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Like their planes, cruise ships, and customers tied to the ground, travel stocks are just itching to take off this summer. Seen as the definitive “reopening” buy, nowhere are investors more hopeful for the correlation between normality and returns.
Their logic isn’t hard to grasp. It’s clear that, once allowed, travellers will waste little time staying at home. A reopening economy spells good news for companies’ balance sheets and, presumably, their share prices.
But the story doesn’t end there. It’s tempting to think only of the airlines, but UK travel stocks are a wide-raging bunch, including hotels, railway companies, cruise liners and more. Within that assortment you have a host of different customer bases and demands, costs and pressures, tailwinds and headwinds.
Nor can we assume it’ll be business as usual once restrictions ease. Consumer habits have changed over the pandemic - only time will tell how far these extend to travel expectations, and how readily the industry can adapt.
There are clear opportunities here, but stock pickers should expect plenty of turbulence ahead. Here are some things to consider if you’re looking to invest.
The story so far
The travel industry was decimated by the pandemic. Unlike other industries which have been able to adapt to changing conditions, it’s generally been all or nothing for travel companies. Income for many simply dried up as lockdown restrictions kicked in.
The problem was twofold. First was the collapse in demand. As the pandemic ran rife, countries closed their borders, national lockdowns restricted domestic travel, distancing reduced capacity, and so on. Consultancy firm McKinsey estimates a 35-48% loss in global tourism expenditures over 2020 compared to 2019.
Second was the high fixed costs most travel companies had to maintain. Offsetting those costs mean most - airlines in particular - will struggle to see a return to pre-pandemic levels of income over the short term. That’s assuming a swift return to capacity, which itself looks far off. McKinsey doesn’t expect flights to return to 2019 levels until 2024.
Facing these obstacles, companies had to significantly cut costs to keep up their cash positions. Furloughs and government support schemes provided lifelines; raising investor capital and renegotiating leases were other options available to many.
Shareholders don’t like to see high debt levels, but stable cash positions do offer hope for the travel companies. Those that folded over the pandemic were usually in a poor position beforehand. Flybe, an early casualty, had been close to collapse in 2019 before being bought out by Virgin Atlantic.
All the same, plenty of damage has been done. The industry is desperate for more positive times ahead. Fortunately, the outlook is starting to get brighter.
Hope on the horizon
The good news for travel companies is that there’s clear evidence of pent-up demand. Airlines have consistently reported a surge in bookings off the back of any positive pandemic news - in February, for instance, easyJet saw UK bookings jump 337% and package holiday bookings up 630% compared with a week earlier after the Prime Minister laid out his “roadmap” out of lockdown.
Evidence from countries that contained the pandemic last spring is hopeful. At around 12,000 per day, domestic flights in China have been above 2019 levels since the beginning of March. In Australia, with international travel restricted, domestic flights surpassed year-ago levels two months ago and they’ve kept on rising ever since.
Investors will hope immediate demand can build on a longer-term upward trend in air travel. The International Air Transport Association thinks that air passenger journeys will grow at an average annual rate of 3.7% over the next 20 years.
There’s a valuation argument here too. While many travel companies have managed to reclaim their losses, others still trade well below their pre-pandemic peaks. Much of this sector looks enticingly cheap.
An industry transformed?
There are concerns too. There’s an assumption that, once the pandemic disappears and the world returns to normal (all questionable in itself), the travel industry too will be back up and running as before. Far from necessarily true, this is an industry that looks transformed - investors should wonder how deep any structural tears run.
Questions mount over the future of business travel. Video conferencing may be no substitute for a beach holiday, but many companies have found it a satisfactory (and cheaper) alternative to international meetings.
At the same time, it’s tempting to overstate the extent of shifts in corporate habits. A Deloitte study predicts a slow initial recovery in business travel, followed by a sudden ramp up. We’re unlikely to be sure until the future of office working as a whole becomes clearer.
Leisure appetites have changed as well. For this year at least, domestic travel is likely to be the primary choice for most travellers. Deloitte found that 24.3 million Brits plan to take a UK break in 2021, while only 16.5 million plan a foreign one (down from 27 million in a normal year).
