A rival's demise can offer rich pickings for survivors, but some will do better than others. Our companies analyst thinks he's spotted a winner.
Is it worth chasing possible beneficiaries from the demise of Thomas Cook (LSE:TCG), or is the foreign travel sector currently best avoided - lest the Brexit fiasco and a bad-tempered general election hit discretionary spending?
Despite £1.25 billion of debt making Cook's equity look worthless, enduring public appeal seems the chief reason it bumped along as a penny stock in a £50 million to £100 million value range. Barring a suspension, you quite wonder if trading might have continued below its last closing price of 3.45p, despite a company liquidation declared.
Rivals such as TUI AG (LSE:TUI) which owns the Thomson/First Choice brands of package holidays, also Dart Group (LSE:DTG) which owns the Jet2 brand, initially jumped around 10%, although this tempered in the afternoon to 7% and 4% respectively as news appeared of Thomson/First Choice bookings dependent on Thomas Cook flights being cancelled.
So how rational are those rises given the repatriation of 150,000 tourists hints at capacity now up for grabs?
Labour's risk to consumer/pensioner spending
Shadow chancellor John McDonnell and senior Labour party officials' reaction offered a hint of the taxation demands required to support their radical programme of public industry ownership. Comparisons were made with the steel industry and the need for jobs protection as justification for a government bailout "with strings attached".
Personally, I think Thomas Cook should have been allowed to fail in 2011: it exemplifies the futility of propping up "zombie" companies in the monetary stimulus era, delaying required restructuring. Leisure travel is highly innovative, a sector where creative destruction flourishes.
- TUI results extend post-Thomas Cook bounce
- Thomas Cook shares worthless
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Some would say that while Jeremy Corbyn is leader, there's scant chance of Labour being elected, but if it happens then tax rises on the relatively affluent are inevitable and pension funds will also be hit to the tune of £520 billion in support of social benefits. So, stocks exposed to discretionary spending are likely to be volatile as a general election gets underway, according to opinion polls.
A silver lining to the clouds surrounding TUI
Thomas Cook is estimated to account for 2.5% of UK-to-Europe airline capacity. Initial projections from analysts at Barclays are for TUI to gain £2 billion of revenue this way – and noting a consensus projection for £19.6 billion revenue in its current year to 30 September, that implies a 10% uplift.
So, TUI's stock twitched up from a sub-8x price/earnings (PE) multiple and yield towards 8% - at least assuming forecasts in data tables – to a forward PE around 8.5x and 7% yield with price currently around 900p. That assumes £468 million consensus net profit for the latest financial year and £696 million in the 2020 year – down from £733 million in 2017/18 after TUI has hit turbulence that could continue a while yet.
Despite low single-digit operating margins, TUI gained a reputation for double-digit earnings advances - helped by a "vertically integrated" business model, owning its hotels, airline and cruise ships.
Fifteen months or so ago its stock tested the 1,800p all-time high. It then fell back with the market and slumped last February when memories of the scorching 2018 summer hit foreign holiday bookings – especially to Spain.
A second profit warning followed in March after two massively fatal crashes grounded Boeing's 737 MAX. TUI has 15 in its current fleet of around 150 planes and has been due to start flying eight more. TUI guided for a £280 million cost for this, including leasing replacement planes, although doubts remain whether the 737 MAX will return to service at all.
Potentially, TUI can continue to recover along a rationale that falls tend to be more extreme when there's a shock, and "bull markets climb a wall of worry". It hit 720p last June and now sits in a somewhat volatile uptrend, which chartists might regard as encouraging.
Six weeks ago, at third-quarter results reporting, TUI spoke vaguely of a "strong" performance for holidays with lower demand for Spain substituted by Mediterranean resorts. Cruises were selling well and Brexit was blamed for softer performance in airlines, as if the 737 MAX groundings were attempted seen as an exceptional item.
This morning, TUI has declared an effectively "in-line" pre-close update - partly also to show it's on the ball as regards the fallout from Thomas Cook. Holidays continue to generate “strong” results, while airlines continue to face the 737 MAX grounding and Brexit uncertainties "which will continue in the 2020 year," so, a focus on price competitiveness. The stock initially blipped to 915p then settled back around 900p.
