As holidaymakers use the Easter break to recline on tropical beaches and companies across the travel sector point to record financial metrics, it’s an opportune moment for investors to consider options in an industry that is now back on its feet after being decimated by the pandemic.
Revenue and operating profits are now generally ahead of pre-pandemic levels for travel-related companies as consumers cough up higher prices despite cost of living pressures. Low unemployment and real wage increases have softened the pain of higher interest rates. While consumer confidence readings are still firmly in negative territory, the oft-cited GfK tracker has been moving in the right direction and shows a vast improvement in how people view the outlook for their personal financial situation over the next year.
This context supports travel spend. It means that holidays are still “a priority for discretionary spending”, according to a Barclaycard survey which found that 73 per cent of consumers plan to go on holiday this year. The credit card brand recorded increased travel spend growth of 9.3 per cent in February.
There are several other positive demand signals. The International Air Transport Association reported that global revenue passenger kilometres hit 99.6 per cent of 2019 levels in January, taking the airline industry “closer than ever to monthly recovery”. Leading European travel group Tui (TUI), which is leaving the London market to focus on the Frankfurt and Hanover bourses, pointed to “consumers’ continued willingness to prioritise spend on travel and holidays” as it posted record first-quarter revenues. The biggest cruise line operator in the world, Carnival (CCL), reported record annual revenue and an all-time peak in customer deposits in its fourth quarter as it flagged its “best booked position on record, for both price and occupancy” at the start of this year.
There is undoubtedly still an element of post-pandemic ‘revenge spending’ in all of this, with consumers now spending on trips they couldn’t previously take because of travel restrictions. There is also the delayed loosening of pandemic restrictions in China to account for. All of which means the question remains: can the travel bounce seen in the past couple of years persist?
A less robust growth outlook, now we are past the reopening of the global travel market, is seen in market commentary. HSBC’s forecasts imply slower sales growth in the near term, which is “reflective of a better cost environment and overlapping tougher post Covid-19 reopening comparatives”. Accountancy network RSM expects flat demand for holidays this year and thinks that “we’re likely to see the demand bubble that emerged post-Covid begin to deflate”. Barclays notes the market’s “gloomy outlook for flag carriers”. Shore Capital highlights that Dalata Hotel Group’s (IE:DAL) disclosure of a tough start to 2024 “appears to have spooked the market”. As this suggests, rosy times aren’t guaranteed for the travel sector, and it won’t be plain sailing ahead.
On the other hand, there are various factors that support a more bullish view. A different approach to work-life balance and time away from the office, as evidenced by the home-working revolution, seems here to stay. An ageing society supports tourism and related consumption, with older generations protected by housing and pension wealth and less exposed to cost of living pressures. And there is more of a focus on ‘experiences’.
Accordingly, investors in the sector are now pondering to what extent share prices can continue to grow after many companies enjoyed surges in 2023 as economies reopened. Despite significant upswings, share prices in many cases are still stuck below pre-pandemic levels. And there are plenty of cheap valuation opportunities on the table.
HSBC European leisure and media analyst Joe Thomas argues that "the best way to look at the travel sector against pre-pandemic is through enterprise values instead of headline valuations and share price movements, because financial structures have changed significantly. Some companies have taken on more debt, and some have refinanced".
On this basis, there are still ratings across the travel space that offer deep value. While valuations are in many cases understandably lower because of the changed interest rate environment, there are a good number of companies trading on unjustifiable rock-bottom metrics.
The climate risk premium
While there are attractive valuations to uncover, there is an elephant in the room for the travel sector. Its level of greenhouse gas emissions is a major risk factor for investors to consider. It can’t – and shouldn’t – be overlooked that transport is the biggest CO2 emitter. While road vehicles are the key driver of total emissions, airlines and cruise ships are significant contributors.
A new report from the Transport and Environment campaign organisation notes that aviation emissions have doubled over the past 30 years. It warns that transport could make up 44 per cent of emissions in Europe by 2030, up from 29 per cent currently, and points out that “transport has been decarbonising more than three times slower than the rest of the economy” since 2007. Analysis by climate science website Carbon Brief, meanwhile, found that transport is one of the few sectors where emissions are rising in the UK, driven by a greater dependence on cars.
