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EMEA Equity Research

Travel & leisure
July 2012

Travel & leisure

Travel & leisure
Lena Thakkar*
Analyst
HSBC Bank plc
+44 20 7991 3448

lena.thakkar@hsbcib.com

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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EMEA Equity Research
Travel & leisure
July 2012

Sector structure
Travel & leisure

Travel*

Hotels

Leisure

Tour Operators

Bookmakers/
Online Gaming

Cruise Companies

Pubs & Restaurants

Caterers/
Vouchers

Accor Hotels

Holidaybreak

Carnival

888

Enterprise Inns

Compass

IHG

Kuoni

Royal Caribbean

Bwin.Party

Greene King

Edenred

M&C

Thomas Cook

Ladbrokes

JD Wetherspoon

Sodexo

Whitbread

Tui Travel

Paddy Power

Marston's

Playtec h

Mitchells and Butlers

Rank

Punc h Taverns

Sportingbet

Spirit Pub Company

William Hill

The Res taurant Group

*For airlines, bus and rail companies see Transport section

Source: HSBC

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%y -o-y change in FTSE 350 Trav el and Leisure Index

80%

10 y ear sw ap rate - 2 y ear sw ap rate (RHS)

2.6

60%

1.8

40%

1.0

20%

0.2

0%

-0.6

-20%

-1.4

-40%

-2.2

-60%

-3.0

June-88

June-90

June-92

June-94

June-96

June-98

June-00

June-02

June-04

UK leaves ERM in September 1992

Interest rates fall
Economy recovers

80%

June-06

June-08

June-10

June-12

Collapse in UK GDP as credit

crunch bites

50
40

60%

30

40%

20

20%

10

0%

0
-10

-20%

-20

-40%

-30
-40

-60%
June-88

EMEA Equity Research

Travel & leisure
July 2012

Travel and leisure sector performance

June-90

June-92

June-94

June-96

June-98

June-00

Source: Thomson Reuters DataStream, HSBC

June-04

June-06

June-08

UK consumer confidence indicator (RHS)

June-10

June-12

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%y -o-y change in FTSE 350 Trav el and Leisure Index

June-02

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EMEA Equity Research
Travel & leisure
July 2012

EBIT margin versus asset turnover chart (2011)*

2 .0

1 .8

C PG

TT

1 .6

TC G
1 .4

SD X

Asset Turnover (x)

1 .2
JDW

1 .0

0 .8
ACCP

WTB

0 .6

0 .4

IH G

M AB
G NK

CCL
RC L

M ARS

E D EN

0 .2

0 .0
5 .0 %

1 0. 0%

1 5 .0 %

2 0 .0 %
E B I T m a r g i n (% )

*Whitbread calculations use FY 2012 numbers; year-end is in February

Source: Company data, HSBC estimates

2 5 .0 %

30 . 0 %

35 . 0%

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0 .0 %

EMEA Equity Research

Travel & leisure
July 2012

Sector description
The travel and leisure sector comprises numerous diverse sub-sectors including pubs and restaurants,
hotels, cruise and tour operators, bookmakers and gaming companies, and catering companies. In
addition, there are a several smaller esoteric businesses that do not fit neatly into a specific sub-sector,
such as the fast-food delivery company Dominos Pizza and cinema operator Cineworld. Airlines and bus
and rail operators in this report are categorised under transport.

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Lena Thakkar *
Analyst
HSBC Bank Plc
+44 20 7991 3448
lena.thakkar@hsbcib.com
*Employed by a non-US affiliate
of HSBC Securities (USA) Inc,
and is not registered/ qualified
pursuant to FINRA regulations

Key themes
Discretionary spend
In the travel and leisure sector similarities between companies are more subtle than for companies in
other sectors. Broadly speaking, companies in this sector depend on some form of discretionary
expenditure. When confidence and incomes are high, spending on discretionary items (like eating out or
holidays) is also likely to be strong. Alternatively, during a downturn, confidence falls and consumers cut
discretionary spending. This makes the travel and leisure sector more cyclical than many others.

Long-term growth
Despite this cyclicality, all sub-sectors have in the past exhibited real structural growth, and look likely to
continue to do so over the long term. Travel-related companies such as hotels and tour operators benefit
from GDP growth, globalisation, and political change, which can allow freer movement of people.
Meanwhile, as disposable incomes increase in both developed and emerging markets, there is greater
demand for leisure activities such as eating out, holidays, sporting events and gambling.