I think the Boeing link kicks this stock into the "event-driven" category: for speculators who envisage this eventually resolving, then it's one to watch, but personally I'd see how Brexit pans out. Once these hurdles are cleared then, yes, more chance potentially as a 'buy', although mind risks even to an expected lower dividend if cash flows are further compromised.
Dart Group as the chief selection on current evidence
AIM-listed Dart Group is a £1.3 billion business providing holiday flights and licensed package holidays under the "Jet2" brand to the Mediterranean, Canary Islands and European leisure cites. It also retains a smaller logistics side group distributing fresh produce throughout the UK.
Like TUI, it has high capital expenditure needs despite a robust cash flow profile, though, since its stock appears broadly in a sideways-volatile channel, it’s not low enough to exact a yield higher than 1.3%.
Source: TradingView Past performance is not a guide to future performance
At around 890p currently, its prospective PE is about 10.5 times, although consensus forecasts (for what these are worth in uncertain political/economic times) project a circa 15% fall in earnings per share (EPS) for the current year to end-March 2020, and low single-digit growth in 2020/21. Summertime had seen the stock retreat from around 950p in May to 716p in August, albeit driven by "risk-off" markets rather than anything company specific.
Indeed, July's annual results to 31 March showed 2019 delivered pre-tax profit up 36% to £177.5 million on revenue up 32% to £3.1 billion with an operating margin of 6.5%. This was organically driven by "growing success of our leisure travel" with strong demand both for flights and package holidays.
Jet2.com increased its flight passengers by 21% and Jet2holidays increased its customers by 27%, although to investment in planes, staff and marketing meant higher operating losses in the second half year. Capex and seasonality are therefore issues to keep in mind, as is July's outlook statement which cited people bookings breaks later than they did in 2018 (implying a need for discounting) and "cost pressures relating to fuel, carbon and other operating charges".
|Dart Group - financial summary|
|year ended 31 Mar|
|Turnover (£ million)||1,120||1,253||1,405||1,729||2,380||3,143|
|Net profit (£ million)||35.9||32.8||88.8||76.7||107.1||145.6|
|Operating margin (%)||4.4||2.6||7.5||6.0||5.3||6.5|
|IFRS3 earnings/share (p)||24.3||22.2||59.9||51.5||71.8||97.6|
|Normalised earnings/share (p)||24.3||31.4||59.9||51.5||71.7||96.4|
|Price/earnings multiple (x)||9.1|
|Operational cashflow/share (p)||88.6||78.6||165||222||278||297|
|Capital expenditure/share (p)||56.5||51.7||144||318||276||203|
|Free cashflow/share (p)||32.1||27.0||21.0||-96.0||2.0||94.0|
|Dividend per share (p)||2.7||3.0||4.0||5.3||7.5||10.2|
|Dividend yield (%)||1.2|
|Covered by earnings (x)||8.9||7.4||15.0||9.8||9.6||9.6|
|Net assets per share (p)||125||107||216||283||346||400|
|Source: historic Company REFS and company accounts|
The 5 September AGM statement then reiterated “strengthening demand” for flights and holidays, with a modest caveat of how "winter season forward bookings have yet to match our seat capacity growth, therefore pricing will need to remain enticing."
While that probably wouldn't satisfy growth investors, the stock leapt from 735p over 810p in reaction, as if priced for worse. After 10 days consolidation, the shares have jumped again on the Thomas Cook news to around 883p. Analysts at broker Stifel argue "the big positive could be Dart Group as TCG's closest competitor with considerable customer overlap, who should be a beneficiary once the dust starts to settle – particularly in the Midland."
Notwithstanding "could" and "should" I'd agree this is a major strategic benefit for Dart: £9 billion-plus of Thomas Cook revenues offer plenty of scope both to mitigate competition and boost growth for other operators. Moreover, Dart appears well-managed.
Respecting Brexit risks, I suggest averaging-in during market volatility as political issues intensify in weeks and months ahead, for fear of missing out should Boris indeed get an EU deal and better Tory majority. A re-rating of UK risk stocks would likely follow. Labour is a definite worry but, unless capturing the youth vote, I suspect with less chance of government under Corbyn. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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