As governments miss net zero and emission targets, regulations and taxes on the travel industry will likely get tougher. This risk factor is evidently at play in the airline space. According to the European Commission, the aviation sector contributes around 14 per cent of total transport emissions, making it the second-biggest polluter behind road vehicles. This has led to a planned phasing out of free carbon permits. Countries such as Spain and France are trying to discourage travellers from hopping on a plane where they could more easily travel by train by banning short-haul internal flights, and the aviation tax discussion is hardening in several nations in Europe. Climate considerations are also relevant to airport expansion – for example, while a passenger cap at Dublin airport has been criticised by the airlines, raising it could significantly increase emissions.
All travel sub-sectors are in some way impacted by the climate challenge, but some are better placed than others. Train stock exposure, for example, could feasibly be viewed as a relative environmental, social and governance (ESG) play. RSM found that an increasing number of people consider environmental factors when making travel plans. This creates opportunities for companies that can take advantage of the trend.
With finding opportunities in mind, let's dive into some of the ways investors can get exposure to the rising travel trend.
Can airline valuations fly higher?
Notwithstanding the above concerns, the airlines are a good place to start, given that the number of people jetting off overseas is an obvious signal for international travel demand. Recent updates have painted a rosy picture of the post-pandemic recovery, with British Airways owner International Consolidated Airlines (IAG) reporting record annual operating profits and Heathrow Airport back in profit for the first time since before the pandemic. Heathrow forecasts that a record 81.4mn passengers will pass through it this year, but there are significant risks for investors to navigate when it comes to supply and manufacturing headwinds.
The demand signals are strong, with the latest noises from the industry indicating that a strong summer lies ahead. This is despite consumers facing significantly higher prices against the pre-pandemic baseline. According to the Office for National Statistics (ONS), the weighted average price of domestic, European and long-haul economy flights in the third quarter of 2023 was 60 per cent ahead of the same period in 2019. Ryanair (IE:RYA) expects to raise prices by up to a tenth in the peak summer period this year due to plane delivery delays.
As this suggests, the industry is dealing with production issues. Capacity remains constrained across the market, although there is a good chance that European levels will return to the pre-pandemic baseline this year. Boeing (US:BA) – whose chief executive will step down at the end of the year – is struggling with well-documented safety concerns with its 737 Max plane and is set to lose more cash in its first quarter than it had forecast. Airbus (FR:AIR) is outperforming its rival, although a special dividend announcement in February didn't impress analysts. The general context is one in which order numbers are outstripping delivery.
Liberum transport analyst Gerald Khoo says that demand is not the problem. “There is a dramatic shortage of supply, as the two manufacturers are producing planes at half the pre-pandemic rate and there is a lack of maintenance capacity and spare parts. Engine supplier Pratt & Whitney is dealing with a raw materials quality issue. This supports pricing."
The budget airlines are looking in good nick. Despite bringing forecasts down, Ryanair expects to carry a record 184mn passengers in the year to March 2024 and around 200mn this financial year, well ahead of the 149mn it recorded pre-pandemic. Jet2 (JET2) has nudged up its annual pre-tax profit before currency movements forecast to £510mn-£525mn, almost double its pre-pandemic record. EasyJet (EZJ) pointed to an "increase in both volume and pricing" for forward summer bookings, while Wizz Air (WIZZ) carried 15.8 per cent more passengers in February compared with the same month last year.
Valuations at the listed airline operators are low, with the market pricing in a weak outlook, which looks overdone. The discount opportunity is a key reason for our bullish views on International Consolidated Airlines, EasyJet and Jet2, where re-ratings are on the cards. RBC Capital Markets analyst Ruairi Cullinane recently raised his view on International Consolidated Airlines to outperform, noting that it generates the second-highest margins in the sector after Ryanair and "North Atlantic capacity is set to be more of a tailwind than a headwind" for British Airways and Aer Lingus this summer.
