Shares in Thomas Cook (LON:TCG) declined by almost a quarter this morning after the company issued a pre-close trading update which perhaps unsurprisingly revealed that the hot UK summer had impacted bookings, margins and hence a reduced target profit for the year. The share price reaction was typically large, with the shares down as much as 25%:
Thomas Cook is a fascinating business for anyone around before the days of the internet, as it is an industry that has seen seismic change. Arguably there has not been a business that has seen more change. In the olden days, travel agents shops on the high street were everywhere, because there was few other places to book a holiday. Huge brochures were produced, and prices were fixed, depending on what day you went. With the lack of real data (such as Tripadvisor reviews), you wouldn’t know whether the hotel was much good or not, and prices tended to be high.
Everything changed with the advent of the internet: people could then book flights and hotels themselves. In addition, the airlines started offering hotels with their flights. It seemed for a while that the travel agent such as Thomas Cook had become irrelevant and could disappear entirely.
But to their credit, they managed to reinvent themselves somewhat. They haven’t disappeared altogether, with many people willing to let the agent do their work and offer an integrated holiday package (as opposed to booking flights, hotel, and transfer separately). And they have moved to vertically integrate their business: Thomas Cook operates an airline, as well as some upcoming hotels.
This has led to some volatile results for the business. Some heavy losses have been incurred over the years, and the share price has moved massively as a result – as low as 12p in 2012. Even this year the decline has been substantial, although not aided by stories such as the death of two Britons on a Thomas Cook holiday in Egypt. In May we were looking at 140p, but today’s new lows has seen the business valued at well under half it was just a few months later.
CEO Peter Fankhauser kicks it off:
“Summer 2018 has seen a return to popularity of destinations such as Turkey and Tunisia. However, it has also been marked by a prolonged period of hot weather across Europe. This meant many customers spent June and July enjoying the sunshine at home and put off booking their holidays abroad, leading to even tougher competition and higher than usual levels of discounting in the ‘lates’ market of August and September.
For anyone living in Europe, this would have been self-evident, although many people would have pre-booked during the ‘Beast From the East’ earlier in the year.
There is a line on Summer trading:
Our Summer 2018 programme is now 90% sold, in line with last year. Total Group bookings are up 12% compared to this time last year driven by the return in popularity of holidays to Turkey, Egypt, Tunisia and Greece. Pricing across all segments remains higher than last year but, with a higher mix of short/medium-haul airline bookings, overall average selling prices are 5% lower.
The overall selling prices is concerning, although arguably can be recouped by additional pressure on hotels who are at greater risk of a downturn, as demonstrated in the next line:
Trading since the last update has been tough, particularly in the Tour Operator, where our ability to drive margins in the ‘lates’ market has been further restricted by excess summer capacity. In addition, we have reflected the more difficult trading environment for some of our suppliers in our approach to historic hotel recoveries, a non-cash item.
Accordingly, we now expect to deliver full year underlying operating profit of around £280 million, of which the greater element of the downgrade is related to the weak trading.
Annoyingly it doesn’t mention the context of the downgrade but looking at the previous years accounts the comparable figure is £365m, so the reduction in profits is fairly significant.
On the face of it, Thomas Cook seems to be a rather cheap company. The market cap has dropped to under £1bn, which seems very little for one that is generating such a level of EBIT, in an industry where many weaker players will have been chased out. But that masks the fact that this is a fairly risky stock. The business is heavily seasonal: making big profits in the summer and losses for the rest of the year; therefore one poor peak trading season can have a big effect.
Their accounts show that the underlying EBIT translates into very little:
The £330m reported therefore translated into a pre-tax profit of just £46m. As you can see, interest is a massive £143m. The ‘separately disclosed items’ is also ugly, full of write offs of onerous leases, implementation costs, restructuring, and other costs. In my opinion these costs will be incurred regularly so are not that exceptional.
The net cash position here is slightly misleading: if only interest could be paid on £40m. With so many customers paying up front for a product they will not use for some months, we would expect there to be a large amount of pre-payments. Most of the debt here is based on bonds, some £750m was issued last year.
The annual report mentions this snippet:
It does not say what these covenants are, but together with the bond (coupon 6.25%) it is fair to say that the business needs to be generating a decent real amount of profit each year in order to pay the c£140m of financing charges. Given the reduced figures this year this might be fairly close depending on the level of adjustments.
The balance sheet is not great here: acquisitions have seen plenty of intangibles booked here, giving a negative figure for NTAV. This is less of a concern here, as essentially the business will be funded by suppliers such as hotels who will be paid in arrears.
Thomas Cook seem to be constantly transforming, perhaps as a part of the environment they trade in. They are pushing their own-brand of hotels and there are other aspects which they could expand into (such as ground transportation).
This seems to have taken its toll on the business though. Operating margins have been weak, even in the good times. Arguably a package holiday has become largely a commodity where it is difficult to add value (although this may change depending on their hotel offering).
Another point would be that further disruption could be possible. In recent years Airbnb has proved itself which potentially could further eat into Thomas Cooks offerings. The increasing proliferation of low-cost airlines could see the airline part of the group suffer especially if there is a price war. Given the large amount of fixed costs in this sector, it is an easy place to lose money.
The debt level is high here and will seem to remain so for the short-term while the bonds and credit facilities remain outstanding and there doesn’t seem to be the performance to change that.
On the plus side, the business is priced fairly cheaply. But I think there is quite a lot of risk here and the next few years might see some tough struggles. I would rate this as 1/5.