Tui has been transformed into 'almost boringly dependable stock' argues David Stevenson as he reviews the group's full-year results and the sector's recent share performance
‘Tis almost the season to be merry so I thought I would look back at share price performance for 2015 as an indicator of how far the travel sector has come in recent months.
To be more specific I thought I’d look at share price performance in the last six months, because this is a much more interesting time frame.
What I find curious is that investors seem to be content to bid up the share prices of those businesses where capacity is expanding at an astonishing rate – the low-cost airlines.
Ryanair and easyJet shares have raced ahead this year, but even the most somnambulant investor must realise that at some point in 2016 or 2017 there will be an enormous capacity crash, sparking a price war of epic proportions.
The great turnaround story has been FlyBe whose shares shot up 66% over the last six months, although from very low levels after its profit warnings.
For now, investors seem to be buying the recovery story, although given the likelihood of a price-cutting bloodbath in the airline sector I wouldn’t be quite so confident.
The great success overall has been from the upstart Dart group, operator of the Jet2 brands. Its shares almost doubled in value over the last year and rose 35% in the last six months. The regionally focussed operator has made a successful move into packaging holidays and the City seems to be lapping up the story.
The share prices of travel industry giants Tui AG and Thomas Cook, by comparison have drifted lower, especially over the last six months – down 6% and 17% respectively.
Both are now relatively lowly rated by the City, yet both seem to be making great strides in curbing past capacity overshoots and are intent on improving profit margins.
Thomas Cook has obviously faced its own challenges not least the news that its major Chinese partner Fosum is in turmoil as its founder pops in for a chat with the Chinese police. The timing is terrible and underlines why so many investors have been cynical about strategic tie-ups with Chinese majors.
For me, the most interesting story here is that Tui looks to be making a transformation into almost boringly dependable stock, paying a dividend of a shade under 4% off the back of a global franchise that seems to be firing on all cylinders.
At least that is the message from Tui’s results announced last week. These numbers contained an interesting mix of stuff we already knew and a few surprises.
In the ‘what we expected’ category, the big story is top-line growth. The stand-out story was those growing profits, consisting of a 15.4% increase in full-year earnings (to €1,069 million) helped by a 23% increase in turnover (to €20 billion), with potential for another 10% growth in earnings in 2016.
These numbers reflect a particularly strong performance in Tui’s Northern Region, Hotels & Resorts and Cruises.
Another highlight was the solid balance sheet which appears to be steadily improving – the net debt position is at €214 million.
This impressive cash flow in turn helped Tui boost its dividend pay-out – the company said it would raise its dividend per share from 33 to 56 cents.
Sticking with the balance sheet, there seems to be progress on tidying up the group’s structure with Hotelbeds likely to be sold for a few hundred million euros in early 2016 and shares in shipping giant Hapag Lloyd up for sale.
The group is also benefiting as expected from its ownership of a fleet of Boeing Dreamliners, allowing it to expand its long-haul offerings and cut costs per seat.
Digging into the operational side, the Specialist travel division yet again turned in excellent numbers although the real profits machine is the differentiated package hotels product.
Moving forward, the core brands will be RIU, Robinson, Magic Life and the new hotel brand TUI Blue.
According to Tui, the offering will be rounded off by the internationalisation of three hotel concepts – Sensatori, Sensimar and Family Life.
UK trading continues to be strong for Summer 2016, with bookings up 11% and 24% of the programme sold at this early stage. Average selling prices are flat, but “trading is strong across short, medium and long-haul”.
There were a few genuine surprises. Investors had been expecting the worst after the terrorist incidents in Tunisia and Egypt, but the anticipated exceptional losses seem to have been more than covered by growth in medium-haul routes such as the Canaries and long-haul destinations like Mexico.
Integration of the English and German businesses also seems to be going much better than many cynics expected.
Tui now expects to deliver cost savings of €50 million per annum (previously €45 million) from 2016-17, mainly from consolidation of overlapping functions.
But for me the stand-out surprise was the growing scale of the cruise business. The current year has seen big advances with the full-year benefit of Mein Schiff 3 (launched in June 2014) and the launch of Mein Schiff 4 in June 2015.
TUI Cruises currently operates four ships in the “high growth, underpenetrated premium German market”.
The cruise business is also pushing ahead in the UK with a five-ship fleet, and with more modernisation on the way starting with the acquisition of Splendour of the Seas in Q2 2016.
This is important for Tui as it pushes the group away from its traditional package airline holiday reputation into a sexier cruise segment, with higher accompanying share prices.
It’s hard to find too much fault with Tui’s numbers. Some analysts have picked up on the fact that business in Germany was weaker than expected.
The group noted: “Germany’s result was adversely impacted by continued competitive market conditions, investment in distribution and an additional airline pension charge in the final quarter, offset partly by the delivery of further operational efficiencies”.
But matters should improve in 2016 as the euro zone picks up speed, so hopefully this won’t be a long-term drag on performance.
I would also highlight a (manageable) risk around the capital position of the business. The debt position of Tui is more than comfortable at the moment, but there are a lot of capacity commitments within the plan, including many new planes and ships, all of which need to be paid for out of the same cash flow that will be dragooned to help service the increasing dividend.
Tui’s ‘asset right’ strategy isn’t asset lite and although there is a target to get the net debt position down to approximately €0.5 billion at year-end there is an additional €0.7 billion of asset-backed finance on the balance sheet, “primarily in relation to new aircraft deliveries under finance lease, as well as the acquisition of Europa 2 which was mainly debt-funded”.
In total, gross debt is running at €1,653 million with interest cover targeted to hit 4.5 to 5.5 times interest.
As long as the European economy pushes ahead these numbers are nothing to worry about, but investors will be keeping a beady eye on capacity commitments.
The big question many will be asking is whether the good times the business is currently enjoying is encouraging management to spend too much on capital expenditure?
One last important caveat – oil prices are likely to carry on plunging in the next three to six months which should provide an earnings boost in 2016, although any impact will be limited by hedging.
But remember that at some point oil prices will bottom out (probably around $20) and with the business currently hedged 60% for fuel in winter 2016-17, investors will be worried that a sudden rebound in oil prices in late 2016 could be a major headwind.
Now is not the right time to take a corporate eye off the hedging dilemma.
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