Are things looking up in the UK travel sector?

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Around the world, businesses linked to the travel and tourism sector have had a torrid time of it lately. COVID, global travel restrictions and now major staff shortages have hammered all air carriers, but British companies are among the worst affected.

Interestingly, some analysts think the sector could be due a comeback. Both businesses operating in the tourism sector and retail investors with exposure to the UK’s FTSE100 index will be heartened to hear that the prospects for a strong recovery are quite good. British Airways holding company International Airlines Group lost more than 60% of its share value in the first few weeks of the Covid pandemic in 2020, as massive layoffs and the seemingly indefinite shutdown of most international travel ravaged their business.

Since then, the stock, which is a consortium of British and Spanish airlines and one of the bellwethers of the tourism sector overall, has not returned to anything like its pre-2020 peaks. However, performance over the last few months has been strong: the complaint at British airports is now one of too many passengers, rather than too few.

The knock-on effects of this change will be significant. British tourists are vital to the economies of many European countries, and to a lesser extent to several in Asia and elsewhere. Around the world, tourism is gradually creeping back up to pre-pandemic levels. It is important to remember though that not all countries have exited the pandemic at the same rate, with China in particular still seeing regional lockdowns.

A further lockdown would of course be catastrophic, but statements by many governments seem to rule out this possibility. As investors tentatively creep back into these once unloved investments, it’s a good idea to take stock of the overall sector, and see where some potential bargains lie.

What does it mean for investors?

Many investors fled airline stocks in 2020, and few have been brave enough to go back in since. Airlines like British Airways were effectively forced into massive layoffs to stay solvent, but after 2 years of employment elsewhere they are now struggling to win back staff. Baggage handlers in particular are in scant supply, and the situation shows no sign of improving. Given the security requirements of working in an airport, lead times for new staff are considerable. Serious delays are starting to harm the bottom lines of airlines who still haven’t recovered from the lost years of the pandemic.

You’d be forgiven for thinking claims of a rebound of airline stocks is an unlikely call. But this is exactly what multiple analysts are now saying. One possible reason is that the current pressure on airports is a sign of strength rather than weakness; fears that international travel would not rebound seem, for now at least, to be mistaken. Others advise more caution. Airlines have managed to lure back tourists, but still struggle with recruitment. After spending large amounts to keep their unused aircraft flight-worthy for two years, airlines need more than just ‘business as usual’ to remain profitable.

Whatever your view on these disputes, its clear airline have a renewed vigour. Many analysts see a return to pre-2020 pricing in the near future, a move that could quadruple the money of lucky retail investors. But this path is fraught. Even small additional shocks to their business model could see share prices dive again – something no investor wants to be on the wrong end of. That said, anyone looking to add tourism and travel stocks to their portfolio will probably find now an opportune moment to do so.

What are the top travel stocks?

Rolls-Royce isn’t a name that comes to mind when most people think of travel stocks. Interestingly, they are wrong. As the worlds main manufacturer of aircraft engines, Rolls-Royce is intimately connected to the fortunes of air travel and the tourism sector.

Unlike pure airline stocks such as BA, Rolls-Royce is somewhat more diversified. Both its famous cars and also defence contracts with major militaries like the US Air Force allow it to ride through periods of market turbulence that have badly battered other stocks. For investors who are keen to share in the recovery of air travel, but fearful of any future shocks, Rolls-Royce may be the ticket.

Beginning in the electrical workshop of Henry Royce in 1884, Rolls-Royce was born in a 1904 merger of Royce’s prototype cars and Charles Rolls’ high-quality car dealership. The brand saw rapid success and began developing aeroplane engines during the first world war, becoming one of the world’s main suppliers for military aircraft and entering the civilian market in 1953. Selling the car business to German manufacturer Volkswagen in 1998, Rolls-Royce has increasingly focused on their aircraft line and continued to innovate technically, including breaking the speed record for an electric vehicle in 2021.

It should be remembered that Rolls-Royce is also a company in difficulty. Having been forced to sell-off various components of its business, some investors have been frustrated over the years by the various unprofitable side businesses (oil and gas, civil nuclear) that they see as distracting from the overall purpose of the organisation.

How does Rolls-Royce compare to British Airways?

Investors looking to gain exposure to the travel sector have a few options. Tour and cruise operators such as Carnival are struggling under years of cancelled bookings, restructured debt, and an inability to hike prices at a rate fast enough to counteract inflation.

Airlines such as British Airways provide a slightly different exposure, including much of the same upside but with a less – albeit still significant – damage incurred in the last two years. Other than a few budget providers who could not make the payments on their aircraft leases, major national carriers have survived. British Airways has a lead position on many major international routes and wins a large share of the highly profitable business traveller market.

