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Thomas Cook and TUI: Big Two tour operators evolve under pressure March 2019 Download PDF

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Thomas Cook and TUI — the last surviving AIT giants in Europe — both posted poor first quarter results for their latest financial years. On top of the relentless decline in the traditional all-inclusive tour market, they now face headwinds from Brexit uncertainty — and with both facing mounting debt piles, at least one of them is contemplating a virtual fire sale of its aviation assets.

Aviation Strategy has been tracking the AIT (Air Inclusive Tour) market out of the UK for many years, and the decline of the traditional package holiday market (the combination of holiday accommodation resort hotel and charter flight) that started in the early 2000s continues apace.

As can be seen in the chart, total charter passengers out of the UK from UK-registered airlines fell again fell last year — for the 17th consecutive year — and the 2018 total of 11.3m is less than a third of the peak 34.5m charter passengers carried in 2001. In terms of the split of scheduled versus non-scheduled capacity offered by UK-registered airlines operating out of the UK (see chart), non-scheduled ASKs fell again in 2018, to 9% — another new low — and compares with the peak 37% that non-scheduled ASKs represented in 1989.

The traditional package holiday is being replaced substantially by consumers who research, assemble and book their own “holiday packages” of accommodation, flights, care hire (etc) from multiple suppliers online. The majority of seats booked on scheduled flights to leisure destinations in the summer are undoubtedly replacements for former AIT bookings. These are mostly self-assembled holidays that have a flight element, but the charter seat has been replaced by a scheduled flight (and more often than not that flight is with an LCC — though it shouldn’t be forgotten that the LCCs themselves offer package holidays).

Brexit B******s

Then there is the mess caused by Brexit, which for the travel industry is made even worse by scare stories in the press such as a front-page story by the UK-based Sunday Times in December 2018 that declared: “Don’t go on holiday after March 29”.

Last year the UK government warned that in the event of a no-deal, travellers should have at least six months left on passports from the date of arrival into the EU (compared with 90 days previously), though frustratingly for those renewing passports it quietly changed the rules so that unexpired portions of existing passports would no longer be added on to the period of a new passport.

Much more helpfully, in early February this year the European Council said it was liaising with the European Parliament to pass legislation that will allow UK citizens visa-free travel for up to 180 days to any of the 26 countries in the Schengen area, as long as the UK reciprocates (which the UK government has already promised). This move will sit alongside (though not replace) existing European Commission plans to make UK visitors to the EU from 2021 pay €7 for the “European Travel Information and Authorisation Scheme” (ETIAS), which will last for three years and mirrors the ESTA scheme that many visitors to the US have to participate in.

At the end of January, market research company Gfk said that summer 2019 bookings out of the UK had fallen sharply in the latter part of the month, thanks to the ongoing Brexit process and a slew of scare stories on travel in the British press.

Remarkably, however, despite that late-January dip, going into February holiday bookings out of the UK for the summer of 2019 were an impressive 4% up year-on-year, with revenue up 1% compared with bookings for summer 2018 of late January 2018. Indeed, Gfk says family bookings for summer 2019 were a significant 7% up year-on year, while all-inclusive bookings were up 10% compared with the same point 12 months ago.

That could be seen as a rejection by the majority of holidaymakers to Brexit uncertainty and those worrying news stories, but the softening in late January is a worry, and clearly much will much depend on whether a Brexit solution of some sort is passed by the UK’s parliament by the new deadline of 12th April (and this hadn’t occurred by the time Aviation Strategy went to press).

Another caveat comes from a closer look at just where UK holidaymakers are booking this year — Gfk reports that as at the end of January it’s non-EU destinations that are seeing the biggest increase in summer 2019 bookings, with holidays booked to North Africa up two-thirds year-on-year, and to Turkey up by almost 50%. Data for holiday bookings out of other EU markets is harder to come by, though German-based TUI Group says demand out of Germany so far this FY is broadly in line with next year.

