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Published 03 April 2013 07:34, Updated 03 April 2013 14:56
Flight Centre is one of the stocks that more conservative investors that want exposure to the travel sector should look at. Photo: Mayu Kanamori
Investing in travel-related stocks must feel like a mystery flight at times. They look exciting and cheap, but where they end up is anyone’s guess, such is the unpredictability in the tourism and aviation sectors. The only certainty in recent years has been losses far outweighing gains.
On one side are tourism and large airline stocks that have become disasters for long-suffering shareholders. On the other are companies that host or organise air travel and tourism. Some have produced spectacular gains and have further to run as confidence improves.
Flight Centre is a good example. It soared from a 52-week low of $17.01 to $33.45 as the market re-rated its growth prospects and international expansion. Flight Centre was rated the best travel stock (at $27.11) in my BRW column of November 15 last year.
After rapid price gains, Flight Centre is due for a pause. It looks fully valued, but any significant price weakness would provide an opportunity for long-term investors to buy into one of Australia’s highest-quality listed companies and best-known brands.
Flight Centre delivered another solid earnings result in difficult conditions. Revenue rose 7 per cent and underlying earnings rose 8 per cent in the December half. Earnings guidance was maintained and the company is marginally ahead of its targeted full-year growth after eight months.
If it can achieve consistent earnings growth in a soft domestic leisure market, what will it do when the market improves? Corporate travel, about a third of Flight Centre’s total transaction value, has good prospects because online travel sites are less likely to make big inroads into the business travel market.
Global expansion is another attraction. Flight Centre’s strong balance sheet and a scalable business model can support rapid offshore expansion. Its international operations, about 10 per cent of earnings, will contribute more in coming years.
Improving travel demand will be another plus for Flight Centre and other operators in the next year or two. The high Australian dollar, likely to ease this year, will remain sufficiently elevated to encourage more overseas holidays. Intense competition among airlines and airfare discounting is unlikely to go away, meaning outbound travel will remain strong. And inbound tourism trends are slowly strengthening, with 6.1 million visitor arrivals for the year to January 2013, up 4.1 per cent on a year earlier, according to Australian Bureau of Statistics data.
The missing piece for travel operators is the domestic market. Leisure travel is sluggish and business travel patchy as companies and government departments cut costs. Price deflation in airfares is another challenge, and the mining downturn is hurting airlines that service fly in, fly out workers.
Watch the domestic travel market improve once the federal election is held, a new government takes power, and business and consumer confidence firms.
Watch the domestic travel market improve once the federal election is held, a new government takes power, and business and consumer confidence firms. Rising property prices and sharemarket gains this year, and interest-rate cuts in 2012, have already buoyed confidence: the Westpac-Melbourne Institute Index of Consumer Sentiment rose slightly to a two-year high in February.
Even so, a rapid improvement in domestic travel demand is unlikely if unemployment nudges higher as the mining investment boom tapers. But there is enough evidence to suggest some of the headwinds for travel-related stocks could weaken, if not turn around, in the next 18 to 24 months.
The market is clearly betting on a recovery. Online travel operator Webjet has a one-year total shareholder return of almost 50 per cent. It looks fully valued and due for a pullback.
Wotif.com, rallying from a 52-week low of $3.84 to $5.04 also looks fully valued, and its interim result disappointed. The much smaller Corporate Travel Management, a 2010 float that raised $21.7 million and listed at $1 share, has soared to $4.47 after a string of impressive results, making it too pricey for value investors.
Contrarians could look closer at Jetset Travelworld, which seems to be forming a share-price base after heavy falls in 2011 and 2012. But an 8.8 per cent decline in revenue for the December half, and 22.9 per cent decline in net profit was further confirmation of the tough domestic travel market, and investing in turnaround stocks always has higher risk.
With travel stocks at full prices, airport and beat-up airline stocks could be a better contrarian play for long-term value investors seeking travel-industry exposure.
Sydney Airports has fallen from a 52-week high of $3.63 to $3.23 amid concerns about a possible challenge from the Australian Taxation Office regarding distributions from certain redeemable preference shares.
The stock’s underlying performance continues to impress. Sydney Airports reported a full-year 7.4 per cent rise in earnings before interest, tax, depreciation and amortisation (EBITDA) to $848 million, with passenger numbers rising 3.6 per cent to a record 36.9 million.
Sydney Airports has an enviable long-term record of outperforming the market, but prospective investors should wait to see how the ATO tax position paper unfolds. An adverse determination would result in an extra $79 million in tax (before interest and penalties), on the company’s forecasts.
Airline stocks could be the travel sector’s surprise winners, despite Qantas and Air New Zealand having delivered shareholder losses over 10 years, and Virgin Australia Holdings disappointing over the past five years. Weak domestic demand and rising fuel costs have hurt.
Airline stocks worldwide have a habit of destroying shareholder wealth. The industry is capital intensive, fiercely competitive, has low barriers to entry, and low switching costs, with consumers being able to move easily between airlines to find a better price. Industrial relations and high sensitivity to changes in fuel costs and the Australian dollar are other problems.
But every stock has its price. Qantas has rallied from a 52-week low of 96¢ to $1.76. A break towards $2 would be an excellent signal for technical analysts, who study share-price patterns, and it would buoy fundamental analysts who believe multi-year laggards, such as Qantas, have plenty of ground to make up as the sharemarket rally continues.
Airline stocks have been a good way to burn money in recent years but groups such as Qantas and Air New Zealand may make reasonable investments if they begin to catch up to the rest of the ASX.Photo: Reuters
Air New Zealand (the ASX-listed version) has risen from a 65¢ low to $1.22 and its 2012-13 first-half result beat analyst expectations. Cost savings and a return to profitability by its international division are good signs.
Air New Zealand looks like it is getting its act together, and could have further to run. However, its earnings are volatile, fierce competition from Jetstar could drive airfares even lower, and domestic travel demand in New Zealand is sluggish. Still, it looks the pick of the airline stocks.
Micro-cap airline stocks Regional Express Holdings and Alliance Aviation Services (a 2012 float) also have virtues. Unlike most airlines, the well-run Rex has delivered a consistently solid ROE, but its revised full-year earnings guidance is 35 to 40 per cent below the previous year, due to soft domestic demand and reduced charter flights for mining companies. A recovery looks some way off.
Alliance Aviation Services is also heavily exposed to the fly in, fly out travel market. It has done well since listing, up from its $1.60 issue price to $2.06. As mining companies continue to cut costs and defer projects, Alliance and Rex could be under increasing pressure. But both stocks warrant a place on portfolio watchlists for investors comfortable with small stocks.
Conservative investors should stick with Flight Centre, while those comfortable with higher volatility should keep an eye on Air New Zealand.