Rolls-Royce is a much more industrially-focused company than BA and accordingly shares trade slightly differently. As a specialist manufacturer with long lead times, high unit cost and sales values, and a focus on R&D, Rolls-Royce does not trade like an airline. Broadly we would expect the share price of Rolls-Royce to follow the fundamentals of the company, the quality of their new products, and general market conditions.

Which should I invest in?

If either or both of these stocks fits into your overall portfolio, it may be worth considering investing. British Airways is perhaps more likely to see a sudden upswing in price, belonging to a more cyclical sector, but Rolls-Royce will appeal more to longer-term, value-based investors. Both are major blue chip British companies and considered ‘sound’ financially, despite their recent difficulties.

What does this mean for the travel industry?

The share price of these companies is both an indicator and a driver or the sectors performance. One of the major costs for airlines is the leasing (or more rarely, outright purchase) of aircraft, which closely tracks the prices set by manufacturers such as Rolls-Royce. Manufacturers are protected from shorter-term fluctuations in the travel industry, but a sustained multiyear downturn in demand could potentially affect their order flow.

The collapse in the user-facing section of the industry is then slightly distant, but still one of the ultimate causes of the declines in share price that led to the two companies’ attractive share prices. Businesses, or employees of businesses, with extensive exposure to the travel industry should then be careful about adding these stocks to their portfolios. Both will likely be correlated with the sectors overall performance.

Key points to take away

Barring a return to travel restrictions, or a severe worsening in overall economic conditions, the British travel sector looks set to continue its recovery. Investors and people doing business in the travel sector would do well to think on the following points:

  • Travel providers, airlines, and manufactures of airplane components all stand to benefit from the sectors recovery.
  • The most cyclical of these are travel companies and the least are manufacturers.
  • All are at risk of renewed worries in the travel sector – travel companies most of all.
  • Strong companies coming out of periods of weak performance are ideal targets for contrarian investors.

Looking back over recent years the travel sector has struggled, badly. Those companies that have survived the period have had to make difficult decisions, trimming down core parts of their business and often requesting new terms from creditors. Many smaller or less well capitalized companies have sunk altogether.

This isn’t all bad news – those businesses which survive such a period have proved themselves as effective and well-managed during a major crisis. Investors should approach these stocks with caution but also an appreciation for the skill with which they navigated the pandemic.

The future prospects of the travel sector

Even before the mayhem of the last two years, the travel sector has seen significant change in recent decades. A decline in the popularity of physically located booking agencies, the growth of person to person room-sharing apps like Airbnb and the birth of comparison websites all permanently reshaped the way we book our trips. This has seen a massive reshaping of the booking and travel consumer sector, though the general trend of rising trips and increasing spending offered support to even poor business models.

Until 2020, all of these trends worked in the favour of airlines. British Airways avoided the fierce competition that characterises the low cost sector by keeping a high price, high quality model throughout. This strategy appears to have paid off with the higher margin business traveller market growing steadily throughout. Relying on the regular travel needs of large businesses provides a less seasonal, less volatile and ultimately more profitable approach.

After foreign trips were banned for much of 2020, and only operating fitfully the following year, in Europe at least there are now effectively no travel restrictions between the most popular destinations. Business travel as well as personal appears to be recovering, with the vast popularity of online meetings software not entirely replacing the human touch.

On the other hand, many airlines face serious staffing shortages after laying off large numbers of support staff including cabin crew and baggage handlers. Over the last two years most of the laid-off workers have found new jobs, often on higher salaries or with greater job security. Accordingly, they are ignoring attempts to hire them back. The time taken to train and complete security checks for aircraft staff also means increases in staff training numbers will take many months to filter through to daily operations.

This in turn creates delays at airports – in the short time this is unlikely to impact the sectors overall performance, although airplanes are obliged to pay back customers if delays exceed a certain amount. Should the situation worsen, some tourists may look for alternative travel methods such as ferries and trains. The cost difference between the two and lack of convenience means delays would have to reach a high level before this became widespread.

Manufacturers with a client base in the sector have a longer-term view, and were protected by military contracts that continued as normal throughout the 2020 – 2022 period. Even so, a major collapse in the travel sector would destroy a large portion of their overall revenues. The main issues faced by such companies today are related to the cost of raw materials and energy at major factories. In this Rolls-Royce’s stock behaves as both a travel and industrial business; differentiating it from British Airways.

Summary

Whatever your view on travel stocks and the sector, its an exciting if difficult time for market participants. Price increases, airport delays, border shutdowns have all taken their toll, but also spurred on a refocusing and renewal of purpose for these historic, large institutions.

For at least two companies, the turmoil of the last two years has come after a long downtrend in their price – one for which the driving reasons seem to have evaporated. Savvy investors will be checking their portfolios to see whether they have room for one or both.

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