Sector drivers
Consumer and business confidence
Quite simply, increasing confidence means greater discretionary spend. We have outlined the nature of
that relationship with regard to consumers above, but it is also worth considering business confidence.
Corporate spending on hotels and catering usually fluctuates with the economy, with rooms and services
being upgraded to premium categories in the good times, but travel restrictions quickly being enforced in
tougher economic conditions.

Capacity and capex

Capacity varies considerably depending on the sub-sector. Within the hotel industry, the current lack of
available finance to build new hotels means supply is increasing slowly, particularly in developed
markets. In comparison, the long-term declines in the UKs drinking-out market mean the capacity of
wet-led pubs is in decline, although this is being offset by capacity increases in the number of food-led
pubs and other restaurants. In the more mature industries, such as pubs and land-based bookmakers,
capex tends to trend in line with depreciation, unless operators are actively looking to roll out more units.

Input costs
Input costs differ between sub-sectors, although labour is usually one of the highest costs. Other key costs
are food and beverages for hoteliers, pubs and restaurants, and fuel for cruise and tour operators. These
costs ultimately depend on commodity markets, although businesses tend to have long-term contracts
with suppliers in order to reduce volatility.

EMEA Equity Research

Travel & leisure
July 2012

Changes in regulation and taxation

Since expenditure in the sector is discretionary, it is often an easy target for governments to tax; duties on
alcohol, gambling and air travel are obvious examples. Changes in regulation often create big operational
risks. When online gaming was outlawed in the US, operators lost more than half of their global market
overnight, and when smoking was banned in all public places in the UK in 2007 wet-led pub operators
had to substitute declining alcohol sales with increased focus on food sales.

Sub-sector drivers
Each sub-sector has its own unique structure and is subject to different macro and micro drivers. For
example, the barriers to entry in the cruising industry are high since large sums of capital are required to
acquire a new cruise ship compared to opening a new restaurant. Key themes in each sub-sector include:
Pubs and restaurants
Themes: growth of the eating-out market versus the decline of the drinking-out market; changes in taste

and preferences; freehold versus leasehold sites and property values; managed, leased, tenanted or
franchise-based operating models; a fragmented industry with consolidation potential; input cost inflation;
competition from supermarkets and the off-trade; changes in duty and taxes; and changes in regulation.
Share price drivers: We believe the three key drivers of share price performance are:

Top-line resilience: Eating out remains a priority for UK consumers. With value a key driver, pub
restaurants should continue to grow and take share. This trend should intensify as diners trade down
to cheaper alternatives if disposable income falls.
Consolidation and polarisation: The industry has polarised at the fastest rate in history over the past
few years driven by the managed listed companies. Stronger operators have grown and acquired
smaller operators which have struggled or even gone out of business. The successful players have
larger food-led pubs with scale, geographical reach and experienced management.
Cost outlook: Managed operators have successfully grown their top lines through the recession, but
profits have been slower to rise as margins have not expanded in line with operational gearing levels.
There are two reasons for this: discounting to drive volumes and cost inflation.
Hotels
Themes: penetration of branded hotels versus non-branded hotels; lower growth in developed markets

than in emerging markets; asset-light versus owner-operated business models; recovering demand and
limited new hotel capacity; changes in corporate travel budgets; loyalty schemes; and asset values.
Share price drivers: We believe the three key drivers of share price performance are:

Macro lead indicators: Hotel revenues are driven by corporate and consumer spend. The common
indicator used by commentators to assess the current health of hotel stocks tends to be RevPAR
(revenue per available room). There is a high correlation between RevPAR and GDP, but GDP
moves tend to lag share prices.
Brand strength: Strong brands are vital for RevPAR outperformance, resilient growth pipelines and a
shift to an asset-light model. In a strong market, when occupancy rates are high, consumers are travelling

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EMEA Equity Research

Travel & leisure
July 2012

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and businesses are expanding, all hotels can have the confidence to raise prices. However, in a downturn,
when budgets are tight, the strongest and most reliable brands are the first to get booked.
Emerging markets success: With Western hotels growth reliant on RevPAR recovery and slim net
additions, companies are increasingly focused on emerging markets as the true growth driver where GDP
expansion, as well as tourism and business travel is outstripping the West. Areas of expansion for the
companies are China, India, the Middle East, Africa, Brazil and Thailand/Indonesia.
Cruises
Themes: ship capacity, oil price, currency, ageing population, increasing cruise penetration, new source

areas, and the launch of new and innovative ships.

