It’s been a busy old month and three stories stood out for the travel industry as absolutely pivotal – the ongoing problems at Thomas Cook, early signs of increasing consumer confidence and falling oil prices.
Each has the ability to completely reshape the trading environment of the sector, and looking at the big macro picture I’d have to say I’m now more optimistic than ever.
The first, and perhaps most important, story for the travel sector is Thomas Cook. Last week’s trading update will have done little to calm nerves in the City.
Understanding the way institutional investors think is always a challenge, but it’s crucially important to understand here. The biggest variable is that trust has been destroyed and that Thomas Cook is a binary bet. This bet is on the intrinsic value of the shares – they’re either worth vastly more or absolutely nothing at all.
On paper, Thomas Cook is an absolute bargain with oodles of cash inflows, more than enough headroom on the debt structure and a new, bold plan to cut out some of the low margin businesses.
At 37p a share this suggests that Cook should be a target for a confident private equity house. But there’s a problem, and the best word that can sum it up is quantum.
This strange, scientific word is widely used by hedgies and private equity types to describe the ‘direction’ or ‘flow’ of a business and its key indicators. It’s also used to describe the relationship between two variables: market capitalisation of a company and its relative level of debt.
Although a bargain, Thomas Cook is a company that will soon be forced into a massive debt-for-equity swap which will involve swamping existing shareholders – that’s what a 37p per share price is telling us.
Cook’s debts tower above its ability to create free and surplus cashflow. The market cap is currently £323m, yet net debts are just over £800m and cash inflows, even after disposals, are unlikely to bring them down to a level that’s remotely near that market cap. In sum, the quantum of debt is just too large and the cash inflows too small.
To make matters worse, I expect the direction of business in continental Europe to fall off a cliff in the next six months. Growth has already ground to a halt in France and I’d wager that Germany and the Netherlands will be next to suffer.
That will produce a nasty shift in sentiment for Thomas Cook – a negative quantum – at exactly the wrong time. A massive debt reduction programme is much easier to pull off if you can grow the top line.
Cook’s decision to cut the dividend was a sensible and eminently predictable one. What’s more interesting now is the reaction in the share price and the volume of trading. We’re likely to see an exit of traditional institutions as they try to unwind their positions and move into more defensive stocks.
The new buyers of Cook’s shares will be less scrupulous types such as hedgies, starting to unwind their short positions and looking to make Thomas Cook a distressed play. This community of investors are nowhere near as mild-mannered as their bigger institutional cousins.
They’ll want immediate action. They are probably already working out the likely debt-for-equity swap ratios and planning for the day when TC essentially becomes yet another bank-owned business.
However, none of this need terribly worry the trade. What happens to equity investors is their business and a sensible resolution of the debt issue will boost confidence across the sector.
It may even pose a competitive threat to bigger rival Tui Travel. Imagine Tui’s consternation at a revitalised Thomas Cook, under new management who’ve dealt with the debt issue, cut capacity, freed up cash flows and started investing in differentiated products.
Confidence could return
The next big story for me is that I believe that consumer confidence will slowly begin to turn in the UK as we approach the end of 2011.
Key consumer surveys such as the closely watched Markit monthly perception scan have started to show a bottoming out of pessimism, especially in the private sector, and a strong rebound in the south of England.
The US is absolutely slowing down, but parts of the stateside economy are beginning to show some life and I think all the key fiscal and monetary authorities now realise how close we are to another nasty downturn.
Their reaction will be varied and muscular, but always focused on making sure that aggregate demand is somehow boosted in the short term as we head into the slow, dark winter months. I’d plan around a surprise to the upside in terms of consumer demand, although there is always a chance of something nasty happening.
This brings me to a less optimistic prediction. On balance I’d suggest that consumer growth will surprise to the upside, although the UK Christmas retail market will be a bloodbath outside of the online world.
The big risk, though, is that the European authorities won’t act decisively enough, at which point I’d start watching out for a dangerous new development – interbank liquidity squeezes.
At the moment the French banks are in a maelstrom of financial panic, but if the crisis isn’t effectively dealt with quickly – preferably by the end of November – we could see major banks starting to pull money out of the interbank market.
The knock-on effect of this liquidity squeeze will be felt throughout the financial system. If a squeeze turns into a full-blown drought and all liquidity dries up, we should expect the corporate money market system to react with horror.
A bank without money is not a bank, and big corporate customers, especially those with lots of customer cash, won’t want to be in a position of being long on a bank with no money to pay out. Rumours will mushroom into panic and the entire system could start to grind to a halt.
Hopefully this doomsday scenario won’t happen, but the risks of a nasty liquidity squeeze are growing by the day. We need decisive action from the authorities.
Perhaps more importantly, corporate treasurers and financial controllers in the travel sector should start making sure that they have access to diversified sources of liquidity, just in case really bad stuff does start to happen.
Good news from West Texas
My last story of the month is by far the most optimistic: oil prices are collapsing, and they’ll continue falling unless some geopolitical monkey business breaks out.
West Texas prices are already at $80 in contrast to the more important European marker price – Brent – which is still above $100.
However, expect this to change any time now as Brent prices start to crumble first below $90 and then $80. I now expect oil prices to touch $70 and perhaps even $60 as optimism in the global recovery ebbs away over the next few months.
If these prices stay low for only a few months, the expected stimulus to the wider global economy will be small, if only because so many corporates are hedged at the moment, but I think there’s a fair chance that we could see prices below $80 all the way through into summer 2012.
These lower prices could put at least 0.5% (if not 1%) back into the global economy, which should show up in increased consumer demand.
My bottom line? Although I think there’s more trouble on its way at Thomas Cook, I think the eventual outcome – a debt-for-equity swap and the massive dilution of investor wealth – will be positive.
A strong new management should command a revitalised ship and are likely to go after Tui Travel in a more muscular and challenging way. This might then prompt Tui’s German parent to make the final move and mop up the outside shareholders via a takeover.
The core continental consumer markets are likely to be a tough place for both Tui and Thomas Cook over the next six months, yet the UK consumer market may surprise on the upside.
Last, and by no means least, falling oil prices, and determined government action might just be enough to arrest the slowing down, putting money back into consumers’ pockets and providing a positive start to 2012.