There are other ways to play the space outside of the pure airline operators, too. Aerospace engineer Senior (SNR) has flagged new contracts to supply components to Airbus, while engines manufacturer Melrose Industries (MRO) is on track to double its profits twice between 2022 and 2025.
Bedding in returns
The return of international tourism has meant a surge in demand and higher prices at hotel operators, with room rates at leading companies well ahead of pre-pandemic levels. It does, however, look as though near-term demand will moderate against tough comparatives. PwC forecasts that the key revenue per available room (revpar) industry metric will be flat in London and will fall by 0.8 per cent in the UK regions this year, as "record levels of hotel development ... [is] met by waning demand".
Hotel room supply in the UK market is below the pre-pandemic baseline despite a ramp-up in activity of late. Premier Inn owner Whitbread (WTB), which forecasts that supply won't recover until 2027, has been gaining market share and adding rooms as smaller operators have exited the market. But supply fluctuations can also hurt listed operators – Dalata's disclosure that additional room supply in Dublin in January and February had hit its revpar knocked its shares on results day.
Hotel valuations are generally pricier than those for the airlines. A rating of 17 times EV/Ebitda (enterprise value against cash profits) at Crowne Plaza and Holiday Inn owner InterContinental Hotels Group (IHG) has kept us neutral despite encouraging trading. It reported that revenue for leisure, business and group visits was ahead of pre-pandemic levels by the fourth quarter of last year, and pointed to hopes for “the last stages of a full post-pandemic recovery in a number of countries”.
We view Whitbread, which trades on six times EV/Ebitda, as a sector favourite due to its market share position and potential, expansion plans and freehold-backed balance sheet. We recently turned bullish on both PPHE Hotel Group (PPH) and Dalata, partly due to their attractive valuations.
Dalata chief executive Dermot Crowley says that “the pandemic hasn’t had a long-term impact on occupancy rates”. Occupancy at the group is now very close to pre-pandemic levels, as it is at InterContinental Hotels, which is progressing back towards its record position in 2018. Whitbread stands out for its growth against pre-pandemic – the lure of the Premier Inn brand to the consumer is obvious.
Crowley adds that the “biggest pressure [for hotel operators] is on the cost side”. The 9.8 per cent increase in the national living wage this month simply has to be absorbed.
Looking ahead, HSBC thinks "the pace of corporate and APAC [Asia Pacific] travel recovery continues to be positive and could be a potential catalyst for positive sentiment and earnings revision". But it cautions that it expects growth to normalise year on year.
It would be remiss not to mention Airbnb (US:ABNB) as an alternative travel accommodation play. Its model benefits from a flexibility of supply while traditional hotel operators are limited by construction and financing, but the company has come in for often justified criticism over its impact on housing markets and local communities.
Cruising to profits
For investors who only associate travel stocks with airlines and the like, it might be a surprise that there are solid retail options available in the sector.
There are two distinct ways to play the travel retailer area. The first is to look at companies that consumers use to book holidays. We like online beach holiday retailer On the Beach (OTB), which benefits from an asset-light and low-cost model. It has been boosted by a recent distribution deal with Ryanair, which now lets its customers access the airline's flights "with full price transparency". This has removed a significant drag on the company’s valuation, which at two times EV/Ebitda is less than a third of its historic average. On the Beach's total transaction value (TTV) of holidays sold was up 27 per cent in its latest peak booking period, helping it to a record forward order book as it focuses on volume growth.
Over-50s specialist Saga (SAGA) is another option here, with the company an obvious beneficiary of an ageing population. It has guided for its travel business to return to pre-pandemic profit levels on an underlying basis this year, as it seeks buyers for a stake in its cruise business. There is also backpacker-focused Hostelworld (HSW) to consider. The online travel agent is utilising an interesting new social network model to boost demand and recently reported record annual revenue under a refreshed management team, but the share price performance has been volatile and the valuation is more expensive than at On the Beach and Saga. Elsewhere, while Carnival may be enjoying some record metrics, the company stands out for the wrong reasons. The state of its balance sheet is why we remain bearish, with over $30bn (£24bn) of debt at the last count.
