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Thomas Cook: how to spot a collapse

Ed Monk

Ed Monk - Fidelity Personal Investing

Thousands of Thomas Cook holidaymakers are stranded overseas and its staff - some of whom have turned up to help their customers anyway - are now without a job.

None

These are the priorities today as the post mortem of the world’s oldest travel agent - now deceased - begins.

Further down the list comes the losses investors in the company have faced as the result of its collapse. Viewing coverage of the Thomas Cook failure it would be easy to conclude that this was inevitable. Business and travel experts have lined up to explain the timeline of Thomas Cook’s demise - it all looks so obvious in hindsight.

Except it wasn’t obvious, at least not to everyone. As recently as February, a small but hardy band of investors was busy ploughing their money into Thomas Cook shares, no doubt hopeful that the slump in its price over the previous year represented the ideal entry point.

They were spectacularly wrong. What signs should they have paid attention to - and how can you learn the lessons?

1. Ultra-cheap valuations

Thomas Cook’s share price suffered a terrible 2018, falling around 80%. That made the shares look exceedingly cheap on a number of popular measures.

The price-to-earnings ratio of Thomas Cook fell to about four times while the dividend yield rose to above 7% this year. That is high, but not excessively so - companies can often sustain such yields for prolonged periods without cutting. A little recent history, however, would have shown that Thomas Cook was a flaky dividend payer. The dividend was cut in 2018 and no dividend was paid in 2014 or 2015.

Sometimes things are cheap for a reason.

2. Unresolved debt

As in any financial collapse, what did it for Thomas Cook in the end was an inability to service its debts. In November last year the company reported debts of around £389m - no small sum - but these had grown to almost £1.6bn by February.

Debt is common in business and even very high levels of borrowing can be sustained - but such a dramatic increase should’ve been a red flag.

Debt has been an issue at the company ever since 2011, when it survived a previous scare. It survived then thanks to an investment package which meant even more debt. Investment since then has come from China and Thomas Cook’s banks have given it breathing space in the past year - but ultimately the debt road had to run out at some point.

3. Failed ‘turnaround’ plans

The words ‘strategic review’ tend to feature in the accounts of companies in trouble, and so it was with Thomas Cook. As its balance sheet and trading updates got worse, management had to signal that they were aware of what was going wrong and had a plan to fix it.

Thomas Cook’s tried an overhaul at the time of its last near-collapse in 2011. A more recent turnaround plan involved reducing airline capacity and focused on selling high-margin brand hotels and ‘differentiated’ holidays. But it was trying to do this at the same time as taking costs out of the business.

A final last ditch move came this year when Thomas Cook announced it would look for a buyer for its airline arm, which also happened to be the profitable part of its business.

Turnaround plans and reviews can work - and recovery businesses can be among the most lucrative investments - but one failed plan after another should ring alarm bells.

4. A business plan that no longer makes sense

Some businesses are hard for ordinary people to understand. Perhaps they sell obscure products or services into specialist markets, driven by forces that only an expert would understand.

Others are far more straightforward because they provide things we all know. Thomas Cook fell into this latter category, and as such it should have been clear to anyone that its model of selling package holidays, many still booked via its agents, had become anachronistic in a world of Skyscanner, Expedia and Airbnb.

That’s not to say businesses cannot successfully transition from one model to another, but it’s a difficult task and may lead to fewer operators in the market once the dust has settled.

Do you buy your holidays through a tour operator? And even if you do, how many of your friends and family do the same?

These should’ve been the first questions any potential investor asked themselves before buying Thomas Cook shares.

Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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