Gamble on crown and star, or invest in webjet and flight centre?

 The share market is convinced a domestic-travel recovery is imminent as health restrictions continue to ease, based on rallies in tourism-related stocks this month. 

Webjet (WEB) is up 84% from its 52-week low. Flight Centre Travel Group (FLT) is up 52%. Helloworld Travel (HLO) is up more than fourfold from its 67-cent low at the crisis peak. Qantas Airways (QAN) and Sea Link Travel Group (SLK) have also rallied off their lows. 

With New South Wales and Victoria opening for interstate travel this month, and the Federal Government confirming a Trans-Tasman travel “bubble” is possible later this year, investors are betting consumers will be desperate to travel. 

Short covering also explains the rallies. Travel stocks were among the hardest hit as the crisis erupted in February and traders bet on heavy share-price falls. As tourism stocks rally, the “shorts” are having to cover their positions, pushing prices higher. 

Still, I would not get carried away with recent price gains or chase most tourism-related stocks higher. The sector is rife with uncertainty. The risk/reward equation does not stack up for all but a handful of tourism-related stocks that can weather the storm. 

Yes, Webjet, Flight Centre and other travel stocks looked oversold amid panic selling. And after recent gains, those stocks are still trading at a shadow of their previous highs. 

But it is impossible to get a read on their FY20 earnings and even FY21 earnings because so much depends on virus containment, government policy and consumer sentiment. 

Contrarians might lick their lips at this equation. I prefer beaten-up sectors like the banks, a position I outlined last month in this report, as a recovery play. 

Short-term pain, long-term gain

To recap, I have written favourably about tourism stocks many times in the Switzer Report over the past decade, largely because of the unfolding boom in Asian middle-class consumption. It was a no-brainer that more Asians would holiday here. 

I am not as bullish now about tourism, in the short term, for three reasons. 

First, there is too much uncertainty with international travel. It is not only a case of Australia eventually lifting overseas travel bans. Other countries need to lift their international tourism bans and that depends on how they combat COVID-19. Many are still struggling with the virus. 

Second, the argument that Australia is on the cusp of a domestic-travel boom is spurious. Nobody doubts people are itching for a holiday and that local travel appeals with overseas markets closed. But that will not make up for the loss of international tourists. 

Moreover, I am not convinced Australians will flock to holiday hotspots. Millions of Australians have lost their job or are paying bills courtesy of government wage subsidies. Deferring or downsizing your next holiday seems logical given job insecurity. What happens when wage subsidies end or are tapered from September? 

Expect more people to “downsize” their holiday: a shorter break they organise themselves, a driving holiday, caravanning, camping or staying at a cheaper hotel. Or holidaying in regional areas, which is good for small businesses but less so for ASX-listed companies that are mostly exposed to tourism assets in capital cities. 

Others might prefer to stay at home. Health fears over the virus or concerns that holidays will be less enjoyable due to social-distancing rules could dampen travel plans. These issues might not deter young tourists, but they could affect the travel confidence of plenty of older ones. 

Third, even domestic travel depends on State governments, such as in Queensland, lifting crazy travel restrictions. Buying stocks that can jump up or down on a politician’s whim (or the latest polling numbers) is too risky. 

I hope I am wrong. My family is in north Queensland, so I would love to see the travel industry recovery quickly, and travel stocks regain their mojo. For now, it is better to miss the early rally until greater earnings certainty emerges. 

Better ways to play the sector

Being bearish on tourism does not mean avoiding the sector altogether. Instead, it requires taking a “bottom-up” approach to company analysis, choosing tourism-related stocks that are more defensive, or those with a strategic rationale, such as takeover. 

Webjet is an example. I included the online travel group in my column on takeover targets for this report on May 13 at $3.24 a share. Webjet has rallied to $4.33 since that story. Webjet is well funded after its capital raising and could attract a bid from a global travel firm. 

Chart 1: Webjet

Source: ASX

Casino operator Crown Resorts (CWN) was included in my two-part series on potential takeover targets on May 6. The trigger for that story came after news that United States private equity giant Blackstone Group had bought about 10% of Crown shares at $8.15 each. 

I wrote at the time: “Buying casinos when the sector is on its knees due to COVID-19 must appeal to private equity. For all the immediate problems, integrated casino resorts have an attractive long-term outlook, amid the coming boom in middle-class consumption in developing countries this decade.” Crown has rallied from $9.26 to $10.17 since that story. 

Chart 2: Crown Resorts

Source: ASX

I also wrote favourably on Sydney Airport (SYD) and Auckland International Airport (AIA) for this report on April 22, noting: “… It is hard to see how the news can materially worsen for Sydney Airport. The drop in passengers, greater than analysts feared, cannot go much lower.” 

