Did travel stocks simply overshoot on the downside amid fears of recession, hence are due at least some extent of mean-reversion back upwards? Or do they remain a somewhat fragile, speculative prospect?
They are generally yet to recover to pre-pandemic levels, possibly because investors do not quite know if there might be further disruptions, such as when the Ukraine war kicked off and more recently Greece’s wildfires. As yet, not even epidemiologists seem to be fretting about further restrictions despite new Covid variants.
Fuel prices could be a factor, but the companies do tend to hedge. Prices rose then fell in relation to Russia/Ukraine. However, OPEC production cuts have seen prices rise around 40% in the last three months.
Interestingly, whether the multi-billion-pound Jet2 (LSE:JET2) and easyJet (LSE:EZJ), or much smaller £200 million business On The Beach Group (LSE:OTB), they all currently trade on forward price/earnings (PE) multiples around eight times (assuming consensus forecasts). Dividends are only just expected to resume, however, with the 4% hoped for from easyJet being the best prospect.
Free cash flow profiles can be erratic (see tables) significantly due to capital expenditure needs – not helped by exceptional spending such as emergency repatriations from Mediterranean wildfires.
But despite fears for discretionary consumer spending, at least one decent holiday abroad seems fixed in people’s behaviour. And that’s likely to be sustained by a wet summer here and, frankly, high costs of accommodation/food/drink in the UK.
easyJet - financial summary
Year end 30 Sep
|Turnover (£ million)||5,047||5,898||6,385||3,009||1,458||5,769|
|Operating margin (%)||8.0||7.8||7.3||-29.9||-62.4||-0.5|
|Operating profit (£m)||404||460||466||-899||-910||-27.0|
|Net profit (£m)||305||358||349||-1,079||-858||-169|
|EPS - reported (p)||64.7||75.9||74.0||-223||-159||-22.4|
|EPS - normalised (p)||65.4||110||73.4||-148||-174||-13.4|
|Return on total capital (%)||9.4||9.3||8.5||-19.3||-12.8||-0.4|
|Operating cashflow/share (p)||141||204||161||-158||-192||103|
|Capital expenditure/share (p)||134||215||209||144||27.6||70.4|
|Free cashflow/share (p)||7.0||-11.0||-48.0||-302||-220||32.6|
|Net debt (£m)||-357||-396||326||1,125||910||670|
|Net assets (£m)||2,802||3,233||2,985||1,899||2,639||2,533|
|Net assets per share (p)||594||685||633||350||348||334|
Source: historic company REFS and company accounts.
An inflection point on charts versus trading updates
Travel stocks have been a frustrating ride in recent years. Jet2, the UK’s largest operator, has been highly volatile after a firm bull run from 2012 to 2019. At around 1,115p currently, it fell nearly 2% in yesterday’s strong market, as if traders knock it around – despite the 7 September AGM statement citing strong booking momentum, with higher-margin package holidays representing nearly 72%, up nearly 5% on summer 2022.
But easyJet - currently 447p - has been in a downtrend from over 1,500p in mid-2015, with a near-300p low last September, similar to most travel stocks. My recollection is easyJet having been pretty richly valued, hence liable to de-rate given competition in travel meant “growth” type ratings were unsustainable.
Yet a strong trading update in respect of second-quarter 2023, cited revenue per seat up 23% year-on-year and with easyJet holidays (launched in 2019) continuing to out-perform – set for over £100 million profit this year.
Of particular interest is On The Beach, which has been in a volatile downtrend from 620p since mid-2018 to an all-time low around 90p only a fortnight ago. Its founder, nowadays a non-executive director, sold 3.9 million shares in a 360p placing at end-2020 – raising £14 million – and bought back £2.5 million worth at 88p a month ago.
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After a bullish update last Wednesday, OTB shares jumped from around 95p to over 120p. Currently at 116p, they’ve exhibited quite an “inverse head-and-shoulders” chart pattern since June. Coinciding with better fundamentals, this – in principle – suggests a long-term reversal point.
In a pre-close update for its year to 30 September, OTB cited record transaction volumes up 26% to around £1.1 billion, driven both by volumes and average booking values. Summer 2023 passengers are 11% ahead and winter 2023 currently 26% ahead. It said: “Following our strong second-half performance – our most successful summer – we will exit the financial year with the momentum of a record order book...”
OTB’s forward PE is similar to easyJet – around eight times – versus below seven for Jet2. Its far smaller size makes it more intriguing, however, given operations progress should translate into better financial growth than the big operators. Mind though, small-cap stocks tend to be more volatile – for example due to less liquidity – so if there is a recession then OTB is probably more exposed.