The second way to consider the retailer space is to look at companies that focus their physical convenience sites in travel hotspots. As the number of passengers going through airports and train stations increases, these companies unsurprisingly benefit.
There are a couple of FTSE 250 businesses to point out here. WH Smith (SMWH) was formerly defined as a lumbering UK high-street retailer, but it is now a transatlantic travel retail business that takes around three-quarters of revenue from travel sites. The opportunity for the company in North America is significant, which along with a valuation at half the historic average, are reasons why we are now keen on a ‘British throwback’. A second retailer in this area is food and drink outlet runner SSP (SSPG), which has just bought an Australian operator, adding £100mn of annual revenue to its accounts. SSP grew revenue by 17.7 per cent in its first quarter on the back of “robust trading led by leisure travel demand”.
Trains and buses
The train and bus sub-sector is perhaps the one most exposed to changing work patterns (ie significantly more home working) in the aftermath of the pandemic given the importance of regular commuters to customer numbers. Industrial action hasn't helped sentiment either. But the area offers some interesting companies, replete with impressive metrics, as a way into the travel space. Given their lower emissions than airlines, train-related companies are an option for investors minded to consider ESG.
There are few signs of demand trouble at ticket app business Trainline (TRN), which recently beat its full-year revenue and cash profit guidance as it continues to pick up steam. More travellers are using digital tickets, and the European market continues to liberalise, with the company's growth in Spain and Italy particularly notable. The government's abandonment of a plan to create a new ticketing retailer under the Great British Railways brand removed a major risk facing the company. We think a relatively rich valuation of 23 times EV/Ebitda is still a price worth paying, with Trainline appearing near the top of the UK mid-cap section of our latest Alpha momentum screen (which looks at earnings growth momentum).
Another company in the space is Aim-traded Tracsis (TRCS), which provides software and other services to train companies. We like its growth potential in the US, where it made the savvy acquisition of New York-based RailComm and has a lot to offer an analogue network. However, we are less sanguine about its premium rating than in the case of Trainline.
We have previously highlighted the contrasting fortunes of train and bus operator First Group (FGP) and the bus business Mobico (MCG), formerly known as National Express, which illustrates that resilient consumer demand isn't a general panacea for travel companies. First Group raised its operating profit and earnings guidance after a better-than-expected performance at its rail business. On the other hand, Mobico suspended its final dividend due to a focus on trying to reduce its high leverage, and is exploring the disposal of its US bus business, which has proved a thorn in its side. It delayed its results and cut its profit forecast, flagging auditor accounting judgement issues regarding its German rail unit. While both companies trade below historic positions, we are neutral, with a potential re-rating possible at Mobico if it can get rid of its American deadweight.
A key risk for the train-connected companies mis the involvement of the state in the market, with the government a key player in the running of networks in several key locales. This adds operational complexity alongside long-term planning uncertainty. With the Labour Party looking likely to come to power in the UK this year, the railway system could potentially go through a major shake-up.
A mixed picture
As this overview of sub-sectors suggests, investors need to be selective when considering hitting buy on travel. There are valuation opportunities – but also value traps. There are positive demand signs -–but also the prospect of slower growth.
There is a frustration in some quarters that the government is not doing more to support the industry. Association of Leading Visitor Attractions director Brian Donoghue argued that the Spring Budget was “a missed opportunity to reintroduce tax-free shopping for overseas visitors” and called for a VAT cut for tourism and hospitality to help companies “repair their balance sheets”.
With climate change risk set to increase, it would be a foolhardy investor indeed who didn't factor in the rising chance of more punitive taxes and stricter incentives to change consumer behaviour in a bid to reach emissions targets. And there are political considerations to ponder, too, from rail reform to air passenger duty. But all in all, these factors shouldn't detract from the opportunities offered by a rebounding travel sector.
