In association with Travelport
David Stevenson takes a broad look at the UK and global economic landscape as the UK prepares to go to the polls, and assesses the prospects for regional travel champs Jet2 and Flybe
This month I’ve got what in effect amounts to an alert about the economy as well as the markets plus a quick catch up on numbers for two regionally focused travel champs, Dart Group (owner of Jet2) and FlyBe.
Both are at a crucial cross roads, with the some big risks looming on the horizon.
First the helicopter view about what to expect from the economy – and the aftermath of the general election.
The key point is that all this talk about deflation masks a very real concern that the global economy is slowing down.
In fact the slowdown is so noticeable that some investment bears/cynics think we are collectively on the verge of another great recession. I’m not so sure they’re right.
My own core view is that the slowing growth rates that are increasingly evident in both the US and the UK aren’t harbingers of a new global recession.
Yes, US corporate earnings growth is slowing down. Yes, the UK export sector is having a tough time.
It’s also indisputably true that UK national growth is currently being sustained by consumer spending, partly financed through increased levels of debt and lower savings.
All of these powerful drivers are present and of concern. But I think this bearish picture somehow assumes that growth is always linear (upwards) and never bumpy.
Growth scares happen, and my own suspicion is that this summer we’ll (yet again) see another uptick in fear and panic, followed by a quietening of the fears towards the end of the year.
The Eurozone expansion, helped along by Euro devaluation and its own version of Quantitative Easing is going to make a huge difference.
But the summer is going to be a rather brutal affair in my humble opinion, made much worse by what are in effect three very specific short term volatility bumps – even lower oil prices, Greece leaving the Eurozone and UK volatility post an election.
I’ll explore each in short detail below but the overall impact will be obvious – fear levels for investors will intensify, market turbulence will increase, and central banks will switch to a reassuring mode and delay interest rate rises (again!).
Core economic data will then emerge at some point post summer that will suggest that fears of a global recession are largely misplaced and investors will feel cheerful again.
Let’s starts with oil. My own core view is that despite being very long (bullish) energy equities, oil has not found a sensible market clearing price.
With the OPEC summit fast approaching in June I wouldn’t be remotely confident that the Saudi’s have ‘done enough’ to reduce global supply.
In particular I’d take great care in examining rig statistics coming out of North America – the Saudi’s want to see a massive drop in horizontal drilling rig deployment. A recent note from analysts at Goldman Sachs suggests that this is very, very far from happening.
Goldman Sachs analysts Damien Courvalin last week told his investors that their research has discovered that “ the current US oil rig count points to US crude oil inventories rising again during this coming Fall’s refinery turnarounds”.
The Goldman’s analysts conclude that “while the decline in the US rig count has been faster than we expected, it remains insufficient in our view. The recent stabilisation in the rig count therefore leaves us reiterating our forecast that prices need to remain low in coming months to achieve a sufficient and sustainable slowdown in US production growth”.
Personally I’d go a lot further than this GS analysis and suggest that we need to see oil prices slip below $40 a barrel before we see any meaningful long term decline in oil supply, especially in North America – with a possible low of $20 before the summer is out.
My next concern is Greece. Having long believed that the Greek government didn’t actually want to precipitate an exit from the Eurozone, in the last few weeks I’ve been quietly changing my view.
The current socialist government is clearly not going to, so early in the game, entirely ignore its resounding electoral mandate for an end to austerity.
I’m also increasingly puzzled by how the EU Troika can possibly allow anything that isn’t a massive climb down for the Greek government in front of its electorate.
Add to all this, I’m also a little disturbed by the harsh rhetoric deployed by both sides – a tactic that doesn’t seem to be a very productive way to negotiate such an important settlement.
Crucially, many hedge fund managers have told me that they are very concerned that both the ECB and the Greek central bank are making very advanced, practical plans for a currency separation.
I hope that all this ‘bad blood’ is just war game planning and that sense will prevail but I’m not sure that will be the case anymore.
Both sides seem to be pushing themselves into a corner. Just a few months ago I would have put the chances of a Greek exit – Grexit – at less than 20%, whereas now I’d suggest it’s closer to 50%, and creeping inexorably higher by the day.
Put bluntly a whole series of repayments will be needed in the next two months and unless a new deal is in place, technical default is looking an inevitability.
Turning to the UK, the macro risks are vastly diminished compared to our Agean cousins.
Despite the rampant rhetoric of the general election campaign, the main parties are not in fact a million miles apart in their policies about fiscal responsibility and business policy.
