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Tough times ahead for the travel sector

The travel sector has endured a turbulent year. Soaring oil prices through the summer and into the autumn, industrial action at certain airlines, extreme weather, uncertainty surrounding Brexit, and weakened consumer confidence all weighed on the industry.

Concerns about the supply of oil kept prices firm in the first half of the year, and the announcement from President Trump that the US would be withdrawing from the Iranian agreement pushed up prices to levels not seen since 2014. Some travel companies weren’t hedged for the sharp upward move in the energy market and that impacted their earnings. There has been a dramatic turnaround in the oil market since October, and it has now fallen to levels not seen for over a year. The slump in the oil market should take some of the pressure off the travel industry, but it might transpire that some companies have hedged their fuel needs when prices were much higher. 

The ‘beast from the east’ caused disruption across the UK and Ireland in March and April. Flights were cancelled due to the snowfall. Admittedly, it didn’t last very long, but it lasted long enough to have a material impact on airlines. The freezing cold winds from Siberia at Easter were then followed by the joint-hottest summer on record. British holidaymakers usually take off to mainland Europe to soak up the sunshine, but the continental climate Britain enjoyed over the summer prompted them to stay at home. Adding to the feel good factor of the summer was England’s performance at the World Cup, and football fans found themselves spending more money at home than abroad.
Brexit is a worry for the aviation industry, but it isn’t as big an issue as some people would have you believe. Michael O’ Leary, the CEO of Ryanair, claimed that planes could be grounded in the event of a no-deal Brexit. Mr O’Leary was a prominent campaigner for the remain side of the referendum, so some people thought his comments were politically motivated. There has been some clarification from the UK and EU, and both sides agreed that flights from the UK and those flying over the EU would be permitted to operate for 12 months. The assumption is that political progress will be made in the interim period. 

There is some evidence to suggest that consumers are curtailing their expenditure ahead of Brexit. UK wages are growing at their fastest rate in 10 years, but headline and core inflation rates are cooling. We have seen discounting and promotions from airlines to lure in customers, which is good for headline revenue, but it puts pressure on profit margins. The travel sector seems to be in a race to the bottom in terms of prices, which us great for the customer but not so good for the shareholder. 

Ryanair shares were hit by a profit warning in October as the group lowered its full-year guidance to between €1.1bn and €1.2bn, when the pervious guidance was between €1.25bn and €1.35bn. The firm had to pay out compensation to customers from flight cancellations due to industrial action. In late October, the Irish airline confirmed that first-half revenue and passenger numbers grew by 8% and 6% respectively, as it seems that the company’s aggressive fare slashing tactic worked. The firm revealed a €540m share buyback scheme, and that should help keep shareholders on-side, but ultimately the group needs to boost its customer and staff relations. 

In November, easyJet posted a 41.4% increase in full-year pre-tax profit to £578m – which was at the higher end of the £570m to £580 million range that the company announced in September. Revenue jumped by 16.8% to £5.898bn. The airline confirmed that bookings for the summer are ‘promising at this very early stage’. There has been solid demand in forward bookings for the first half of next year. The airline’s numbers are impressive, especially when you consider how their competitors are performing. The group has expanded its operation, and the acquisition of the Tegel airport in Berlin is showing promising signs. The group expects the unit in the German capital to breakeven in 2019. Ryanair have dented their reputation due to the pilot roster fiasco last year, and the spate of industrial action this year. EasyJet have had their own issues, but not on the same scale and should be able to gain more market share in the low-fare sector. 

Thomas Cook issued a profit warning in September and November, so investors were well prepared for the 18.8% fall in annual profit, which was announced shortly after the second profit warning. The airline division had a solid performance as earnings grew by £35m, but the tour operator saw profit fall by £88m. Prices were slashed to entice potential holiday makers, but the warm weather in the UK over the summer lead to a poor performance in the last minute holidays. Although the dividend might have been suspended, the company’s covenants are compliant, and there is headroom for future covenant tests, and this underlines the firm’s access to funds. Net debt soared from £40m to £389m, and that was largely because a €400m bond was refinanced. The stock is just off its six-year lows, and that sums up the weak sentiment. 

Flybe shares soared last month after it was reported that Virgin Atlantic is interested in acquiring the struggling airline. The two companies already operate a code-share as Flybe are regional focused, and Virgin are geared towards transatlantic flights. In November, Flybe effectively put itself up for sale, and it seems that Virgin are keen to look into the possibility of a takeover. Given that the sector has been struggling recently, the prospect of consolidation isn’t a surprise. Flybe rallied from their all-time lows on account of the Virgin takeover talk.

TUI had a disappointing third quarter as earnings dropped by 18%, but full-year revenue rose by 6.3% and underlying earnings ticked up by 10.9% - topping forecasts. The group issued an upbeat outlook as underlying earnings are expected to increase by 10%. The current winter trading nearly matches last year’s level. The hotel, resorts and cruises divisions continue to perform well. The dividend was upped from 65 cents to 72 cents and this is a clear indication they are confident in their future earnings ability.

IAG, the owner of British Airways and Aer Lingus, held up better than most in the sector as first-half profit jumped by 24.8% to €835m, but analysts were expecting €848m. Revenue edged up 3.1% to $11.2bn. The strikes by French air traffic controllers caused disruption to the airline, and in particular to the low-cost operation Vueling. Despite the troublesome summer for the industry, the firm issued an upbeat statement in November. IAG mapped out plans to increase investment by an average of €500m per year between 2018 and 2022. The aim is to boost average profit by €700m over the next five years. The company raised its forecast for average seat kilometres to 6%, from 5%.

Source: CMC Markets

The travel sector had a difficult 2018, and given the concerns about global growth, a slight decline in consumer appetites and uncertainty surrounding Brexit, the industry is likely to have a downbeat start to 2019. On the plus side, the oil price has dropped considerably, but that might be irrelevant if firms have locked in their exposure already. The drop in the oil market is also a reflection about worries of a slowing economy. The Brexit clock is ticking, and UK consumers are likely to be cautious in the first few months of next year.


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