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Bright spots in travel despite Thomas Cook sinking

Glenn Freeman  |  24 Sep 2019Text size  Decrease  Increase  |  
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The demise of Thomas Cook, the world’s oldest travel business, highlights the tourism sector’s difficulty in dealing with the challenges of mounting debt, Brexit, high fuel prices, bad weather and the migration to online booking.

But the segment still holds a number of bright spots for Australian investors, including travel agent giant Flight Centre (ASX: FLT) and another tourism-linked company Ardent Leisure (ASX: ALG).

Thomas Cook’s demise, announced in the early hours of Monday after it failed to secure a deal with creditors or a government bailout, sparked alarm at hotels where some customers have been asked to pay their bills anew by out-of-pocket resort owners.

Hundreds of thousands of holidaymakers were stranded on Monday by the collapse, which sparked the largest peacetime repatriation effort in British history.

Peter Fankhauser, CEO of Thomas Cook Group, singled out several reasons for the company's collapse, including Brexit, the UK's heat wave of last summer that dampened holiday bookings, the weak pound and high fuel prices.

Parallels exist between Thomas Cook and Flight Centre – they're both in travel booking and have large physical store footprints.

Flight Centre adapts its strategy

Though Thomas Cook was still increasing its investment in shopfronts in recent years, Flight Centre has been gradually reducing these numbers as leases come up for renewal.

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Morningstar senior equity analyst Brian Han says Flight Centre's scale and extensive store network have made it a key distribution channel for travel suppliers.

"However, with the threat from online competitors increasing, we believe physical stores are likely to increasingly lose relevance longer term," Han says.

Flight Centre's stores were once a competitive advantage, but they are increasingly becoming a liability.

In response, management is pursuing a strategy that blends online sales with flagship stores – using its online presence to drive customers to these specialist outlets – as well as expanding into the corporate travel sector on a global scale.

"We applaud these initiatives by Flight Centre on the consumer leisure side, but it will take time to reverse the downward earnings outlook while consumer sentiment remains subdued in Australia," Han says.

This is putting pressure on its Australia and New Zealand margins, which are down to 11 per cent for fiscal 2019, from 20 per cent in fiscal 2015.

"Flight Centre risks cannibalising its margins if the competitive position of its stores wanes, its online presence lags competitors, or disruptions arise from restructuring," Han says.

In its fiscal 2019 results announcement, management flagged the creation of more jobs in marketing and other roles, which could increase its costs.

Priced at $48.08 at midday on Tuesday, Flight Centre is trading at a 22 per cent premium to Morningstar's $39 fair value estimate.

In contrast to Flight Centre's approach, Thomas Cook doubled its shop numbers to more than 1,200 in 2011 as part of a merger with another travel company, The Co-operative Group.

“However, the biggest difference between Thomas Cook and Flight Centre is debt, in the sense that the former just carried too much of it and the latter has none," says Han.

Several large UK fund managers held stakes in Thomas Cook, including Invesco, Jupiter, Orbis and Standard Life Aberdeen.

Thomas Cook was one of the biggest share price fallers on the FTSE in 2018, when it dropped around 80 per cent.

The group is one of the most-shorted stocks on the FTSE, with almost 10 per cent shorted, says Morningstar UK editor James Gard.

Ardent Leisure in five-star territory

Elsewhere among locally listed companies exposed to tourism, Ardent Leisure Group recently crossed into Morningstar five-star territory, as its share price has fallen 13 per cent since its fiscal 2019 results were announced on 23 August. This prices the company's shares at around half Morningstar's $2 fair value estimate.

Han says this is too pessimistic, pointing to Ardent's US division Main Event, a bowling-alley-based entertainment business. He says shares in Main Event's closest competitor in the US, Dave and Buster's, are trading at almost 6-times adjusted earnings of US$311 million.

"It implies the current Ardent stock price is valuing the theme parks division at an enterprise value of $132 million, just 4.3 times normalised midcycle EBITDA of $31 million," Han says.

New management for Main Event is currently making efficiency improvements and adding new games and technology-driven guest experiences to the entertainment lineup.

He notes that though improvements are being put in train, corporates appear more willing to wait than individual investors, pointing to recent acknowledgement of a potential acquisition offer – an offer that Ardent dismissed earlier this month.

Han also points to reinvestment in Ardent's Australian theme parks – Dreamworld, Movieworld and Seaworld.

"We continue to forecast that theme parks' EBITDA will hit $31 million by fiscal 2024," he says.

"This may sound like an illusion given the AUD 10 million loss suffered in fiscal 2019. However, our estimated earnings in five years' time is merely in line with the annual average EBITDA of $32 million generated by the theme parks in the six years before the Dreamworld tragedy."

is senior editor for Morningstar Australia

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