I bought a new stock for my income portfolio in February. It’s a long-term portfolio to which I rarely add new holdings.
However, I was missing some exposure to the travel and leisure sector. To address this, I bought some shares of FTSE 100-listed TUI AG (LSE: TUI), which operates brands including Thompson, TUI fly and Hapag-Lloyd Cruises. This Anglo-German group has a £6.9bn market cap, and generated an underlying profit of more than £1bn last year on sales of £17.2bn.
Flying high
I was attracted to TUI by its 5% dividend yield, strong balance sheet and improving outlook.
The group’s business model is based on a vertically integrated approach. This means it provides flights, hotels, cruise ships and pretty much everything else required for holiday travel.
The advantage of this model is that TUI takes a slice of the profit from both your travel and accommodation. The potential downside is that operating hotels, cruise ships and airlines ties up a fair amount of capital. Ongoing lease commitments could put serious pressure on TUI’s profits in the event of a major recession.
Happily, there’s no sign of this at the moment. Sales from continuing operations rose by 2.3% to €3,285.9m during the final three months of last year, while the group’s underlying operating loss reduced by 25% to -€60.3m. It’s common for holiday firms to make a loss at this point in the year, so TUI’s reduced loss is actually good news.
Tuesday’s Q1 statement also confirmed the group’s previous guidance for underlying operating profit growth of 10% this year. Based on the latest consensus forecasts, this puts TUI on a forecast P/E of 13, with a prospective yield of 4.8%.
It’s early days, but so far I’m pleased with my purchase. I may buy more.
A high-class alternative
TUI’s focus is firmly on package holidays and the leisure industry. You might prefer to focus on a company that earns cash from both business travel and holiday makers. One possibility is InterContinental Hotels Group (LSE: IHG).
InterContinental owns a portfolio global hotel brands including Crowne Plaza, Holiday Inn and of course InterContinental Hotels & Resorts.
The group operates 5,099 hotels, but more than 80% of these are franchised. This means that InterContinental collects a share of the profits from each hotel, without having to invest the capital needed to build and run the hotels.
It’s a profitable business model that underlines the value of owning major global brands. InterContinental generated an operating margin of 41% during the first half of last year. Almost all of the group’s $344m operating profit was converted into free cash flow, which totalled $336m for the period.
With economics like this, it’s easy to see why this is a pricey stock. The group’s shares currently trade on a forecast P/E of 24 and offer a yield of just 2%. However, it wasn’t always like this: four years ago, InterContinental was trading on a P/E of about 13.
Although I’d very much like to own these shares, the yield on offer is too low to meet my criteria. I’m going to leave them on my watch list and hope for a better opportunity in the future.
