Tour operators may see their bad luck end

Kathleen Brooks
FIRST there is a global recession and rising unemployment to put people off booking a holiday, then, just when it looks like the economy has turned a corner, a giant volcanic ash cloud drifts from Iceland and disrupts flights for more than two weeks.

UK tour operators have had a dismal 2010 and the extent of the damage was made clear last week. Both Thomas Cook and Tui released results for the second quarter and neither of them made for pleasant reading. Both companies said that full year profits for 2010 would be at the lower end of analyst estimates, partly due to uncertainty about public sector job cuts. This sent shares falling, at one point Tui’s share price was 10 per cent down, wiping nearly £230m off of the company’s value.

Thomas Cook didn’t fare much better after it said that earnings before interest and tax would be £405m for the year, significantly below City estimates, which ranged from £450m to £529m.

But can things get worse for the UK’s tour operators and has this spell of bad luck ended? Analysts fall into two camps about the prospect for UK travel operators: those that think all of the bad news is priced in already and things can only go up from here and those that don’t.

For example, Alphavalue, the independent research company, has a buy recommendation for Thomas Cook. It argues that the stock is extremely good value, and expects earnings per share of 6.4 this year, significantly lower than average for the FTSE 100 which is around 15 times.

Analysts at RBS also have a buy recommendation for Thomas Cook. They say that investors are too sceptical and that the industry is more robust than many might think: “We believe market concerns about the death of the package holiday are overdone. The problems thrown up by the erupting Icelandic volcano reminded holidaymakers of the dangers of going it alone.”

RBS adds that on current multiples, “it appears to us that Thomas Cook Group, like Tui, is discounting more disappointment in both the short and long term, which we believe is misplaced.” So there could be some short-term gain for spread betters.

Even though Sam Hart, retail analyst at Charles Stanley, the stockbroker, says that valuations look cheap for tour operators, he warns that the quality of earnings in the sector could be weak and stock prices could fluctuate with news about the strength of the consumer. He prefers other sectors of the travel and leisure sector, and is optimistic for the fortunes of Whitbread, the owner of Costa Coffee and Premier Inns. “It is well-placed to benefit in the current environment,” says Hart. “It is orientated to the budget sector and if consumers are cautious then Premier Inns become more attractive.” He also likes Costa Coffee, and believes that the UK’s adoption of “coffee culture” has further to go. Hart thinks there are good opportunities for Costa Coffee to expand in universities, hospitals and motorway service stations over the next year or so.

For spread betters, the highly cyclical tour operator sub-sector holds some good opportunities for those who like to trade value stocks. However, there are headwinds in the distance, so it’s worth being disciplined and using stop-loss orders to limit your downside.