City Insider: New year brings renewed optimism but dark clouds loom over the UK

City Insider: New year brings renewed optimism but dark clouds loom over the UK

City Insider - FT journalist David Stevenson on the travel industry

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What a difference a new year makes.

By the end of December last year one could have been forgiven for thinking that the world was looking like a very dark place indeed.

Sentiment in the City towards any listed company with the words ‘consumer’ and ‘discretionary spending’ in its business credo was unremittingly hostile, not helped by the debacle at Thomas Cook.

Flash forward just one month to the end of January and suddenly most things begin to look a little more positive.

The big success story is that Tui Travel’s shares have now risen by just under 20% over the last month and I’d confidently expect a slow uptick in City sentiment to the UK’s number one travel giant.

Just before Christmas, analysts at Shore Capital posted a buy note on Tui although their estimates for earnings per share for the coming year weren’t exactly a blow out.

Shore reckons that profits should run to 24p per share at which point Tui would be valued at less than nine time earnings on a yield of just under 6%.

But the point is that sentiment is turning positive, and in the last few days its share price rally has even begun to outpace the equally impressive rise in the FTSE 100.

Sadly that uptick in sentiment and share price hasn’t extended much beyond Tui (and Easyjet) with Thomas Cook’s equity still stuck in the doldrums – at 13.5p they’re down 8% since the beginning of the year.

But even at Thomas Cook some brave institutional investors claim to spot tiny specks of hope – as one distressed bond trader put it to me this week:

“I’d say that Thomas Cook might be able to salvage some dignity from the mess if it can show that it’s getting enough cash on to its books to keep the bond vigilantes away from the door”.

Another institutional equity investor also suggested that if Thomas Cook can get itself past the spring, “we might think about joining all those speculative private investors taking a punt on Thomas Cook surviving in its current form”.

Cruise operator Carnival has, perhaps not unsurprisingly, had a miserable January given the Italian disaster and its shares are down 9%, yet even here there are some glimmers of hope.

I’d suggest that there’s no real risk of demand capsizing – most investors realise that the disaster was 90% ‘idiosyncratic’ risk as one investor put it, which is a polite way of blaming the captain.

Very few analysts I’ve talked to expect much weakening in the medium- to long-term demand for cruise holidays, and some even think that cost-conscious travellers might be tempted to look again at a cruise holiday if prices remain weak in the next few weeks.

But two potential clouds still remain on the horizon: class actions against Carnival and the oil price.

If legal actions remain in the European juridical arena, Carnival should be in the clear but in a new world of globalised litigation and external investors backing class actions, Carnival must be worried that some plaintiffs will be tempted to try their hand in the US courts.

As for oil, the risk is obvious. Carnival’s shares and indeed its whole business is a massive and unhedged play on oil prices. 

The bad news for Carnival – and indeed everyone in travel – is that according to an analysis from Swiss private bank Lombard Odier, oil prices will almost certainly need to remain above $100 barrel. 

This $100 number is an important threshold for OPEC member states, as it implies that they can afford to finance the cost of their “social programmes to contain unrest in the Middle East and North Africa”.

The Swiss analysts also suggest that fears of an Iranian inspired blockade are over-done.

The most obvious point is that Iran will not want to annoy one of its last remaining allies – China, which happens to receive most of its oil via the Straits of Hormuz. 

The Lombard Odier analysts also note that there’s more slack in the system than we might imagine – US Strategic Petroleum reserves have increased by 1,412% over the last 32 years and the number of consumption days they can cover has increased from 2.5 in 1978 to almost 37 days now.

This huge buffer of oil makes “the US much less dependent on imported oil in the event of a temporary disruption”.

Equally, estimates of Saudi’s spare capacity stand at around 2.5 mmb/day while Iran’s production level is about 4.3 mmb/day – that means that “Saudi’s spare capacity can cover close to 60% of the shortfall should all Iran’s production disappear from the market”. 