Thomas Cook woes

Thomas Cook, one of the two European AIT giants, is essentially still suffering from poor management of the past, and specifically a much later realisation (than its key rival, the TUI Group) that the AIT was going through structural changes. The company is now furiously trying to change its strategy in a very similar way to TUI, through differentiating its products and trying to improve margins, but it looks like a case of too little action, too late.

In its 2017/18 financial year (ending September 30th 2018), Thomas Cook saw revenue rise 6.4% to £9.6bn, but underlying EBIT fell 23.3% to £250m and a pre-tax profit of £43m in 2016/17 turned into a £53m loss in 2017/18. Management partly blamed a prolonged heatwave in Europe that restricted the ability to achieve good margins in crucial late holiday bookings for summer 2018, as well as poor airline performance, higher hotel costs in Spain and “complexity and scale” of the group’s transformation plans.

The woes have continued into this year. In the first quarter of its 2018/19 financial year (ending December 31st), Thomas Cook’s revenue rose by 0.1% on a like-for-like basis compared with Q1 2017/18, to £1,656m. However, an underlying operating loss rose by £14m year-on-year, to a £60m loss.

Brexit fears (or at least an ailing Sterling against the Euro) may have had an effect via weaker demand for winter holidays to Spain, whereas demand for winter holidays in Turkey and North African destinations grew. But overall holiday margins were lower in the quarter, which Thomas Cook says is “a continuation of the highly competitive market conditions in the UK at the end of the summer season”.

The performance of the group’s tour operations out of the UK and Northern Europe was “weak”, though partially compensated for by a good performance in demand out of continental Europe. The group airlines performed well, according to the group, even though they delivered an underlying loss comparative with Q1 2017/18. Added to this was a £4m hit from “currency translation movements” during the quarter.

Will things get better in the crucial summer season? Peter Fankhauser, chief executive of Thomas Cook is downbeat, stating that “bookings for Summer 2019 reflect some consumer uncertainty, particularly in the UK”, and the group has been adjusting capacity downwards.

In its latest trading update, released in early February, Thomas Cook said that its summer 2019 programme was 30% sold, which was “slightly ahead” of the same point as of 2018.

Significantly though, the group gave far less detail than normal on its 2019 summer bookings, and instead only revealed that tour operator bookings were down 12% year on-year, which is “consistent with the capacity reductions we have made across our markets to closely manage our risk capacity

throughout the year”. However, average prices on sold bookings was up in all key segments, and 4% higher overall.

In terms of airline bookings, they were “below last year”, thanks to reduced capacity in short- and medium-haul destinations through less wet-leased capacity. This was partially offset by growth in bookings to long-haul destinations, and average selling prices were up 6% year-on-year.

Critically, net debt for the group as at the end of 2018 was a hefty £1.6n — a worrying increase on the £1.3bn net debt level as of one year previously, and this is ringing alarm bells among analysts, particularly given the group’s abysmal share price performance. Last November a second profit warning in three months saw shares collapse by 30% in a single day, and overall the share price has fallen by around 75% since late 2014.

While there is still some growth story — 20 new hotels are being opened this summer and a strategic alliance with Expedia is being expanded — the clear narrative for the group is to try and reduce its debt mountain.

Alongside its Q1 results, the group announced a strategic review of the company’s airlines that Fankhauser says will “consider all options to enhance value to shareholders and intensify our strategic focus” — which analysts are interpreting as signalling the sale of the airline assets in an attempt to pay down debt and give the beleaguered group some breathing space.

It’s a complete strategic about-turn for the group, with Fankhauser now saying the business “doesn’t need to own an airline outright to be a successful holiday company”.

The group currently operates a fleet of 110 aircraft, in five different models and operated by four group carriers. The largest airline is Condor, based at Frankfurt and which operates nine A320s, nine A321s, three A330s, 14 757s and 16 767s. Those 51 aircraft have an average age of more than 18 years. Thomas Cook Airlines is based in Manchester and has a 41-strong fleet (with an average age of 11 years) comprising 30 A321s, 10 A330s and a 757.

