Shares in TUI (LSE:TUI) are up 16% since the start of the year. If a post-pandemic travel recovery can push the stock back to where it was in 2019, there’s a potential 180% gain for investors.
I think this is unlikely, though. Rather than a once-in-a-generation opportunity, this looks to me like a value trap.
TUI
In 2019, TUI generated £402m in operating income and its share price reached £4.58. This was the product of three things.
First, the company’s low level of debt meant that most of its operating income flowed through to its bottom line. £402m in operating income translated into £371m in net income.
Second, the company had around 1.1bn shares outstanding. As a result, £371m in net income meant 34p in earnings per share (EPS).
Third, interest rates were at 0.75%. Consequently, investors were willing to pay a price-to-earnings (P/E) ratio of 13 for the company’s stock.
None of these things is the case in 2023. The company has much more debt, far more shares, and interest rates are significantly higher.
This means that I don’t see the stock heading back to its 2019 levels any time soon. Even if travel demand means TUI’s operating income gets back to £402m, I think there are ongoing problems.
Problems
The first problem for me is the company’s balance sheet. The interest payments TUI makes on its debt have gone from £69m in 2019 to £401m last year.
As a result, if the company makes £402m in operating income today, that won’t leave £371m in net income. As I see it, it will leave almost nothing after the company has made its interest payments.
I therefore doubt that a return to pre-pandemic operating levels would mean a return to the net income levels of 2019. But even if they do, there’s another problem.
Back in 2019, £371m in net income equated to 34p per share. But TUI has increased its share count by 63%.
That means that £371m in net income now equates to 21p in EPS. Applying a P/E ratio of 13 to that number still leaves the stock some way short of its 2019 levels.
The last problem for TUI shares has nothing to do with the company’s intrinsic features. Interest rates are now much higher than they were in 2019.
Instead of 0.75%, the Bank of England base rate is now 3.5%. And with inflation still high, that rate looks set to rise further.
As a result, investors are paying lower multiples for stocks than they were before. And this makes me doubt that TUI shares will trade at the same P/E ratio as they did in 2019.
Value trap
TUI shares are currently benefitting from a resurgent demand for travel. And this might well push the stock higher in the near term.
As an investor, though, this just doesn’t add up for me. Even if it can recover its 2019 levels of operating income, the business faces significant headwinds.
TUI’s debt is lowering its net income, its share count is weighing on its EPS, and higher rates make it unlikely to trade at its previous P/E ratio. Each of these is a big problem.
The stock is down 75% over the last five years. But everything about this looks like a value trap to me.
