Investors guide to Brexit and the Travel Industry

We got a profits warning today from Thomas Cook - and they blamed the summer heatwave for their travails rather than Brexit.

More and more people leave it to the last minute to book their summer holiday - and Britain was so warm in June and July that many people didn't really want to go away, they opted to either sunbathe in their own back gardens or go on a short driving trip to some of the more picturesque parts of the UK. In other words a staycation.

Thomas Cook did mention that

Bookings for summer 2018 are 12% higher, driven by the return in popularity of holidays to Turkey, Egypt, Tunisia and Greece. However, average selling prices are 5% lower.

In other words the pound had an effect too - Spanish and European holidays were too expensive so those who did go abroad opted for the cheaper stuff in Turkey (whose currency has plummetted).

How does Brexit affect the travel industry?

The first thing is the currency. The travel industry prices it's package holidays in advance, on what it thinks the value of the pound will be. If they think the pound will be worth $1.32, they'll err on the side of caution and price holidays as though the value is $1.25. That way, if the pound comes in as per predictions, they make a profit, and if the pound actually falls below the $1.32 they are predicting, they don't make a loss. Some of the bigger travel groups take out currency hedge options in the financial markets too, to protect themselves.

Now consider that the pound was about $1.40 just prior to the referendum in 2016. It's now hovering at $1.30 or thereabouts. A No deal brexit will mean it may fall towards $1.20.

Holiday firms will be pricing accordingly - and losing volume as a result as Brits deem foreign holidays are too expensive. The alternative strategy for them is to increase the number of holiday offers in places like Turkey, Morrocco and so on - but as we have seen with Thomas Cook, just having people switch to those destinations is not enough - to make up for the lower prices you need to increase volumes substantially. And though Thomas Cook increased volume by a respectable 12%, it wasn't enough.

Because negotiations on Brexit are at an impasse, travel groups like Thomas Cook and TUI will be going into the New Year faced with pricing a very low pound. This will hurt all their European holiday destination packages.

So my reccomendation is that despite Thomas Cook and TUI shares plunging today, Don't Buy Yet. They have further to fall especially if they're hit by a combination of a low pound and warm weather in the UK again next year.

What about a No Deal Brexit

No Deal means that UK aircraft can't land in any airport in the European Union. (Though they will be able to fly over European airspace). That means all European holidays will be out of the question and companies like Thomas Cook can only offer holidays to places like Turkey etc which are out of the EU.

The good news though is that the volumes should be decent enough to make a profit, as long as the weather in the UK is cold and people want to get away to the sun. So as long as they prepare carefully so they actually have non-EU destinations to offer in sufficient quantities, they're OK.

Now some people have argued that banning Brits from all European destinations will hurt the EU so much that the EU will make an exception and allow British planes to land. But don't bet against the stupidity of the EU.

What usually happens is they have a summit meeting - and the dominant countries like France and Germany assert what they want, and the weaker countries acquiese even if it hurts them. Spain for example needs British tourists - but they also need EU transfer funds and they need the ECB to continue to buy Spanish govt bonds as part of it's QE program.

If they're in a room with Macron aggresively telling them that the EU must stand firm to "teach the Brits a lesson" but there is no-one in the room saying "hang on, this will hurt the economy", they'll cave. They have already caved and agreed to many many policies that are destructive to their economy, that have been demanded by the aggresive countries like France and Germany. This time will be no different. In theory they should resist self-harm, in practice they tend to hurt themselves when pressured by a stronger country.

The UK of course is very flexible and wil unilaterally allow everyone to land here. This means inward tourism will continue.

Who benefits from inward tourism to the UK?

We've already seen record numbers of tourists from the USA and Canada flocking to the UK, drawn by the cheap pound.

The beneficiaries are UK hotel groups. Premier Inn, Travel Lodge, Holiday Inn and other companies do really well out of all this. As do the restaurant chains and entertainment complexes.

For example, knowing that Windsor Castle is a big tourist draw (it's a massive Norman castle and was the location for Prince Harry's wedding to Meghan Markle), Legoland decided to locate it's theme park there. That way, people visiting the castle also visit the theme park.

British holiday resorts like Centreparcs also benefit from the staycation trend.

Conclusion

There are winners and losers from Brexit and No Deal Brexit.

The losers are airlines and those who market package holidays to Europe. Those who market package holidays to the rest of the world (especially those who market exotic holiday destinations) should be fine.

Winners are hotel groups in the UK as they benefit from the staycation trend and the increased numbers of tourists from North America attracted by the cheap pound.