On the Beach Group - financial summary
Year end 30 Sep
|Turnover (£ million)||83.6||104||148||71.2||30.5||145|
|Operating margin (%)||25.3||25.2||13.0||-64.5||-117||1.8|
|Operating profit (£m)||21.1||26.2||19.2||-45.9||-35.8||2.6|
|Net profit (£m)||18.0||21.5||15.7||-38.8||-30.2||1.6|
|EPS - reported (p)||13.8||16.5||11.9||-27.7||-19.0||1.0|
|EPS - normalised (p)||15.6||16.8||17.5||-8.2||-14.9||2.2|
|Return on total capital (%)||20.5||20.3||14.2||-28.9||-23.5||1.6|
|Operating cashflow/share (p)||15.4||20.1||17.3||-53.5||0.8||13.1|
|Capital expenditure/share (p)||2.4||4.6||6.4||3.7||3.2||7.4|
|Free cashflow/share (p)||13.0||15.5||10.9||57.2||-2.4||5.7|
|Net debt (£m)||-33.0||-42.8||-54.8||-32.3||-53.1||-60.6|
|Net assets (£m)||96.6||118||129||152||150||157|
|Net assets per share (p)||74.0||89.7||98.7||96.8||90.6||94.3|
Source: historic company REFS and company accounts.
Lack of sustainable dividends contributes to volatility
I suspect one key reason PE multiples have contracted is that investors are still waiting for a resumption of dividends after Covid led to further disruptions, compromising cash flow.
With income-oriented investors mostly absent, those for capital growth may trade more frequently, the resulting volatility tending to weigh on ratings.
Jet2 has the relatively better free cash flow record of these three stocks, but despite a 3p a share payout in its March 2022 year, it like the others is yet to restore payouts consistently. The table does, however, show relatively lower capital expenditure than easyJet, presumably due to easyJet being an airline group turning to holidays rather than vice versa.
Jet2 - financial summary
Year end 31 Mar
|Turnover (£ million)||2,380||2,964||3,585||395||1,232||5,034|
|Operating margin (%)||5.3||7.0||5.2||-85.0||-26.3||7.8|
|Operating profit (£m)||127||207||185||-336||-324||394|
|Net profit (£m)||107||140||116||-271||-315||291|
|EPS - reported (p)||71.8||91.6||74.8||-167||-147||127|
|EPS - normalised (p)||71.7||90.3||60.6||-167||-147||126|
|Return on total capital (%)||9.0||11.9||10.6||-16.7||-14.0||17.4|
|Operating cashflow/share (p)||278||324||297||-465||350||395|
|Capital expenditure/share (p)||276||203||160||20.8||50.5||81.6|
|Free cashflow/share (p)||2.0||121||137||-486||299||313|
|Net debt (£m)||-32.3||-63.9||-189||-52.2||-658||-1,248|
|Net assets (£m)||502||578||634||964||897||1,012|
|Net assets per share (p)||338||388||426||449||418||472|
Source: historic company REFS and company accounts
Mean-reversion of operating margins and net cash could help
Again, OTB intrigues me by way of comparison in part because it achieved margins over 25% back in 2017 and 2018. That’s not to imply history can repeat itself, just that it’s an interesting context where there might at least be scope for improvement. Last year saw barely 2%.
Pre-Covid, easyJet was on 7-8% and is yet to prove recovery. However, Jet2 was back near 8% in its March 2023 year.
Jet2 was in a £1.25 billion net cash position last March (despite over £1 billion debt and leases), while OTB had a much smaller £10 million position. It’s unclear quite whether that jumped thereafter (perhaps due to bookings?) as Wednesday’s update cited profit at the top end of market expectations “benefiting from higher than anticipated interest income”.
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easyJet’s end-March balance sheet had nearly £2.7 billion bank debt and £960 million leases, versus £3.4 billion cash.
These companies should therefore be able to cope with what could be the median scenario – “stagflation”, with the UK struggling to achieve much growth, while wage increases keep inflation measures at around 5%. Interest rates have risen but we are yet to see debt costs hurt profit.
Yes, the UK does have embarrassingly high elements of the population having withdrawn from working – whether for health reasons or early retirement – but skills shortages mean relatively secure employment for those in work.
Listed travel companies should therefore have a sound macro context. Even in a mild recession, and barring renewed Covid restrictions, many people are going to carry on booking holidays abroad.
It helps explain easyJet launching 15 new routes from a new base at Birmingham airport from next year, with package holidays now being sold.
Overall a ‘Hold’ but dependent on risk appetite
I think stances on these stocks are very significantly influenced by what extent of volatility you are able to accept and your objectives as an investor.
If you are primarily income-oriented and need security in that respect, and also want to eliminate the risk of a major disruption, then best avoid the travel sector.
But unless the latest positive updates are soon negated by recession and/or rampant Covid, I think we are looking at a broad inflection point – versus PE multiples at historic lows.
The OTB founder's £2.5 million “buy” is a standout technical indicator and also of belief in value. I find OTB the most intriguing but rate all three as medium to long-term “buy”.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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