City Insider: A bumper year ahead?

Expect consumer demand to strengthen, argues City Insider David Stevenson, who foresees a strong year for the sector

My guess is 2015 could prove a bumper year for travel, although if you talk to mainstream economists and institutional investors my cautious optimism is not shared.

Here is my shortlist of reasons why travel industry insiders should be hopeful for 2015:

1. The eurozone economy is at its worst and determined action across Europe should see a rebound in sentiment. That will be great for any business that has a focus on the core markets of Northern European.
   
   
2. The US economy kept everyone afloat in 2014 and I suspect we are only mid-way through a multi-year recovery in North America.
   
   
3. The US Federal Reserve and the Bank of England are contemplating small interest rate rises and some tightening of their balance sheets but the effect will be minimal especially given the fact that the eurozone and Japanese central banks are now massively stepping up their interventions. If interest rates do start rising I would be astonished if they went up by more than 1% over the next year or so.
   
   
4. Energy prices have collapsed. Three main factors stand out:
   
   a) Indiscipline by OPEC producers, led by Saudi Arabian and Kuwaiti efforts to maintain market share against high-cost producers. Maybe we are witnessing an epic battle between the Saudis and the US to be the swing producer;
   b) Accelerating growth in non-OPEC production, led in part by the US which has also played a major role in;
   c) Driving the cost curve lower for oil and gas production globally.
   
   I’m not sure any of these forces will abate. My only note of caution would be that oil products (gasoline, diesel and jet fuel) might show greater pricing strength as US demand slowly grows and refining constraints become increasingly obvious.
   
   
5. Consumer spending will carry on increasing in the UK. Much of this uptick will be driven by what some of us call ‘balance sheet’ issues. This is jargon for the fact that poorer consumers will borrow ever more money (a bad thing in the long term) while wealthier retired customers start to spend their pension pots on once-in-a-lifetime travel trips. But it’s also fair to say that increasing consumer demand will be helped by wage rates showing signs of a rebound among skilled workers and increased minimum wages at the lower end of the wage curve.
   
   
6. Currency wars: the good news is every major economy is desperate to weaken its foreign exchange (FX) rate. The bad news is that not everyone can weaken their FX rates at the same time – someone’s rate has to strengthen and that someone is the US dollar. That is bad news for UK travellers to the US.
   

These positive trends will, of course, have some negative side effects. In particular, investors will be keeping a beady eye on profit margins especially in industries like travel where margins are razor tight and easily overwhelmed by boisterous revenue expansion.

The key concern here is that capital costs will be slowly rising, wage rates might start bumping upwards and governments will need to start increasing tax rates to help fix structural deficits. We have already seen a vision of the future in Japan where the government hiked consumer tax rates towards the end of last year and almost caused a slump.

Poorer consumers cannot afford increases in tax, but governments will be desperate to raise extra revenues. The fix might come from increased industry-specific taxes – I would wager that energy-price fixes, aviation duties and carbon taxes will increase. Falling energy prices will be especially tempting – governments will want to plug holes in their energy levies by pre-emptive raids on the transport sector.

I would also argue that although the eurozone should have a better year, there is still one big risk – France. Put simply, the country is in a mess with a potentially systemic revolt against its political elite, a worsening balance sheet, and stalling consumer confidence.

So given this big picture, what should we expect at company level? Industry leaders such as British Airways’ parent IAG, easyJet, Ryanair and Tui will be in good shape.

Both Ryanair and easyJet should see a big bounce upwards in profit, although at the margin level I would argue both will be under some pressure. IAG should be sitting pretty, but slower growth in North America might have an impact.

I can’t see either Tui or Thomas Cook experiencing a big upturn in profits although Cook should move comfortably into profit. Both will face company-specific issues – integration with German-merger partner Tui AG at Tui, and the challenge of building differentiated brands without massive increases in marketing budgets and taming the group debt at Cook.

Tighter capital markets for big corporates won’t help. Overall, I would keep an eye on the balance sheets of all the major travel companies. Steady growth on the top line might encourage capacity expansion just as capital costs start to rise, liquidity tightens and consumers demand cheaper deals.

One last observation on those likely to be the biggest winners (the cruise sector) and the biggest losers (digital-travel businesses). Sharply lower energy prices will be unalloyed good news for the cruise giants, as will the increasing focus on all-inclusive holidays – a consequence of cash-strapped consumers needing to know what they are going to spend in total on a trip.

By contrast, the digital-travel giants might face a tougher time especially as I suspect the market will be saturated, with Tui and Thomas Cook desperate to grab back market share via their own expanding web businesses. Add in Google’s steady encroachment on the space and the digital-travel giants’ focus on the core US market (which might slow down) and we could see some big profit misses in the digital sector – with a knock-on effect on funding for new start-ups.

This is an extract from the Travel Weekly Insight Annual Report 2014 – now available