Join our community of smart investors

Holiday fever with the coronavirus

Lock-downs and quarantine are a hard sell for tour operators
March 4, 2020

The main full-year reporting season is in full swing and every day more and more companies are warning about the negative impact of the coronavirus on trading, export volumes and supply chains. Outside of China it’s perhaps difficult to square the threat of economic damage with the clinical reality, but that could change rapidly.

For now, around one-in-10 UK public companies (excluding investment trusts and funds) have confirmed that they will be affected to some degree, although few have been able to quantify the impact. There are some sectors, however, which have seen trading slide right from the get-go.

Aside from the deserted streets of Wuhan, perhaps the most striking manifestation of the outbreak was the Diamond Princess cruise ship held in quarantine off the port of Yokohama earlier this month. Six passengers have already died from the Covid-19 infection, but the effect on seaborne holiday bookings, although perhaps not terminal, could hole many a smaller cruise operator below the waterline.

Asia has been the chief driver of global passenger numbers in recent years. Capacity has more than tripled over the past five years and the trend was expected to accelerate. That stellar rate of growth is now imperilled.

For a cruise company such as Carnival (CCL), which currently generates 12.6 per cent of revenues from Asian and Australian bookings, it is certainly a material issue, although one imagines that any impact will be amplified if a cruise ship outside of the Asia-Pacific region goes the way of the Diamond Princess.

It’s not as if the group hasn’t had to deal with negative publicity in the past – consider the wreck of the Costa Concordia in 2012 – but global bookings would be decimated if the analogy between a cruise ship and a floating petri dish becomes entrenched in the public consciousness. Many holidaymakers already reject the idea of a cruise ship holiday for that very reason.

It’s still too early for Carnival to quantify the financial impact of the outbreak, but it did posit that if it was forced to suspend all its Asian operations through to the end of April, it would weigh on financial performance by $0.55 to $0.65 a share. (Earnings through 2019 came in at $4.34 a share.) A large part of this estimate relates to guest compensation, which brings us on to another early victim of the lurgy – the insurance industry.

In the last two weeks of February, the MSCI Europe Insurance index fell by 15 per cent, but worse could come. The extent to which the UK industry will be hit by direct claims and reinsurance commitments depends on several factors, including the number of travel claims that will be invalidated if claimants acted outside of the official advice given by the Foreign and Commonwealth Office (FCO). (Anyone who had bought insurance and travelled before the FCO issued its advice on which locales to avoid should be covered.)

There are other industry considerations. Direct Line Insurance (DLG) revealed that it has incurred claims of around £1m thus far, although it can call on reinsurance protection to a maximum of £10m. These types of policy arrangements are commonplace, so it will be a testing time for global reinsurance heavyweights such as Swiss Re AG (SWX:SREN) and Lloyd's of London.

Assessors will also be busy looking at event cancellations and policy exclusions relating to infectious diseases. Events specialist Ascential (ASCL) recently reassured investors on this score, detailing that revenues from China represent less than 5 per cent of the group total, but it has still taken the precaution of moving the Money20/20 Asia event in Singapore from March to August. That falls into line with other updates from industry rivals, to the effect that although China remains a key growth target, exposure (ie, market penetration) is relatively limited.

Any companies looking to secure recompense based on the business interruption component of their policies are likely to be disappointed, as most insurance policies generally require physical property damage to bring it into play. But there is a broader issue that will affect the total level of liabilities for insurers: the extent to which corporations will be able to invoke force majeure clauses. This can occur if it’s determined that the obligations under a supply contract are impossible to be fulfilled, thereby absolving (or in some cases delaying) the liabilities of the contracting parties. The process essentially shifts the risk to counter-parties, which is a bit rum. Anyway, speculation has it that China's state-owned energy giant CNOOC has already declared force majeure on several LNG contracts – others may follow suit.

Eventually, underwriters will be tasked with formulating future premium levels, adding to the cost-base of businesses across the board. But profits for insurance companies are likely to come under pressure due to the increased likelihood that central banks will trim base rates as a stimulus measure. The US’s Federal Reserve has already done so, and it’s possible that the Bank of England (BoE) could follow suit.

The FTSE 100 retraced slightly earlier this week after Mark Carney confirmed that the BoE would intervene to mitigate any economic slowdown brought about by the virus. The other side of the coin is that any fall in the base rate means that net investment yield will take a hit, with insurers' earnings, liquidity and capital coming under pressure.

Prospects for insurers might not be that rosy, but at least they can eventually claw back losses through increased premiums. What happens, though, when you have an insurer which also acts as a travel agent and is engaged in the building of cruise ships? Saga (SAG), which already will incur one-off costs of £4m following the collapse of Thomas Cook, has postponed an auction of Titan Travel, which provides escorted holidays to countries including Egypt, South Africa and the US.

The group remains on track (and on budget) to launch the Spirit of Adventure in August. Normally, this would be cause for celebration, particularly as a recent trading update suggests that its sister-ship, the Spirit of Discovery, is forecast to deliver £20m in cash profits over the second half of Saga’s financial year. The trouble is that if the outbreak worsens outside of China, it will probably deter Saga customers from making advanced bookings. After all, most of Saga’s punters are probably acutely aware of the dangers of respiratory illness for the over-50s.

Although there is every likelihood that seaborne bookings will come under pressure, the immediate impact on the airlines couldn’t be starker. Ryanair (RYA) has notified passengers that it was reducing its short-haul flight program (primarily to and from Italy) by up to 25 per cent through to 8 April. This mirrored an earlier move by easyJet (EZJ), which is reducing the capital intensity of the carrier through a series of measures beyond flight cancellations, including recruitment freezes, unpaid leave arrangements and putting the squeeze on third-party suppliers. Prudent enough measures, to be sure, but both airlines admit that it is too early to put a reliable estimate on the likely cost of the outbreak.

The news wasn’t any more encouraging from IAG (IAG), the parent group of British Airways, Iberia and Aer Lingus. Although the airline group recorded improved revenues and a marginal increase in adjusted operating profit, earnings were undermined by a €672m (£586m) charge linked to the group’s defined pension liability. Passenger numbers and the load factor (people on a flight divided by the number of available seats) were up on the prior year.

Matters are also febrile where the travel agents are concerned. TUI AG (TUI), which is in the process of shifting its Hapag-Lloyd Cruises subsidiary into a joint venture with Royal Caribbean Cruises, saw its shares pull back at the end of February when a four-star Tenerife hotel within its stable was put on lock-down. Management at TUI is unable to put a reliable estimate on the likely financial impact of the outbreak, but you can always rely on scuttlebutt where travel companies are concerned, ergo the level of discounting through to the end of the second quarter.