City Insider: The outlook for travel

City Insider - FT journalist David Stevenson on the travel industry

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City Insider David Stevenson considers how listed travel companies could fare in the coming months

If a more positive assessment of opportunities is right, as I outlined yesterday, what can we expect from the travel sector in the next six months?

My view is the big airlines will have the biggest upside, as both Tui Travel and Thomas Cook may struggle with company-specific issues.

In the case of Thomas Cook there is still a need to develop more differentiated, higher margin product in order to boost top line revenue growth.

There is also a requirement to generate enough additional cash to get debt levels down to sensible levels, although quite how one can invest in new product as well as pay back the banks at the required rate escapes me.

At Tui Travel we should expect steady-as-she-goes growth against the backdrop of that all-important merger with Tui AG.

Tui’s recent numbers ticked all the right boxes, with the differentiated mainstream product continuing to sell well.

I’m not going to rehash all the major numbers from the third-quarter results – a 21% jump in profits, with underlying operating profit on a like-for-like basis hitting £92 million compared to £76 million in the same period last year – but Tui appears to be ‘on plan’.

The big challenge now is to sell the merger deal to investors. As the weeks tick by I would say the chances of securing investor approval are declining dangerously below 50%.

Great numbers on the trading front plus Tui AG’s declining share price makes for a very unappealing mix in my view – an opinion shared by more and more travel analysts.

I’d argue the airline sector should see the biggest upside from here on in – with IAG my candidate for most growth.

The recent second-quarter numbers were especially impressive, with the British Airways/Iberia/Vueling combo raising its pre-exceptional operating profit by 55% over the quarter. At the half-year level, the group swung from a loss of €33 million last year to a profit of €230 million.

The big story here is that group revenues were up around 6% – no scaling back on capacity – while Iberia has clearly turned a corner and is about to see sustained investment in new capacity.

Unit costs are declining sharply, with growth on long-haul routes especially into emerging markets. The only concern seems to centre on the group’s cargo business where revenues, yields and volumes continue to fall sharply.

The key development at IAG is the growth of the fleet – 16 new aircraft will be delivered between 2015 and 2020, with eight new A350-900s and another eight A330-200s.

These efficient new planes will help boost profits, especially as oil prices start to fall back.

The other big beneficiary of a sustained increase in UK, US and even European growth rates should be Ryanair.

Although easyJet has been the clear winner for the last few years, Ryanair’s underperformance based around brand ‘issues’ should mean it benefits most from a turnaround in sentiment as growth picks up again.

Recent quarterly numbers from the low-cost carrier confirm the turn in its favour.

Helped by the inclusion of Easter in first-quarter numbers, Ryanair raised its profit guidance for 2015 partly off the back of higher volumes and lower costs.

Ryanair more than doubled its first-quarter profit to €196 million and operating profit increased 124% to €232 million. Seat capacity remained essentially flat while average fairs increased 9% and passenger numbers were up 4%. 
Crucially, the group should also see the first fruits of its ambitious ‘rebranding’ exercise.

The “Always Getting Better” programme should be powering ahead, helped by the launch next month of Ryanair’s business traveller service plus a raft of technology launches and app updates.

As with IAG, the key factor will be increased capacity – powered by the delivery of new aircraft.

Ryanair plans to accelerate capacity growth over the next few quarters, which should help compensate for increased growth in unit costs (in part to pay for all that marketing).

The big question mark surrounds yield in the second half. Will extra capacity and higher spending result in lower average prices or will Ryanair be able to increase prices to pay for a more friendly service?

My guess is Ryanair will surprise to the upside – perhaps forcing easyJet to retaliate with its own wave of price cuts.

Perhaps the most interesting turnaround challenge will be at Flybe. I suspect the regional carrier was a few months away from a meltdown as losses escalated, cash started to run out and the new management team struggled to cut costs.

A £150-million fundraising among investors helped steady nerves, while new boss Saad Hammad reported some positive trading numbers in June – including a return to profit (£8 million) and an increase in revenue (up 1%).

Investors will now be watching two factors – costs and new capacity.

Aggregate costs were down 4.2%, with labour costs down 17% (helped by a loss of more than 1,000 employees).

But my guess is we are only at the beginning of a long journey on costs. Flybe’s hideously expensive cost base is an open invitation for Ryanair to take a pot shot.

The other issue will be how to manage capacity – by cutting old aircraft and upgrading to new – at low cost.

The 70-strong fleet desperately needs to be upgraded, but I’m not sure how Flybe can afford to pay for more-efficient planes.

Hammad’s focus on the five Ps – performance, positivity, passion, people focus and playfulness – will be essential if the airline is to grow the top line.

But I’m not sure how this emphasis on ‘soft touch’ issues will help with the bottom line and profits, which will be determined by revenue growth, fuel costs and increasing capacity on key routes.

Maybe a resurgent UK economy will help push profits higher – especially as business travellers increase spending – but my guess is Flybe desperately needs to sell more tickets to leisure travellers at lower prices.

Sourced from Travel Weekly

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