City Insider: The Thomas Cook recovery story is losing its lustre

City Insider: The Thomas Cook recovery story is losing its lustre

City Insider - FT journalist David Stevenson on the travel industry

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City expert David Stevenson says investors are going cold on Thomas Cook's prospects as the travel giant should be making hay while costs like fuel are so low

Without wanting to put a dampener on the summer – and the buoyant state of the travel sector as evidenced by Tui’s decent numbers last week – I must admit to having that sinking feeling again about Thomas Cook.

The shine has well and truly come off this remarkable recovery story and more and more investors I talk to are privately worrying that the travel giant is in a bind.

To be fair there is absolutely no sense of an impending crisis and the group is clearly trading satisfactorily but there’s also a brutal realisation taking hold amongst many in the square mile.

Put simply the job – restructuring and even downsizing - is very, very far from being done and that not enough is being done to make hard profits during the current upswing.

Be under no illusions: 2015 and probably 2016 will be great years for the travel industry, likely followed by much leaner years as interest rates start to rise again.

Consumer spending across Europe is picking up, energ y prices are tumbling and interest rates are low.

And while we’re on the subject of falling costs, I’d suggest that we are now entering the final leg of the great energy market crisis. As I’ve long predicted, we are now about to see a decisive break below $45 for West Texas crude with $30 a barrel the next step.

If I’m right I can’t think of a more benign environment for a major travel business to make hay.

Yet Thomas Cook is struggling to fully capitalise on this environment. The share price tells a simple story which is that investors are getting cold feet, helped along by analyst sentiment which has turned decidedly frosty with only outfits like Numis sticking with its buy recommendation on the group.

Gone are the days when Cook’s shares was trading well above 140p – its shares are currently at just 114p, with 100p the likely next stop on a rollercoaster journey over the last year.

To put some perspective on the plight of Cook’s share price, compare its share price fall against Ryanair and newest travel whizz-kid on the block, WizzAir.

Ryanair has seen its shares advance 15% in the last three months, WizzAir a storming 26.7%. Tui’s is down 16.9% but Thomas Cook has suffered a dizzying 28% fall.

At the moment the short interest in the shares (funds looking to make money from selling shares) is still fairly subdued by hedge fund standards, but outfits like US firm World Quant LLC are slowly building a noticeable stake.

The most recent numbers from the end of July (the 30th) paint a depressing picture. The business is still painfully constrained in margin and cashflow terms, while ‘events’ (previously Tunisia now Greece) continue to smash into the profits.

Added onto this is a worry among some that the group’s tie up with Fosun (owners of Club Med) is an unnecessary diversion from the difficult task of downsizing and righting the business.

The trading numbers from July for the third quarter clearly put a dampener on market sentiment although there was plenty of good news sprinkled in amongst the surprises.

Net debt is now falling fast – down £111 million to £392 million. Operating profits also increased £53 million, making this the twelfth consecutive quarter of improved profitability. And yes, summer holiday bookings to most destinations were “in line with expectations”.

But Tunisia and Greece have been causing no end of angst, not helped by a foreign exchange translation impact which is now expected to take a £39 million chunk out of full-year 2015 numbers.

Stepping further back, revenue has declined over the quarter while underlying EBIT remained an anaemic 1.5%, producing a net profit from operations of just £3 million.

On a trailing 12 months basis the revenue has also been falling and although EBIT is up at £334 million the actual profits from operations is running at just £163 million.

The UK seems to be holding up well – as one would expect – but there have clearly been major problems in continental Europe where “margins have been impacted by tough market conditions in Germany, as we have previously reported, and by weak demand in France for MENA destinations”.

If we are generous and accept that the coming year will produce better numbers, I suppose it’s plausible to accept analysts’ estimates of profits of around £200 million for the full year.

Given its declining revenues and low margins, plus that debt, I can’t see why the business should be valued at multiple of six to seven times earnings implying a market value of around £1.3 to £1.5 billion which is well down on the current £1.78 billion valuation.

Turning to those events, investor’s should also be under absolutely no illusions about a number of givens. The first is that Syria and Libya will both get much, much worse before they get any better.

That implies more migrant mayhem (bad news for skint Greece, which accounts for around 15% of passenger volumes during the summer season) , as well as more disruption and more political pain through the Med.

The second factor is Egypt and Turkey are likely to be rocked by intense political turmoil – with the Turkish president almost certain to use war as an excuse to boost his party’s vote in a likely imminent general election.

The last factor likely to cloud the geopolitical environment is Russia. Oil prices are collapsing and that’s indisputably making life tough for everyone’s favourite Slavic strongman.

My guess is he’ll make an attempt to destabilise the Baltics fairly soon but he won’t be the only ruler feeling the pain of drastically lower oil prices. Watch this space as the whole regional political architecture of the Middle East comes crashing down fuelled by the end of the era of expensive oil.

Which brings us to those folk from Fosun and their marketing and distribution partnership with Club Med.

This is being run in parallel with an ambitious hotel investment vehicle which will help push forward Cooks already ambitious plans to push into differentiated products.

Frankly I sense that investors would much prefer it if Fosun did the decent thing and bought Cook outright rather than divert precious management time to all these ‘relationship’ projects.

Overall, I can’t help but think that Fosun is getting a lot more out of this than its UK based partner. Arguably Cook needs to be spending every hour of every working day working out how to a) aggressively scale down key bits of the business whilst also b) aggressively ramping up its higher margin business units.

That might mean ditching ambitious digital growth plans, selling even more businesses (including the airline) and then reinvesting every last pound, shilling and pence in moving upmarket.

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