondary operating licence in a European country would soon be sought to hedge the company against any fallout from the imminent negotiations.
Investors in the airline and tour operator sector should in 2017 be mindful of what some analysts call its ‘original sin’ – overcapacity. When times are good airlines often expand too quickly and if demand then wanes, it becomes a race to the bottom on ticket prices to get bums on seats. This is fine if you can aggressively manage your costs – something many commentators say Ryanair is the best at globally – but can start to hit revenue per seat (an important metric for the sector), if costs are less containable. British Airways owner International Consolidated Airlines (IAG) is taking a slightly more pragmatic approach and marginally cooling its expansion plans. Keeping an eye on capacity and per-seat revenues and costs will be vital for shareholders.
This is especially the case as there are potential cost pressures building, notably in the form of fuel costs. The low oil price has massaged airlines’ cost-per-seat metric and while active hedging policies will keep the amount spent on fuel under control, as hedging contracts need to be rewritten there is likely to be a slow upward movement in price in the next few years.
The steep drop in sterling is an issue for airlines and tour operators, too, as some of their costs will be in foreign currencies – again a case in point is easyJet, where 73 per cent of its costs in the 2016 financial year were in euros, dollars or Swiss francs. This means more pounds are needed to service these costs, even if they haven’t actually risen. Currency movements in 2017 will, therefore, have a bearing on performance.
Tour operators have the potential to deal with rising costs in a different way as they can sell package holidays, which usually have higher margins than flights alone, especially if their own hotels are used rather than those of third-parties. Thomas Cook (TCG) seems to be taxiing in the right direction after returning to the dividend roster in 2016, while rival Tui (TUI) is still bedding down after the UK and German entities merged in 2015. Package holidays could be useful if consumers tighten their belts this year in the face of inflation because all-inclusive deals mean travellers can control their costs. The problem for the two aforementioned incumbents will be Aim-traded Dart Group (DTG), whose Jet2 brand offers package tours and low-cost flights. It is small in comparison, but is a high-growth stock with a burgeoning presence.
Some of the issues that affect airlines can also drag on hotel businesses. Terror attacks in metropolitan areas put tourists off staying in urban locations, if only temporarily. InterContinental Hotels (IHG) suffered a 20 per cent drop in revenue per available room (RevPAR) in Paris in the first half of its 2017 financial year due to weakened demand in the city following the terrorist attack there. IHG has also been hit by the downturn in the oil price as 14 per cent of its US RevPAR is linked to that industry, compared with an 11 per cent hotel group average. UK-listed rival Millennium & Copthorne (MLC) will also be affected by these issues and has recently suffered a downturn in per-room revenue. Still, the fact Millennium reports in pounds but registers the largest proportion of sales in US dollars has been helping the stock of late.
| Price (p) | Market value (£m) | PE (x) | Yield (%) | 1-year change (%) | Last IC view | |
| Carnival | 4,172 | 7,928 | 18 | 2.6 | 14.1 | Buy, 3,620p, 21 Dec 2015 |
| Cineworld | 591 | 1,581 | 18.3 | 3.0 | 23.2 | Buy, 586p, 11 Aug 2016 |
| easyJet | 1,051 | 4,172 | 9.7 | 11.0 | -34.4 | Buy, 1,065, 15 Nov 2016 |
| InterContinental Hotels | 3,757 | 7,421 | 28.2 | 1.7 | 66.7 | Sell, 3,073p, 10 Nov 2016 |
| Int'l Consolidated Airlines | 490 | 10,386 | 6.9 | 3.4 | -10.2 | Buy, 403p, 29 Jul 2016 |
| Merlin Entertainments | 481 | 4,889 | 26.9 | 1.4 | 19.1 | Buy, 432p, 3 Oct 2016 |
| Millennium & Copthorne | 475 | 1,542 | 23.4 | 1.4 | 19.4 | Sell, 436p, 22 Sept 2016 |
| Thomas Cook | 85 | 1,299 | 9.9 | 0.6 | -19.9 | Buy, 78.45p, 24 Nov 2016 |
| Tui AG | 1,128 | 6,622 | 7.5 | 4.7 | -3.7 | Hold, 1,048p, 12 May 2016 |
| Wizz Air | 1,822 | 1,045 | 1131.9 | 0.0 | 0.1 | Buy, 1,576p, 9 Nov 2016 |
Favourites: Although it was an annus horribilis for easyJet, we’re keeping the faith. In the long term, we feel the new aircraft it is purchasing, which will have more seats, will help it smooth its cost-per-seat metric, and its move to gain a second operating licence shows it is on the front foot with regards to Brexit. We also like IAG because of its low-cost and premium exposures and our belief in Thomas Cook has come good now that the stock is back on the dividend roster.
Outsiders: We’re not keen on the hotel groups. Millennium in particular could be under pressure as its dividend is under review due to investments it wants to make in the business. Its rival InterContinental saw pre-tax profit drop by a third at its half-year results in August but the fact it reports in dollars – which translate healthily into the currently weaker sterling – may have helped support the share price in recent months.