That’s likely to hurt companies focussed on lucrative corporate and long-distance journeys, and benefit budget, domestic-focussed providers.
One beneficiary could be Ryanair. Despite well-publicised criticism against the government’s handling of the travel sector, chief executive Michael O’Leary has been relatively bullish over the period. An order last year for a fleet of Boeing 737-MAX aircrafts, which offer higher capacity and more efficient fuel consumption, should help reduce costs going forward.
Relatively speaking, Ryanair looks in a strong position to justify the move. A €1.2 billion Eurobond issuing last year has helped the Irish flyer retain one of the strongest balance sheets across the industry. It’s had it fair share of trouble - an 82% fall in revenue in the third quarter of the fiscal year 2021 is pretty staggering - but it’s acted well over the period. The company said it could come close to breaking even this financial year, subject to vaccine rollouts and the easing of European travel restrictions, even as it reported a record annual loss.
EasyJet has also struggled, but it’s another budget airliner which would be in prime position to enjoy the reopening trade as travellers scramble to book tickets. Unlike Ryanair, its share price still looks cheap relative to where it was before the pandemic.
IAG is more internationally focussed, and that perhaps goes some way to explaining why its share price still languishes well below its pre-pandemic peak.
The company’s profits and share price were decimated by the pandemic, but, like Ryanair, its balance sheet is relatively strong and it was able to secure financing last year to keep its cash position stable. IAG could enjoy a sizable upswing if a US-UK travel corridor opens.
Some pandemic shifts have actually proved beneficial to airlines. Cautious approaches to flying and a desire for space saw passengers opting for add-ons like assigned seating and extra luggage. These enabled both Ryanair and budget airliner Wizz Air to grow their non-ticket revenues per customer at double-digit rates even during a rarefied 2020.
Another way to play the airline recovery story could be Rolls-Royce, which (among other things) supplies plane engines. IAG and Rolls Royce were the two biggest FTSE 100 losers over 2020. Both are still well below their pre-pandemic peaks, but whereas the former has been making strong gains of late, Rolls-Royce has continued to struggle through 2021.
That’s partly because Rolls-Royce would be slow to benefit from the recovery. It will take a while for increased travel demand to translate into increased engine production and maintenance. All the while, Rolls-Royce’s cash position - squeezed ever more tightly by those high fixed costs - looks increasingly precarious. Still, similar structural drivers behind airlines apply here, if less overtly. For investors with a long-term approach, this is one alternative option.
Where airlines are hopeful for international travel corridors, domestic focussed firms will be looking at staycations with glee. One to benefit from increasing domestic demand would be National Express. Though its coaches’ close seating arrangements may put off cautious travellers, the company has seen a recent spike in bookings from fully vaccinated over-65s (who previously formed the vast bulk of National Express’ holiday customers).
Similar narratives apply among hotels. A recovery in domestic travel should play into the hands of Premier Inn owner Whitbread, while its expanding international business means there’s opportunity for growth here too. Whitbread also owns restaurant and café brands like Beefeater and Costa, industries which are slightly less exposed to lockdown disruptions than its hotel chains.
InterContinental Hotels Group tells a similar story. Brands like Holiday Inn and Crowne Plaza have already reported significant increases in bookings.
However, the hospitality industry is seeing structural shifts of its own. As it stands, people are preferring to travel to rural destinations rather than cities. That’s likely to benefit private serviced apartments and B&Bs at the expense of big city hotels, as are cautious attitudes to travel and preferences for privacy. Again, it’s hard to know how long such concerns will linger.
A final, outside call, is cruise lines. For UK stock pickers, P&O-owner Carnival is the classic pick. The company was successful in raising plenty of cash to see it through the pandemic, but that does come at the cost of share dilutions and mounting debt levels which aren’t attractive to investors. At the same time, Carnival is a massive company that dominates the industry. It would be first to benefit from an uptick in demand. It’s also used the period to streamline, laying off 16 of its less efficient liners.
Like many travel companies, Carnival has suffered - a $10.2 billion net loss over 2020 is no joke. Nevertheless, having made it this far, shareholders can still hope to see their investments sail on fairer seas soon.
Important information: 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. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Investors should note that the views expressed may no longer be current and may have already been acted upon. 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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