Share price drivers: We believe the three key drivers of share price performance are:

Net yields: Cruise companies provide forward capacity numbers and always fill their ships over
100%, so the only unknown is net revenue yield. In general, passengers tend to book cruises well in
advance. Therefore, changes in consumer sentiment can have a lagged effect. Yields are affected by
shocks like maritime accidents, natural disasters, terrorist attacks and financial market panic.
Industry supply: With 8-9% pa supply growth over the past decade, cruise companies have struggled
to gain any pricing power. In the next three years, industry supply growth is planned at c3% pa, much
lower than the last decade, and so pricing may show some improvement.
Oil price and currency: Fuel and currency fluctuations are key drivers of earnings volatility for the
cruise companies. Fuel makes up 15-20% of the cost base for the cruise companies.
Tour operators
Themes: changes in aircraft capacity; growth of independent travel, disintermediation caused by the

internet; changes in booking patterns; growth of low-cost carriers; exchange rates; geo-political risk and
climate change; fuel costs; and changes to excise and duty rates.
Share price drivers: We believe the three key drivers of share price performance are:

UK consumer: UK packaged holidays make up a third of tour operators profit. The UK has been the
most challenging and volatile source market. Future performance will ultimately rely on the
consumer environment.
Structural challenges: Independent and internet travel agencies continue to take share. Packaged
holidays are a commodity product leading to price wars and margin loss in the lates market.
Bid speculation: Tour operators have been subject to bid speculation in the press owing to distressed
valuation and poor operational performance. Share price rallies following such takeover speculation
have been short-lived, with the gains nullified soon after the euphoria settles.
Bookmakers and gambling
Themes: high growth in online versus subdued growth in land-based gambling; changes in tastes and

preference, such as growth in football betting and the decline in horse racing betting; changes to global
regulation, taxes and duties; social acceptance and awareness of gambling.

EMEA Equity Research

Travel & leisure
July 2012

Share price drivers: We believe the three key drivers share price performance are:

Regulation: Changes in regulation affect the profitability of the gambling industry. Regulation is
mostly in the form of taxes applied to the gaming companies or rules around whether certain forms of
gambling are permitted.
Move to digital: Digital revenue growth is driven by a change in consumer behaviour, launch of new
products and increasing marketing efforts. Many European countries are discussing the approval of
online gaming which will provide a boost to online gaming businesses.
Mergers & acquisitions: Companies derive cost synergies from disposals of overlapping facilities
and software. Established gaming companies can make acquisitions to gain the benefit of successful
proprietary gaming platforms/technologies developed by small companies.
Caterers
Themes: size of overall market and potential growth of outsourcing; penetration levels vary across

industry sectors and regions; cyclical or defensive; types of contract; input costs (food and labour); and
opportunities in facilities management. Revenues are driven by price, volume and net new business.
Share price drivers: We believe the three key drivers of share price performance are:

Employment levels: B&I accounts for a major chunk of the catering outsourcing business. When
businesses cut their workforce, this affects the volume of food sold at company cafeterias. Facilities
managements volume of work is less transient, as it is dependent on clients expanding their offices.
Inflation: Food and wages make up the bulk of the cost structure of food services companies. Food
and wage inflation therefore have a major impact on contract profitability. Inflation also affects the
pricing of new contracts, as well as renewal of existing contracts.
Outsourcing/penetration rate: Outsourcing rates for facilities management are relatively low in all
sectors aside from B&I (Business and Industry) and remote sites. The opportunity is in sectors such
as healthcare and education where penetration remains low. In food services globally only 45-50% of
the business is outsourced and 50% of new business comes from first-time outsourcers.

Valuation
Understandably there is no one valuation methodology that is appropriate to the whole sector. In fact there
is not one methodology that is relevant to all companies within most sub-sectors. For example the pub
industry is mature, and has relatively predictable cash flows; a DCF valuation is often favoured. However,
a DCF fails to consider the asset backing inherent in the freehold pub companies.
Likewise in the hotel industry there are two models the asset-light model tends to attract a higher
multiple as returns on capital are higher, but the capital-intensive model clearly has support from the asset
values, which can often support more debt. We think the most commonly used methodologies are relative
multiple analysis and DCF, with returns-based measures and asset values providing support.

