The sun is here again for travel companies

After a bad time the sector is getting a welcome break. Jenne Mannion looks for hotspots in the tourist trade

Hotel and other travel-related companies have suffered from a sharp downturn in customer numbers over the past few years, but the picture is starting to look sunnier for this part of the stock market.

Hotel and other travel-related companies have suffered from a sharp downturn in customer numbers over the past few years, but the picture is starting to look sunnier for this part of the stock market.

Overall, the long-term fundamentals for the sector are positive. Changing lifestyles and higher standards of living mean more people are going on holidays more often, so companies that are associated with travel should be the beneficiaries of this increased spending.

However, it has been a choppy ride in recent years. A combination of the global economic downturn and fears of terrorism has put a dampener on international travelling, and leisure companies such as hotels and airlines have borne the brunt.

Stuart Fowler, head of UK equities at Axa Investment Management, says a more recent headwind is the weak dollar, which makes it relatively more expensive for US tourists to visit the UK. This puts pressure on British companies that earn the majority of their profits at home, although UK airlines and tour operators' overseas operations benefit.

The high oil price has also increased costs and put the squeeze on margins for airlines. This has put a big dent in the share prices of airline companies such as British Airways. And there has been a bloodbath among the low-cost airlines due to over-capacity, leading easyJet to issue a profits warning.

Nevertheless, there are some good news stories emerging from travel-oriented companies, led by the hotels sector. Hotel industry profitability has been recovering since the summer of 2003 after two dreadful years. Profits at Intercontinental - the world's largest hotel operator by rooms - doubled in the first quarter of 2004. This has contributed to Intercontinental's share price reaching a record high last week. The company, which runs the Holiday Inn and Crowne Plaza chains, has benefited from a pick-up in US economic growth, Mr Fowler says. The pick-up in US occupancy rates is now starting to be felt in the UK and continental Europe, though it is less advanced.

Another positive factor for Intercontinental is that it has a sizeable asset base, owning the freeholds for many of its hotels. During 2003, the group sold some 30 per cent of these hotels, mostly properties where returns have been weak, raising about £1bn, and there will probably be a return of cash to shareholders before long.

But Mr Fowler thinks the excitement may already have happened at Intercontinental, so it is arguably not the time to buy this stock. He expects that the share price is unlikely to make further significant gains in the near future. He is likely to take profits on the shares if there are further gains.

Other key hotel companies in the UK include Hilton Group, which owns the Hilton name outside the US, and Millennium & Copthorne. Hilton's strong performance has been largely driven by its UK betting shop chain, Ladbrokes.

Mervyn Douglas, a UK fund manager at Morley Fund Management, says he does not feel Hilton has the same quality offering as Intercontinental Group. However he likes Millennium & Copthorne for its strong asset base There is potential to follow the industry trend by selling these assets, and if this did occur some cash could be returned to shareholders.

Millennium & Copthorne announced on Thursday that it was back in the black after posting a second-quarter profit, amid recovery in its New York, London and Asian operations. Net income amounted to £11m, compared to a loss of £7.9m a year earlier.

At current share price levels, Stephen Ford, an analyst at the stockbroker Brewin Dolphin, rates Intercontinental, Hilton and Millennium & Copthorne shares all as holds rather than buy opportunities.

Another bright spot among travel-oriented companies has been Carnival, the global cruise operator, whose share price hit a record high early in July. Carnival owns and operates cruise ships, and has a dominant share of the global market, which is likely to grow strongly due to demographic trends towards an ageing population. Barriers to entry are high, so there is little threat of increased competition. A rival cruise operator, Royal Caribbean, has also released strong second-quarter results.

Mr Ford pointed out that, unlike many other travel operators, cruise ships are largely insulated from threats of global terrorism. He said: "The mobility of cruise ships makes it comparatively easy to redeploy ships away from sensitive regions of the world to more politically equable areas. This insulates cruise ships against many of the problems faced by hotels in the aftermath of the 11 September attacks."

Following its recently strong share price performance, Mr Ford rates Carnival as a hold.

It may pay, therefore, to look at stocks that have not performed so brilliantly. Holiday package operators have been struggling for some time.

Leigh Himsworth, a mid-cap fund manager at the broker Rensburg in Leeds, West Yorkshire, says the rise in popularity of the internet means that a growing number of people now prefer to buy flights and hotels separately, rather than opting for a package. "This is a difficult market to be in for these operators, and the only beneficiary has been the consumer," he says.

MyTravel, based in Manchester, is a casualty of the tougher times, having incurred two years of losses. The company, which now has a £1.3bn debt, bought more than a dozen companies in the years prior to the 11 September terrorist attacks nearly three years ago, but has since suffered from the decline in travel demand. It is winding down its services in a bid to reduce costs, but few investors could find a case for investing in this company.

