Interactive Investor

Stockwatch: my successful triple tip and what I’d do now

Despite the UK falling into technical recession last year, this sector has prospered and generated significant returns since analyst Edmond Jackson backed three stocks in September. Here’s his update.

16th February 2024 11:50

Edmond Jackson from interactive investor

Despite the UK technically being in mild recession during the second half of last year, we should not lose sight of the fact that some sectors will be thriving.

Despite being competitive, package holidays are one such sector. Enough people are in stable employment on inflation-linked wages, such that even if higher living costs do compromise aspects of discretionary spending, there’s no way they’re giving up their holidays. If anything, the relative “value” operators are in better business.

If the UK does see material job losses, then at some point travel would get affected. But unless something more sinister transpires on the geopolitical stage, I suspect the majority will continue flying abroad. 

All this explains why Jet2 Ordinary Shares (LSE:JET2), the UK’s largest leisure travel group and third-largest airline after easyJet (LSE:EZJ) and British Airways, has just cited winter 2023-24 bookings up 17% - with higher-margin packages slightly ahead of last winter at around 60%.

There is “robust” pricing both for flight-only and package holiday products. Demand appears sufficiently firm versus industry capacity, which ought to bode well for the shares on a forward price/earnings (PE) multiple below eight times.

Annual profit to 31 March is upgraded 3.5%.

The company says: “With February and March 2024 bookings displaying similar trends to recent months, plus the benefit of an extra day’s flying in February and an earlier Easter, we tighten and slightly raise our guidance for pre-tax group profit (at constant currency) to £510-525 million from £480-520 million...”

Medium term is always tricky to judge

Before this update, the consensus projection was 34% growth in normalised (for currency fluctuations) earnings per share to 168p in respect of the March 2024 year, based on a 25% increase in revenue to near £6.3 billion.

The shares rose over 4%, settling up nearly 3% at 1,360p which capitalises Jet2 near £3 billion - effectively a mid-cap company despite its AIM listing. It shows that large, strong companies exits on AIM, although travel is admittedly higher risk due to occasional unforeseen disruption. Half the challenge is guessing whether PE ratings fairly or overly discount such risk, besides estimating earnings. Due to capital spending needs and potential risks, dividend payments tend not to be material.

As yet, 2025 earnings per share (EPS) is expected to consolidate to 2% growth, implicitly flat given this latest mild upgrade, despite a 12% advance. But it is premature to look even this far ahead on a travel stock, another reason for modest ratings.

The operating margin looks to have improved to high single digits after losses during the 2021-22 financial years due to Covid disruption, although recent years are a tricky context to judge what percent is sustainable.

Jet2 - financial summary
Year end 31 Mar

 201820192020202120222023
Turnover (£ million)2,3802,9643,5853951,2325,034
Operating margin (%)5.37.05.2-85.0-26.37.8
Operating profit (£m)127207185-336-324394
Net profit (£m)107140116-271-315291
EPS - reported (p)71.891.674.8-167-147127
EPS - normalised (p)71.790.360.6-167-147126
Return on total capital (%)9.011.910.6-16.7-14.017.4
Operating cashflow/share (p)278324297-465350395
Capital expenditure/share (p)27620316020.850.581.6
Free cashflow/share (p)2.0121137-486299313
Dividend/share (p)7.510.23.00.03.00.0
Cash (£m)1,0091,2741,3471,3712,2282,623
Net debt (£m)-32.3-63.9-189-52.2-658-1,248
Net assets (£m)5025786349648971,012
Net assets per share (p)338388426449418472

Source: historic company REFS and company accounts.

Broadly this still affirms a recent stock inflection point

I drew attention to Jet2, easyJet and On The Beach Group OTB last September as stocks left behind by the market while others recovered pre-pandemic highs or better.

Since then, and despite a bit of continued drift into October, Jet2 is up 23% from 1,115p, easyJet by 28% to 570p and On The Beach Group (LSE:OTB) up 24% to 144p (although it had risen 53% to 178p by end-December).

Prospective dividend yields of 1.0%, 2.5% and 2.2% respectively, mean there is no real prop to these stocks – compared, say, with the stronger free cash flow profile of retailers translating into dividends.

While Jet2 only directs about a third of operational cash flow to capital expenditure, versus more like half for easyJet and On The Beach, its yield is the lowest because it pays out less than 10% of earnings. That in itself sends a message about earnings risk.

Investing here is thus largely about trying to be on the right side of volatility, where last September’s call – so far – seems roughly right.

An apparent growth stock in long-term context

Jet2 is distinguished from easyJet and On The Beach due to its exemplary long-term chart showing an uptrend from around 60p in early 2012, which more than ten-bagged pre-Covid. The pandemic left it sideways-volatile, mind.

easyJet is quite the opposite: a downtrend from 2015 putting it back where it traded in 2012. Similarly, On The Beach has seen a downtrend since 2018 to all-time lows and it has yet to recover to the 200p we saw in 2015.

Of the three, only Jet2 therefore has genuinely delivered long-term shareholder returns.

The balance sheet carries £761 million financial debt and £633 million lease liabilities, which generated a £33 million finance expense in the first-half-year; albeit offset by £80 million income on 1,343 million cash as of end-September, most of which is likely to be bookings deposits. This mitigates risk from operational volatility, unlike a geared company, although easyJet and On The Beach similarly have negative net gearing.

Shareholder value requires adept balancing of capacity

Management has invested ahead of the summer season: seat capacity is up 12.5% but that trails package holiday customers up 17% (unless flights last year were short of full capacity). It exemplifies the balancing act in pursuit of value, and how capacity needs to adjust adeptly without cost over-runs.

Five new aircraft from Airbus are involved, with a further six due by March 2025. A new retail operations centre is fully functional, and flights commence from Liverpool airport this March – Jet2’s 11th UK base.

There remains an element of caution, with management saying that despite higher pricing “we remain mindful of the current macro-economic and geopolitical environments and how these could impact future consumer spending”.

Interim earnings rose nearly 40%, albeit benefiting from currency translation given a 32% rise at the normalised pre-tax level, on revenue up 24%.

From note four of these results – segmental reporting – it is possible to calculate how package holidays constituted 82% of revenue, 10% flights-only, 7% non-ticket revenue, with the residual 1% “other leisure travel”.

It marks continued progress, for example on last September’s AGM update which cited strong booking momentum with higher-margin package holidays up 5% on summer 2022 – to constitute nearly 72% of revenue.

All three companies are doing well currently

easyJet similarly issued a strong trading update on 24 January in respect of its first quarter to end-December: revenue per seat was up 23% year-on-year and easyJet holidays is set for over £100 million annual profit. Its shares have risen from 520p then, to near 570p.

Curiously, on 26 January, On The Beach declared the best operational update of the three: recent total holiday revenue was up 27% on the equivalent period last year. It “continues to invest in its proposition, brand and platform to differentiate its offer, powering year-on-year growth across core and expansion areas...” Yet this has failed to stop the share’s gradual retreat after December’s rally.

I had thought On The Beach the most intriguing of the three, given its smaller size meant operational progress should translate into better financial growth than the big operators. An “inverse head-and-shoulders” chart pattern from last June coincided with improved fundamentals, as if a long-term reversal point. Its PE multiple was similar to easyJet at around eight times, which has expanded to 9.3x on a forward basis.

With January UK retail sales showing a 3.4% rebound after a 3.3% drop in December, it affirms UK consumers are largely in decent shape. I take this as confirmation that last autumn was indeed an inflection point for these travel stocks, and so I retain an overall “buy” stance on all three – if more cautiously, given their rallies since I first backed them.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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