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EMEA Equity Research

Travel & leisure
July 2012

Accounting issues
Most operators have fairly predictable cash flows since customers pay for their goods and services when
they receive them. Therefore the conversion ratio of operating profit into free cash flows tend to be high,
and this, in most cases, means accounting standards are fairly straightforward.
One issue to be aware of is operating leases, which can be used for property assets such as real estate and
aircrafts. Since these assets are simply leased, the potential full liabilities are not capitalised on the
balance sheet. To compensate for this, a calculation to capitalise the annual lease cost at 8x is often used
or we can use the fixed cover charge, which takes into consideration both interest costs and rent.
Another area to focus on is working capital, particularly for the tour operators as, owing to the seasonal
nature of their businesses, they can see a large swing in working capital from the time cash comes in over
the summer months as customers pay the balance of their holidays, to the low point, usually at the start of
the calendar year, when they pay hoteliers for their allocation of rooms for the previous year.
Hotels sector: growth and profitability

Growth
Sales
EBITDA
EBIT
Net profit
Margins
EBITDA
EBIT
Net profit
Productivity
Capex/sales
Asset turnover (x)
Net debt/equity (x)
ROE

2010

2011

2012e

2013e

8.6%
22.5%
11.8%
5.9%

7.1%
10.6%
18.2%
23.4%

3.0%
3.7%
2.4%
11.6%

5.8%
7.6%
8.9%
11.3%

23.6%
16.8%
10.2%

24.5%
18.4%
11.7%

24.8%
18.4%
11.9%

25.3%
18.9%
12.3%

9.9%
0.59
0.48
42.7%

12.5%
0.67
0.42
33.0%

13.2%
0.68
0.24
24.7%

12.7%
0.70
0.12
21.8%

2010

2011

2012e

2013e

5.7%
7.4%
8.1%
13.9%

5.6%
8.3%
9.3%
12.2%

4.4%
7.5%
7.4%
5.9%

5.2%
9.4%
9.9%
12.2%

12.7%
10.8%
6.3%

12.7%
10.9%
6.8%

12.7%
10.9%
6.7%

13.0%
11.2%
7.0%

2.7%
1.41
0.18
14.8%

2.7%
1.40
0.17
13.5%

2.6%
1.43
0.24
13.5%

2.4%
1.47
0.20
13.2%

Note: based on all HSBC hotels sector coverage

Source: Company data, HSBC estimates

Food services sector: growth and profitability

Growth
Sales
EBITDA
EBIT
Net profit
Margins
EBITDA
EBIT
Net profit
Productivity
Capex/sales
Asset turnover (x)
Net debt/equity (x)
ROE
Note: based on all HSBC food services coverage
Source: Company data, HSBC estimates

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EMEA Equity Research

Travel & leisure
July 2012

Sector snapshot
Core industry driver: US and Europe consumer confidence

95

Compass, IGH, Sodexo

0.9

May-12

25
May-11

97

May-10

50

May-09

99

May-08

75

May-07

101

May-06

16.8%
40.0%

100

May-05

630
58,888

103

M ay-04

Trading data
5-yr ADTV (GBPm)
Aggregated market cap (GBPm)
Performance since 1 Jan 2000
Absolute*
Relative to MSCI Europe US
Dollar*
3 largest stocks
Correlation (5-year) with MSCI Europe
US Dollar

125

May-03

0.9% of MSCI Europe US Dollar

May-02

MSCI Europe Hotels,

Restaurants and Leisure Index

May-01

Key sector stats

US consumer confidence index

Europe consumer confidence index (RHS)

* Absolute and relative performance of HSBC Travel and Leisure coverage

Source: MSCI, Thomson Reuters DataStream, HSBC

Source: Thomson Reuters DataStream, HSBC

Stock rank

Stocks

1
2
3
4
5
6
7

Compass
IHG
Sodexo
Carnival
Whitbread
Accor
Tui travel

Index weight*
36.6%
13.1%
12.9%
11.3%
10.9%
8.5%
2.2%

PE band chart: MSCI Europe Hotels, Restaurants and

Leisure Index
250
200
Pri ce level

Top 7 stocks: MSCI Europe Hotels, Restaurants and Leisure

Index

*These are top ten stocks as per index weight

150

20x

100

15x
10x
5x

50

Source: MSCI, Thomson Reuters DataStream

Jun-12

Jun-11

Jun-10

Jun-09

Jun-08

Jun-07

Source: MSCI, Thomson Reuters DataStream

PE vs. PB: MSCI Europe Hotels, Restaurants and Leisure

Index

2. 6

10

1. 8

1. 0
Jun-12

3. 4

15

Jun-11

4. 2

20

Jun-10

25

Jun-09

5. 0

Jun-08

30

Jun-05

Source: MSCI, Thomson Reuters DataStream

74.2%
21.4%
2.5%
1.9%

Jun-07

UK
France
Greece
Italy

Weights (%)

Jun-06

Country

Jun-06

Jun-05

Country breakdown: MSCI Europe Hotels, Restaurants and

Leisure Index

MSCI Europe Leisure index P/ E (x )

MSCI Europe Leisure index P/ B (x )- RHS
Source: MSCI, Thomson Reuters Datastream

10