The stocks set to fly as travel takes off again

Dominic Rose

Montgomery Lucent Investment Management

With COVID-19 travel restrictions beginning to ease, the Montgomery Small Companies Fund has been adding to its investments in ASX listed travel businesses. In particular, we like the look of Alliance Aviation Services, Corporate Travel Management, Flight Centre and Webjet, which should all do well as travel rebounds.

The skies finally appear to be clearing for the travel sector to take off as restrictions ease around the world after a challenging couple of years for the industry. Both the UK and the European Union have scrapped COVID-19 testing requirements for fully vaccinated travellers while recent commentary from numerous US airlines suggests that North American leisure activity is back at or near pre-pandemic levels with corporate improving to 25-30 per cent behind.

The Montgomery Small Companies Fund has been adding to its travel exposure to benefit from the improving industry outlook, preferring those companies which have materially improved their competitive positioning during the downturn which should see them emerge as market share takers and materially outperform as the cycle recovers. Our travel exposures include Alliance Aviation Services (ASX: AQZ), Corporate Travel Management (ASX: CTD), Flight Centre (ASX: FLT) and Webjet (ASX: WEB).

Alliance Aviation Services

Alliance Aviation Services seized the moment when global airline fleets were grounded and airlines offloaded assets at distressed prices to stay liquid. In June 2020, the company raised $122 million in equity to purchase a fleet of 32 Embraer E190 aircraft from various vendors, paying just cents in the dollar, and taking a view that demand for these assets would rebound quickly because carriers would seek operating efficiencies through fleet optimisation. Qantas (ASX: QAN) has taken options over 18 of the E190s with AQZ expecting full deployment of the 32 E190s by the end if this calendar year. Although the timing of the deployment has been delayed by the recent Omicron wave, the significance of the fleet expansion remains intact; increasing the company’s annualised operating capacity by a factor of c.3.5x compared to pre-COVID (FY19). In addition to being a much larger business once the expansion assets are fully deployed, we view the company as more diversified with expanded leisure exposure (complementing the FIFO business) and we also expect improved unit economics given the higher asset utilisation of the new E190s compared to the older Fokker aircraft.

Corporate Travel Management

Corporate Travel Management capitalised upon opportunities thrown up from the pandemic disruptions, raising fresh equity to undertake a transformative acquisition of leading US corporate travel agent, Travel & Transport (US$200 million deal announced in September 2020), and more recently raising capital to purchase Helloworld Travel’s (ASX: HLO) corporate and entertainment travel business in Australia and New Zealand, Helloworld Corporate (A$175 million deal announced in December 2021). While competitors were scrambling to cut operating costs during the depths of the downturn, mainly headcount which negatively impacts customer service levels and therefore client retention, Corporate Travel Management was strategically expanding through opportunistic M&A. The company is now estimated to be the fourth largest global corporate travel manager worldwide with fully recovered EBITDA of around $265 million, some 77% higher than pre-COVID levels. Although corporate travel activity might not fully recover to pre-pandemic levels due to structural factors like working from home and video conferencing, CTD will be a much larger business and appears well placed to outperform the recovery thanks to its enhanced scale and superior technology offering, delivering better client outcomes and lower cost to serve. Being predominantly a northern hemisphere business, the trans-Atlantic route remains a key catalyst for the company, along with workers returning to offices (at least partially).

Flight Centre

Flight Centre is arguably the most levered play to a rebound in travel activity considering it was hardest hit by the pandemic-related border closures owing to the company’s significant exposure to Australian outbound leisure travel (which has only recently resumed). Management’s response to the initial demand shock was to stand down staff and raise equity capital at deeply discounted prices ($700 million equity raise in April 2020 plus a number of subsequent convertible bond issues) to strengthen the balance sheet and fund the significant working capital unwind (ticket refunds). Importantly, Flight Centre also used the pandemic as a catalyst to clean up shop and industrialise the business, structurally reducing the legacy cost base, modernising the brand and accelerating investment in technology to drive productivity gains. The major cost-out initiative came from halving the ‘bloated’ retail store footprint, delivering significant savings in both employee costs and rent. Despite having half the number of shopfronts, management still expects to retain 95% customer reach. Meanwhile, many smaller competing travel agents throughout Australia shut their doors and likely won’t reopen. As such, Flight Centre should retain its dominant market position in the Australian leisure travel market with the potential to take further share from weakened competitors as conditions improve. 

The cost base will also be structurally lowered through increased automation with the company investing heavily in technology during the downturn. Key focus areas were improved online capabilities and store productivity systems. The company’s global corporate travel business has also taken advantage of the changed competitive backdrop, winning a number of significant new client contracts over the past year. Overall, FLT is looking to deliver pre-pandemic volumes with 20-30% fewer costs. And if travel volumes were to fully recover, profits will be much greater.

Webjet

Webjet is another highly levered play on a travel sector recovery, particularly Australian domestic leisure through the Webjet B2C online airline ticketing business and international leisure via the WebBeds B2B hotel digital ‘bed bank’ business. Similar to Flight Centre, when borders closed Webjet was forced into an emergency capital raise ($275 million equity raise in April 2020 plus a number of subsequent convertible bond issues) to refund tickets and keep the lights on. With the balance sheet strengthened, Management’s attention then turned towards restructuring the business and building a platform for enhanced growth with a particular focus on the WebBeds segment. WebBeds is looking to take advantage of the changed competitive landscape and become the number one travel wholesaler globally (currently number two). The strategy involves targeting a greater share of a larger market opportunity and structurally reducing fixed costs to extend the business’ cost leadership advantage and drive higher profitability. Channel expansion, diversifying into previously untapped domestic markets and materially increasing North American penetration expand the addressable market opportunity. Management is also targeting a structural 20% reduction in the Group’s overall cost base at scale, mainly from WebBeds where cost initiatives involve streamlining the technology stack, leveraging data analytics and simplifying processes across the business. Additionally, Webjet, which commanded a 50% share of domestic online bookings pre-pandemic, is aiming to outperform the market recovery by 1.5x as the structural migration towards online accelerates and underpinned by superior technology.

Commentary from U.S. airlines at a recent broker conference paints a positive picture for the travel sector recovery. Delta Airlines said revenue has recovered to around 78 per cent of 2019 levels with system cash sales now above pre-pandemic levels at 87 per cent restored flight capacity. United Airlines pointed towards first-quarter revenue being 81 per cent of pre-pandemic levels with forward bookings for both leisure and corporate just 2 per cent below FY19. American Airlines also updated its forecasts, now expecting first-quarter revenue to be within 82 per cent of pre-COVID levels with capacity around 90 per cent. The airline experienced two days this month with revenues 15 per cent higher than any other day in the company’s history.

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Dominic  Rose
Portfolio Manager
Montgomery Lucent Investment Management

Dominic is Portfolio Manager of the Montgomery Small Companies Fund – a small-cap Australian equity fund investing in 30 to 50 high quality, undervalued small and emerging companies with strong growth potential. The fund invests outside the ASX100.

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