For a cruise operator such as Carnival – and the major airlines for that matter – the prognosis is mildly positive, with oil prices continuing to stay high but not at levels that will snuff out any growth.

The Big Picture? The Global Economy recovers….slowly

Stepping back from the travel market, the last few weeks have seen a new consensus emerge over the prospects for the global economy overall – the title of a recent Barclays paper probably best term sums it up, ‘Cautious Improvement’.

Like many economists and analysts in the world of investment banking, the Barclays team claim to have spotted a broad improvement in the pickup of new orders, especially in the US and India.

This positive view is backed by the recent US non-farm payroll survey which was surprisingly positive – according to one trader (Marcus Bullus at MB Capital) these positive US jobs numbers were a “humdinger” which “smashed expectations and will be a fillip to markets globally. The US economy is growing and it’s continuing to add jobs at an impressive rate”.

And the good news doesn’t stop with the US. The last few weeks has seen a significant rally in prices for Euro area government and bank debt, with yields on Italian debt in particular falling to recent lows.

The key factor is a massive new programme by the ECB called LTRO, which is basically a huge bailout of the banking sector performed under the guise of supporting the liquidity of banking through the ‘repo’ markets.

Be under no illusions as to what’s really happening though– the German government may not want to bail out Mediterranean governments directly but the LTRO programme is an enormous boondongle for banks who are then using the fresh injections of liquidity to buy local government debt – i.e its a covert Eurobond programme designed to keep the Germans happy.

The Dark Cloud? The UK

So good news all around, even here in the UK? Sadly not.

Lots and lots of potential ‘macro’ risks still lurk in the shadows, not least that Europe comprehensively mucks it all up, although most investors expect the Eurozone to just about wing its way through the mess.

The really bad news is that the UK economy looks even worse than any of us first thought – the canary in the coal mine for the league of dismal economists is money supply, which has been utterly dreadful in recent months.

UK money supply contracted sharply in December – news wire Dow Jones reported that one measure of broad money contracted by £11.5 billion in December or 0.7% per month, while the broader total money supply shrank by a scary £28.8 billion.

And just in case these numbers weren’t bad enough, the Bank of England also reported that net unsecured lending to consumers fell by £377 million in the month, the largest fall since April 1993, while net lending to businesses fell by an ever-so-scary £5.5 billion.

Be under no illusions as to what could happen next – we could be one step away from a deflationary downwards spiral just at the moment when UK government spending cuts kick in.

Banks are not lending because no-one wants to borrow while consumers are cutting back borrowing and slowly (from a low base) increasing savings.

This caution and abstinence is now having an inevitable effect on money supply, with significant falls in the inflation rate likely over the next few months.

Faced with this precarious situation, another bout of quantitative easing is almost certain (probably in the order of £50 billion), as is a less than subtle attempt to devalue sterling again.

I’m guessing that somewhere in a darkened room in either the Treasury or the Bank of England, someone has a chart suggesting a target rate of £1.05 to the Euro and $1.40 to the pound.

That’s horrible news for the UK outbound travel sector, and a grim start to 2012.

On this ever so slightly depressing note I’ll leave you with a few words of warning from the past, from eminent economist JM Keynes.

For Keynes the dangers of encouraging savage cutbacks in both consumer and government spending at the same time were very real, especially when enacted without a massive programme of debt forgiveness and credit write offs.

One of the reasons that US consumer spending is rising again is that countless tens of millions US consumers have had their mortgage debt written down, freeing them from the shackles of expensive houses and unaffordable debt.

Here in the UK house prices are still far too expensive and banks are unwilling to slash debts.

Any business dependent on UK consumer spending needs to listen carefully to the words of Keynes and hope that someone, somewhere has a plan to deal with the mountain of UK debt.

If they don’t, we’re facing a decade or more of depressed consumer spending.

“For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself.” – JM Keynes (underline added by author)


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