Based in Copenhagen is Thomas Cook Airlines Scandinavia, with eight A321s and five A330s (and an average age of 12 years). A Brussels-based Thomas Cook Airlines Belgium ceased operations in October 2017, with three of its A320s transferring to other Thomas Cook carriers, while two other A320s were sold to Lufthansa-owned Brussels Airlines.

However, in October 2017 the group established another carrier — Thomas Cook Airlines Balearics. Based in Palma de Mallorca, the airline operates five A320s (including three that previously operated with Thomas Cook Airlines Belgium), with an average age of 17 years.

The group doesn’t have any aircraft on firm order, and overall the fleet is pretty old. While management is reportedly valuing its aircraft at more than £1bn, this may be a case of wishful/muddled thinking, as the entire group’s market cap is currently below £500m, and the global market for elderly aircraft is not exactly strong at the moment. At the very least any potential buyers will know that — if not quite a fire sale — then the Thomas Cook group will be very eager to get whatever cash it can for its assets.

TUI wobble

The German-based TUI Group was the first of the Big Two to react to the changes in the underlying AIT market, and has been long been pursuing its strategy of moving to more-defendable, higher margin segments with “exclusive content” — whether holiday packages, hotels or cruises.

CEO Friedrich Joussen has a vision of TUI becoming the “Amazon of Travel” — as do quite a few other aviation and travel companies — developing into a digital one-stop shop for holiday/airline bookings, destination experiences, holiday review portal etc.

In the 2017/18 financial year (ending September 30th 2018), the group posted a 5.3% increase in revenue to €19.5bn, but operating profit was down 0.9% to €1,982m and net profit (at continuing operations) was down 14.3% to €780m. The downward trend is continuing. In the first quarter of the 2018/19 financial year (the three months ending December 31st), group revenue rose 4.4% year-on-year to €3.7bn but EBITA fell from a €56.9m loss in Q1 2017/2018 to a €105.6m loss in October-December 2018. At a net level, losses worsened from €69.3m in Q1 2017/18 to €111.9m in Q1 2018/19.

TUI admitted that it had a weak performance in its core “Markets & Airlines” business (the AIT and airline part of the group) in the quarter, where the ”seasonal loss increased significantly”. The group gave a long list of reasons for this, including the knock-on impact of the summer 2018 heatwave (resulting in later bookings this year); overcapacities in Spain (especially in the Canaries) arising from a shift in demand to the eastern Mediterranean (particularly to Turkey); pressure on yield; continued sterling weakness; Brexit uncertainty and weaker results from the Nordic region year-on-year. And the disappointing Q1 result came after a net one-off benefit of €11m from special items, which included a €20m gain from the Niki bankruptcy impact and a €29m gain from a hedge taken out in the group’s northern region.

Similar to Thomas Cook, TUI has been far less forthcoming with detail on prospects for the summer season as it usually does. It says is that there are “significant sector headwinds”, and that “previously it was anticipated that these headwinds would impact negatively on our H1 (winter); however, we are seeing from current bookings an adverse impact on H2 (summer)”.

As at early February, Market & Airlines bookings for winter 2018/19 were 1% down on the prior year, with the average selling price down 2% and a “lower margin performance” than the prior year. For summer 2019, 34% of the programme had been sold to date, with a flat average selling price and again a “lower margin performance than prior year”. The group is explicit about the threat of downside scenario for Brexit — and particularly a hard Brexit — and says that “the main concern remains whether our aircraft will continue to have access to EU airspace”.

The group insists its overall growth strategy is still intact, but it’s clear where the problem lies. Its Holiday Experiences division (which includes hotels, cruises and other activities/excursions) delivered just 13.2% of revenue in Q1 of the 2017/18 financial year, but posted (positive) earnings of €111m. In contrast, the Market & Airlines business) was responsible for 82.6% of revenue in the quarter but delivered a massive loss of €178m (compared with a €141m loss in Q1 2017/18).

While the first half of the financial year is traditionally poor/loss-making for all tour operators, this pattern of contrasting performance between the businesses was also evident in the last full year (2017/18), when Holiday Experiences delivered 9.3% of revenue and 75% of earnings, while Markets & Airlines contributed 87% of revenue and 19% of earnings.