Sydney Airport has mostly drifted sideways since that story and Auckland International Airport is up from $5.46 to $6.40. Both stocks look modestly undervalued and owning infrastructure monopolies is safer for portfolio investors to position for a long-term tourism recovery. 

Crown, Sydney Airport and Auckland International Airport still appeal for long-term investors, with or without takeover. After recent gains, I am holding off on Webjet, for now. 

The Star Entertainment Group (SGR)

The casino operator appeals after heavy share-price falls this year. The Star slumped from a 52-week high of $4.93 in late 2019 to $1.52 at the crisis peak in late March. The stock has rallied to $3.17 and has further to run, albeit at a slower pace, from here. 

Demerged from Tabcorp Holdings in 2011 (then known as Echo Entertainment Holdings), the well-run company owns The Star casino in Sydney, The Star Gold Coast and the Treasury casino in Brisbane. Each integrated resort has hotels, restaurants, nightclubs and bars. 

With international and domestic tourism cancelled during the crisis, The Star stood down around 8,500 staff, executed an additional $200-million debt facility, deferred its dividend and accessed the Federal Government’s JobKeeper program. 

The Star has many headwinds. Short term, the loss of international tourists and a slowly recovering domestic tourism market will weigh on earnings this year and next. In early 2021, the new rival Crown Sydney casino is expected to open, taking a huge chunk of Sydney’s casino market and possibly The Star’s revenue. 

The Star accounts for almost two thirds of group earnings. Although Crown Sydney will target higher rollers and VIP customers, the new casino will be a formidable competitor to The Star, given Crown’s sparkling new facilities and location. 

Star’s plans to redevelop its Sydney harbourside complex to include a new 66-story tower were rejected by the NSW Independent Planning Commission last year. 

Nevertheless, the Star was performing solidly in a difficult casino market before COVID-19 and the new Sovereign room for private gaming and high-end Oasis lounge/restaurant were due to open in May and June 2020 respectively, just in time for The Star’s phased reopening this month. 

The big news this week was the NSW Government extending The Star’s exclusivity as the only casino provider of Electronic Gaming Machines (EGMs) in Sydney. EGMs are The Star’s main competitive advantage against Crown Sydney. 

Sydney’s casino market looks like being segmented into high rollers and wealthier international and domestic customers at Crown Sydney; and a higher proportion of domestic customers at The Star, many of whom favour the venue for its slot machines. 

EGMs are an early beneficiary of health-restriction easings. SkyCity Entertainment Group (SKC), owner of casinos in New Zealand and Adelaide, this week said EGM revenues in Auckland and Hamilton since the easing of restrictions were 80% of average daily revenue in the eight months to February 2020. 

That suggests gaming businesses are experiencing a “V-shaped” recovery, despite ongoing social-distancing and mass-gathering restrictions. That is good news for SkyCity – a reason why its shares rallied this week – and bodes well for The Star and other casinos that rely on pokies. 

There is also evidence overseas that casinos have had more of a V-shaped recovery than other sectors after COVID-19 restrictions were eased. After staying at home for weeks, many consumers were eager to have a bet at their local casino and seek entertainment. 

Longer term, The Star has the $2.6-billion Queen’s Wharf development in Brisbane underway (50% SGR) and says construction is on time and budget. The integrated resort, due to open in late 2022, has an eye-catching design and should dominate the high-end Brisbane entertainment market. 

At the Gold Coast casino, the first joint-venture tower is expected to open in FY22 and pre-sales for the second tower are underway. 

Competition risk from Crown Sydney and construction risk at the Queensland casinos have been the main market concerns on The Star Entertainment Group. EGM exclusivity strengthens The Star in Sydney and construction risk is reducing as the Queensland developments continue. 

Federal and State governments will be itching for Queensland casino projects to proceed smoothly, given the number of jobs they will create in the next few years in a depressed labour market.  The projects are fortuitously timed given international and domestic tourism markets should be in full swing by 2022. 

With more than $700 million in cash and undrawn debt, The Star is well placed to weather a prolonged COVID-19 downturn, without needing a dilutive equity capital raising. 

Morningstar’s $3.90 valuation for The Star suggests it remains undervalued against the current $3.17, despite the recent price rally. The stock suits investors with at least a three-year timeframe or preferably longer, given the development pipeline. 

Casinos have many challenges but high-profile integrated resorts in Sydney, Brisbane and Gold Coast have strong long-term prospects as the middle-class consumption boom in Asia continues. And as more Asians holiday in Australia, visiting or staying in our casinos. 

If you want to bet on tourism stocks, stick to the big casinos. As they say, the ‘house always wins’ in the long run.    
 

Chart 3: The Star

Source: ASX