>One of the hardest hit industries from the Covid-crisis is the travel industry, for obvious reasons. While some observers have criticized the tendency of companies to securitize assets rather than keep them on the balance sheet, we believe that the shift in the industry toward an asset-light model will help to save many of its members during the Covid-lockdowns.
Capital-intensity haunts the industry
A common feature of much of the travel and leisure industry is its heavy use of capital. Some ancillary businesses such as restaurants or booking systems may be able to operate with lesser capital intensity, but generally, heavy investment is required. This, in turn, can cause serious financial difficulties if cash flows dry up during a recession.
Over the years, many travel and leisure companies have moved to a capital-light business model, mostly through sale-leaseback transactions of real estate, aircraft, vehicles or any other asset that can be securitized. While that improves the capital efficiency of individual companies and the industry as a whole, it does not change the underlying dynamics of some companies in the industry: high fixed costs lead to trouble if cash flow declines significantly. Nevertheless, if we look at the travel industry as a whole it appears that operating companies are better off navigating the crisis than if they had the additional complexity of managing large balance sheets with the associated maturities and refinancing needs.
Airlines
Airlines are some of the most procyclical companies, irrespective of whether they focus on business or tourist travel. They were some of the first companies to adopt an asset-light business model by leasing aircraft and securitizing aircraft leases. During the pandemic, airlines around the world have been beneficiaries of taxpayer largess. In the U.S., direct loans to the companies and wage support paid directly to employees kept the industry out of bankruptcy. Note, though, that it’s debatable whether these funds are well spent. After all, the industry is known to be cyclical and experienced many bankruptcies during the 2003 recession without causing disruption to the economy more broadly.
Since August, global airline capacity has remained stable around 60% of last year's number, while the situation in the U.S. is dramatically worse with capacity only at 30% compared to where it was a year ago.
At one point, actual traffic fell by as much as 90% (do you mean global or US traffic? Clarify this). However, the industry is on a clear uptrend. Traffic is improving to a decline of 70%. Moreover, cargo is up: for example, United saw an improvement of 50% of cargo revenue year-over-year. However, passenger revenue is down 84%, so despite the improvement in cargo, overall revenue has fallen 78%. In Asia, airline traffic has resumed faster than in the U.S., notably in China, where traffic is even up year-over-year.
Canada has recently begun to debate $5 billion in subsidies to its airlines. We expect the global subsidy game to escalate further as air traffic numbers remain depressed in the West.
Hotels
Marriott was a pioneer in the hotel industry by spinning off its real estate into a REIT as early as 1993. The trend continues, with holdouts of the traditional owner-operator model, such as Accor, recently selling off their real estate. After experiencing declines during Covid that were more severe than those of the 2003 and 2009 crises, many of the larger hotel chains like Marriott, Hyatt and Hilton are seeing, overall, a pickup in revenues per available room. Much of this growth is driven, however, not by the U.S. or European markets but by the pickup in travel in Asia. Hilton, for example, considers its Hampton Inn brand the fastest expanding hotel brand in China. Similarly, Hyatt is working with local partners in China to expand in that country with a capital-efficient franchising model. The longer the pandemic lasts, the more that we expect hotel operating companies to outperform lodging REITs and owner-operators who have to handle the capital-intensive parts of the hotel business.
Cruises
Cruise ships in the Americas remain moored, although operators are selling tickets for departures starting in December. In Europe, ships began sailing recently and some have even completed cruises. Reports suggest that despite extensive testing, some passengers were infected during the trips, so it is unclear whether this pickup in activity can be sustained.
Carnival is a U.S.-listed firm that owns several European brands which are sailing, but this has not done much to help its stock price: its stock price is down 70% YTD as of the end of Q3, in line with Norwegian and about 20 points worse than Royal Caribbean. And even Tui, a London-listed heavyweight in the slowly recovering European vacationing market, has a stock down 68% over the same period, despite a reopened cruise line division.
We believe that, despite the CDC's no sail order, all three big U.S. Cruise operators have sufficient liquidity to survive well into 2021. Royal Caribbean recently strengthened its cash position through an equity offering that dilutes shareholders by a modest 3.3%, much less than the ensuing 14% one-day selloff implied after that offering.
Casinos
Casinos have been relatively late to the asset-light business model, with some casinos spinning off their real estate into REITs only in the last 5 years. It can be argued that with visitor volume in Las Vegas down 57% and convention attendance down 100% year-over-year, capital intensive models almost do not even matter. The action has, of course, been in online and sports betting, which is still in its infancy in most U.S. States. Casinos are the one area where the recovery in China lags that of the West: visitors to Macao are still down 87% as of August. As with hotels, we believe that casino operators would be in a much weaker position if they owned all of the properties that they operate. The disentanglement of real estate ownership and business operations simplifies balance sheets and increases financial flexibility in a time of crisis.
Overall, it is clear to us that by having implemented an asset-light business model a long time ago, financial pressures on many companies in the travel industry are much less than they would have been otherwise. While financial engineering of this type is often maligned by critics, we believe that it has proven to be beneficial in times of extreme economic stress such as the Covid crisis and the associated lockdowns. The economic crisis would be more severe had it not been for financial engineering.