The group needs to turn Markets & Airlines around fast. It had already combined the airlines and regional AIT businesses to form a single division in order to drive efficiencies and cost savings, and it is also trying to sell more capacity direct to reduce distribution costs (in FY 2017/18 74% of bookings were made direct, and 48% online).

Interestingly, in a trading note issued in early February (before the quarterly result was released), the group said that it expected that continued headwinds may trigger market consolidation (such as the bankruptcy of Berlin-based Germania in February 2019), and that “TUI could be a beneficiary of this”. That’s a more passive approach than Thomas Cook; at this point in time TUI still seems attached to the concept of owning its own fleet — but will this last?

That TUI group fleet currently comprises 155 aircraft, flown by six airlines. The largest is Luton-based TUI Airways, with 36 737s, 13 757s, 12 787s and four 767s, followed by TUIfly, based at Hanover airport and which operates 34 737s and a single A321. TUI Airlines Belgium (based in Brussels) has 27 737s, two 787, a single 767 and four ERJ-190s; Schiphol’s TUI Airlines Netherlands operates six 737, three 787s and a 767, while TUIfly Nordic (Stockholm) has four 737s. The only non-TUI branded airline is Orly-based Corsair International, which operates four A330s and three 747s. TUI has been trying to sell the loss-making carrier for years, and in March announced a deal to sell 53% to German turnaround specialist INTRO Aviation for an undisclosed amount, with TUI initially retaining a 27% stake and Corsair’s Employee Benefit Trust keeping 20%. The TUI group also has 61 737MAXs on firm order.

Thanks to the strength of the Holiday Experiences division, the TUI group says underlying earnings will be “broadly stable” in full 2018/19 compared with FY 17/18. However, the pressing problem is the group’s debt position; net debt has more than doubled in just 12 months, from €874m as at December 31st 2017 to €1,832m a year later (and due partly to finance leases for additional aircraft). If Thomas Cook sells its aircraft portfolio for anything approaching a decent price, then surely the TUI group might be tempted to follow?

The challenger —

After the big two AIT group airlines, with the demise of Monarch the largest independent UK airline operating in the AIT segment is

Based at Leeds-Bradford airport, Jet2 dates back to 1983 and is owned by the Dart Group, a UK holding company that also owns a chilled food distributor.

In the first half of its 2018/19 financial year (the six months ending September 30th 2018), Jet2 recorded 4.4m flight-only passenger sectors and had 2.3m package holiday customers (up 24.4% and 27.6% year-on-year respectively). Overall, Jet2’s revenue grew by 38% to £2.2bn in the half-year, with operating profit up 69% in April-September 2018 to £347.8m and net profit up 56.8% to £274.8m.

Jet2 operates 100 aircraft from its main base and eight other UK airports to more than 70 leisure and city destinations in Europe. It also operates major bases al Alicante and Mallorca airports.

The last of an order for 34 737-800s was delivered in January 2019, and this summer three new destinations will be added — Chania in Crete, Bourgas in Bulgaria and İzmir in Turkey. A total of 12m seats are available on summer 2019 season, which is a capacity increase of 15% compared with summer 2018.

In November Philip Meeson — the chairman of the Dart Group — said that he was ”unclear how demand will develop in the medium term”, thanks to “the overall uncertain UK economic outlook, particularly related to Brexit and how it may impact on consumer spending”.

At the time he added that Jet2’s strategy remained consistent — to grow both flight-only and package holiday products, though this was “on the assumption that the UK government secures a pragmatic and balanced Brexit agreement with the EU”.

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Source: UK CAA

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1987 1990 1995 2000 2005 2010 2015 2018 Scheduled Charter Scheduled Charter

Source: UK CAA

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Source: UK CAA

gnuplot Produced by GNUPLOT 5.3 patchlevel 0 20 30 40 50 60 80 100 150 200 300 400 2015 2016 2017 2018 2019 Indexed (Jan 2015=100) TUI Thomas Cook Dart Group TUI Thomas Cook Dart Group

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