There are differences between the parties – big ones that matter – but they’re not irreconcilable.
Some investors I’ve spoken to at the international level admit to being cagey about Labour plans, for instance, but no one is seriously suggesting that a big sell off will result from a Labour win.
What is concerning investors though is the lack of a government mandate and a general reluctance post-election to confront difficult structural issues – a worry that could apply to all the parties.
Investors can usually be reconciled to most major party manifesto platforms but they’ll be deeply un-nerved by zombie minority governments forced to soldier on while the UK slides into acrimony and constitutional uncertainty.
Investors will be especially worried about the UK’s deep structural imbalances ie our worsening balance of payments and accelerating levels of consumer debts.
I think Paul Jackson at Source ETFs captures this concern very well in the following observation – “in many ways, the UK is looking more and more like the sort of badly managed and imbalanced economies that the British would have called “Bongo-bongo land….The BoE might be about to hike rates but short term uncertainties and long term disequilibria suggest sterling may have to go lower”.
I’m willing to speculate that we could see a nasty run on sterling before 2015 is out, with foreign investors aggressive sellers of British shares and bonds.
The timing of this move could be dreadful, with political uncertainty legion and the Bank of England desperate to increase interest rates as local inflation rates start to increase following what, in effect, would be a sterling devaluation.
What impact will all this turbulence have on the travel sector?
Lower energy prices represents fantastic news for the UK consumer and I think we’ll see another energy dividend finding its way into consumers’ pockets ready for summer 2016.
Weaker sterling, though, will make those foreign holidays much more expensive but this may be helped along by the sad reality that even if the Bank of England does manage to raise interest rates later on this year, it’ll almost certainly have to bring them down again sharply as the economy threatens to contract.
So, overall I think the UK consumer revival will remain fairly robust and we should all benefit from a resurgent Eurozone – I’d bet that the recovery underway in Germany and to a lesser extent France will be much stronger than we all believe possible.
So, in summary I’d say the recovery will remain intact though it could look a little battered and bruised.
Which brings me nicely to two regional travel champs Dart and FlyBe.
I was quietly impressed by the trading statement from Jet2.com’s owners Dart Group a few weeks back that operations were running “ahead of current market expectations and broadly in line with last year (2014: £49.2m), as a result of lower than anticipated winter losses.
“Looking ahead to the year ending 31 March 2016, forward bookings in the Leisure Travel business for summer 2015 are encouraging, with over 50% of the season having already been sold, which is ahead of where we were at this stage last year.”
What was even more curious was that Dart Group has recently acquired a new shareholder in the shape of Crystal Amber.
This is a fascinating UK stockmarket fund run by a very successful investor called Richard Bernstein.
The fund’s own website describes it as “an AIM-listed activist fund investing predominantly in small and mid-cap UK equities where it identifies opportunities to enhance long-term shareholder value through active engagement with companies”.
Let’s just say that I would emphasise the word ‘active’ – Crystal Amber takes decent-sized stakes and likes to see its holdings move up a gear in terms of corporate delivery.
The fact that a highly successful business like Dart has been targeted is not surprising – its share price has risen but it’s still relatively undervalued compared to its peers.
My guess is that Bernstein is looking to maybe unlock some of the value within Dart Group by getting the haulage business spun off.
Alternatively he may start asking some pointed questions about how much capital the fast expanding holiday business is going to suck up – growing capacity takes a great deal of cash flow which investors might start to balk at.
I hope it doesn’t come to that as Dart has produced something of a travel industry miracle, namely building a well-run growth business within a publicly listed vehicle.
As for FlyBe the gods aren’t smiling on Saad Hammad, chief executive of the regional airline.
He’s made huge strides in turning around the business although he’s encountered more than a spot of turbulence with his aggressive move into London City airport.
But its share price tells an alarming story. My worry is that the share price is becalmed at below 100p with the 50p a share level absolutely crucial.
At the moment the short interest in the shares is very low (short interest tells us how many hedge funds and institutions are looking to profit from a falling share price).
But if the shares take another hit and lunge below 50p the short sellers could start emerging from the woodwork.
If this did happen it would be a huge tragedy as I think FlyBe has a decent chance of turning into a reasonably profitable business although it has to try to a) find a way of getting rid of the small fleet unwanted aircraft on its books and b) make sure that it runs capacity at enough frequency to keep both the business and leisure customer base satisfied.
I’d suggest Flybe is not quite out of the danger zone yet and any more nasty surprises could be terminal.
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