City Insider - FT journalist David Stevenson on the travel industry

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The sun is out, the UK economy is finally turning the corner and the travel sector looks like it’s having one of its best summers in recent years. 

That positive mood is even reflected among those curmudgeonly types in the City, with Thomas Cook in particular attracting a great deal of positive attention.

This time last year Cook was a virtual pariah in the City – now if I look down the list of brokers analysts reports, they’re pretty much all positive about the travel industry number two, with only one analyst rating the stock a hold. That positive assessment is, of course, helped by a transformation led by a certain Harriet Green.

Her team deserve particular credit for the transformation around the balance sheet which has involved a massive £1.6 billion capital refinancing, and net debt halved from £1,099 million as at June 30 2012 to £452 million as at June 30 2013 – though to be fair that halving of debt is only because shareholders have had to fund a massive rights issue.

There’s even a hint of a profit at the operating level, with Q3 underlying EBIT on a like-for-like basis improved to a profit of £1 million, an increase of £46 million compared with the same period last year – underlying EBIT was a positive £104m, with gross margins up by 1.1% to 19%.

So trebles all around ? Not quite. I’d agree with our very own Ian Taylor’s cautious assessment.

I think Ian is spot on when he says that that there “is significant work still to do on cutting group-wide costs” with the jury very much “out on key planks of Cook’s strategy: the UK web business, concept hotels and group cost reduction”.

In fact, if I were especially curmudgeonly I’d note that a solid wall of broker buys is usually a contrarian signal that suggests that the share price is due a bout of profit taking soon.

I’d also observe that before the crisis Thomas Cook was regularly making EBIT profits of between £300 and £440m, with net margins between 2.5% and 4.5%.

We’ve a long way to go before we get back to those numbers and in the meantime investors are being asked to value Cook at £2bn or 170p a share, including that additional £400m of new money invested in the business after the rights issue.

The consensus amongst brokers is that profits at Cook will probably hit 5p a share in 2013, which makes the travel giant valued at a toppy 34 times profits.

Personally, given that £2 billion price tag and that huge fund raising, I’d be demanding that Cook get back to a solid £400m profit base within two years at worst.

Also if I was especially ungenerous, I’d be tempted to compare the fortunes of another perennial travel sector number two – easyJet.

The discount airline is constantly battling its bigger Irish-based rival, but look at the difference in business operations and shareholder reactions when compared to Thomas Cook in its struggle with Tui.

While Cook adjusted profit has gone from £45m to a loss of £485 million in 2012, easyJet has pushed its profits from £45m to a staggering £317m, with £442m expected this year. 

Again, looking at turnover Cook has basically gone nowhere over the same period whereas easyJet has boosted that top line number from £2.6bn in 2009 to a likely £4.2bn in 2013.

That’s an impressive transformation and helps explain why easyJet’s share price has rocketed.

Nevertheless it’s fair to say Thomas Cook is a fundamentally changed beast and is now ready for growth, which is probably well timed as the UK economy is set for a very positive 2014.

The national newspapers are full of relatively upbeat stories about the UK economy, but I would make three big observations.

The first is that those UK recovery stories are probably under-estimating the strength of the domestic consumer economy as we move into the last furlong for 2013.

Here’s just a small selection of recent numbers courtesy of BNP Paribas’s UK economist Dave Tinsley.

  • Manufacturing recovery. “The UK manufacturing PMI rose to a 28-month high, at 54.6, from 52.9. This is the fourth month in a row that the index has been above 50 and signals an increase in forward momentum as we head into the third quarter…

    New orders rose to a very splendid 58.2, which is the highest level since February 2011. It appears this is being led by domestic orders.

    Export orders rose too, but by less, with the index rising to 54.1 from 53.3. … export orders are rising to most regions, including the eurozone, Australia, China, Africa, Russia and the US.”

  • Inflation under control. “Output prices are rising, but the index (at 52.4) is in line with where it has averaged in the first half of 2013.”

  • GDP growth: “Q3 GDP growth could easily come in as good as it did in Q2, possibly better. That in turn implies that GDP is probably growing right now at levels close to trend growth – a very marked improvement compared to the last few years.”

  • UK Retail: ” UK retail sales managed a reasonable performance in June, rising by 0.2% on the including and excluding fuels measure…..The 0.2% rise in June was driven by non-food sales, with these rising 0.6%. Non-specialised retail store sales rose 3% on the month, with household good sales rising 0.6%.”

  • Housing: ” There is likely to be a noticeable firming in housing transactions in Q3, which will help drive associated spending higher. “

These numbers have not gone unnoticed in the City with the hot money currently betting that sterling will strengthen against the Euro and the dollar over the remainder of 2013.

If that does happen that’ll be good news for UK inflation rates, although it’ll also have the negative side effect of making UK exports more expensive.

In fact, I’d suspect that the new governor of the Bank Of England, Canadian Mark Carney, will be constantly battling FX markets, with a push to ever more lax policy to boost employment rates and generally engineer a manufacturing recovery.

That positive prognosis could even find an echo in the Eurozone – its obviously only mid way through an enormously painful austerity phase which could in fact get worse before it gets any better.

But word on the street is that many economists are beginning to quietly mark up or increase their growth estimates for the Eurozone in 2014.

If that happens, the UK could be in for a very strong 2014 indeed – which augurs well for crucial summer 2014 bookings later in the year.

All this cautious good news does come with a big sting in the tail though. Oil prices are likely to rise near term, with the potential for sharply increased airline fuel costs.

There’s obviously a wall of publicity surrounding the US shale revolution and excited talk that oil prices could collapse as China slows down, but I wouldn’t believe a word of it if I were you, or not at least for the next year or so.

The really big story on the global energy markets has been that the gap in the price difference between oil from the US mid west (called WTI) and our Brent Crude has almost vanished.

Vast reserves sitting in tanks in Cushing oil hub in the mid west have been progressively drawn down, and the US market in particular is showing signs of rude health.

In fact this summer’s seasonal demand for oil has been much stronger than expected – that WTI crude oil price has rallied 12% from around US$93/bbl in late June to US$105/bbl at the end of July.

Although many oil analysts, especially those at the International Energy Authority retain a bearish long term view for oil prices, even this respected body reckons that this summer’s seasonal demand for oil will be larger than usual.

It has revised its European oil demand for Q2 2013 up by 0.3mb/d as April data came better than expected. The EIA analysts suspect that refiners in the US are running at high capacities in order to meet global demand.

A recent report by analysts at commodities specialist ETF Securities echoes these positive numbers.

The ETFS report notes that “crucially US oil inventory has declined by 7.5% over the past month indicating that supply struggles to keep up with refining demand.” Their verdict – oil prices will increase.

“In the near-term, we think the spike in global oil demand is likely to continue, supported by an improving economic outlook in the US and in China. … In the near term, we believe a strong WTI will continue to provide support for heating oil and gasoline. Both distillates are likely to trade in a range of between US$3.0 and US$4.5/gal, both currently standing at US$3.0/gal”.

The bottom line? If these analysts are right, that’s particularly bad news for the travel sector, with fuel surcharges on the increase – and cost inflation a challenge for the airlines and cruise operators.