The slimming down of MyTravel is, beneficial for First Choice Holidays, the key remaining UK-listed British tour operator. But Mr Douglas added that First Choice is not immune from the lack of popularity in traditional packaged holidays. "Nevertheless," he said, "First Choice has been on top of this trend. It has replaced much of its business of traditional holiday packages with more specialist offerings, such as adven- ture holidays, trekking and diving. This accounts for more than half the group's profits."

Internet travel agencies are also feeling the pinch. Take ebookers, Europe's largest internet booking agency: it has seen more than 70 per cent wiped off its share price in the last year. Much of those falls came in recent weeks when the company announced that its annual profits were likely to fall short of expectations.

Ironically, strong growth in online sales has lowered gross margins for ebookers. The forecast of lower profits is primarily due to the rapid growth of online sales, which yield lower gross margins than those earned by selling travel offline. Online sales currently earn lower gross margins as they mainly relate to air travel.

The key quoted rival to ebookers is lastminute.com, whose share price has fallen by around 35 per cent over the past year. In May, lastminute.com announced a second-quarter loss of £21.3m due to acquisitions such as Med Hotels and First Option. Lastminute.com has a different business mix to ebookers, by operating right across Europe and also selling car hire and theatre and concert tickets over the internet.

Mr Douglas says he is not a fan of such companies. "I don't believe they have any pricing power. Their role is to sell holidays and flights that are left over, and margins will continue to be squeezed," he says.

COMPANY ROUND-UP

CENTER PARCS

Leigh Himsworth, a UK mid-cap fund manager at Rensburg, says that although this company has listed on the market recently, it is a relatively established brand in the UK for adult and children's holiday breaks, offering activities and water sports. He says main activities are covered by transparent domes, so bad weather is not a threat to a good weekend. "Because these weekends are not priced cheaply, the type of person that goes there generally does not mind spending further money," says Mr Himsworth. The one drawback is that with just four parks and 90 per cent occupancy there is little room for growth unless further parks are opened, which is a possibility.

HOLIDAYBREAK

Mr Himsworth says Holidaybreak has taken advantage of the changing nature of holidays. "The Superbreak part of the business has adapted to the fact that people are taking a lot more short breaks," he adds. The company has reduced the length of its hotel vacations to meet customer demand and boost sales.

Meanwhile the camping operation, which has struggled in recent years, is starting to improve. He says camping is a difficult business because people tend to book at the last minute. Last year, amid the heatwave in the UK, people tended to stay at home rather than go to Europe, which hurt the business. Cooler weather until recently this summer means this is less likely to have been an issue this year.

CARNIVAL

James Rollo, an analyst at Morgan Stanley, says in a research note: "Carnival is the dominant player in a duopoly with high entry barriers, strong demand drivers and high cash generation. We forecast a more favourable balance of supply and demand, leading to an improvement in yields, returns and valuation. "We think 2005 will see historically low capacity growth and a greater focus on cost efficiencies and slowing capital expenditure. These should allow Carnival to generate rapid earnings per share growth, as well as return some of its prodigious cashflow to shareholders. Carnival is our top pick in the sector."

BRITISH AIRWAYS

Mervyn Douglas, a UK fund manager at Morley Fund Management, says British Airways offers potential as a holiday recovery story. The share price has been hit due to the high oil price and decline in international travel over recent years, but will rebound when the oil price falls. "The recovery in travel has further to go but there is more potential in those stocks that do not already reflect the optimism," he says.

FIRST CHOICE HOLIDAYS

Jeffrey Harwood, an analyst at Oriel Securities, says in a research note: "Since the end of the Euro 2004 football competition, bookings for the summer 2004 season have increased significantly. The shape of the group has changed significantly in recent years, and the specialist business now accounts for around half of profits. The shares offer a high and increasing dividend yield. Set against the encouraging trend in recent bookings, the share price under-performance looks anomalous, and we have recently upgraded our recommendation to a buy."

BAA

Stuart Fowler, head of UK equities at Axa Investment Managers, believes a good way to capture growth in increased travel is through investing in the UK airports operator BAA. "It is difficult to know which airline will be thriving, but you can be pretty sure that they will be using a BAA airport, so this should be beneficial," Mr Fowler says. BAA last week reported that passenger numbers are indeed picking up. The number travelling through Heathrow, Stansted and Gatwick in London, and BAA's other UK regional airports, rose by 9.7 per cent to 36 million in the three months to 30 June. This led to a first-quarter profit increase of 28 per cent.