VALUE INVESTING
Can Airtours Pull Up?

By Stephen Bland (TMFPyad)
October 13, 2000

I am continuing my series on "non-pyad" value shares this week: that is, shares that I would not normally buy personally but that may be interesting to some readers. My particular value style only rarely throws up suitable buys, but in fact most value players do not insist on criteria as tough as mine, and therefore find far more opportunities. This week's company is Airtours (LSE: AIR) which is in the leisure sector. As the name implies, it is a travel group, quite a large company, presently capitalised at over £1b and a constituent of the FTSE 350, which comprises the 350 largest companies in the market by market capitalisation.

The share price has become depressed because of a profits warning in July. Bad news, because profits warnings are sometimes followed by further warnings. So beware, this is a serious risk factor with this company. Here are the fundamentals:

• Share price 219p
• High/low this year 404/205
• High/low five years 545/120
• Market capitalisation £1.07bn
• Normalised earnings per share year ended 30/09/99 24.7p
• Forecast earnings per share year ended 30/09/00 consensus 17.4p, lowest 16.6p
• Forecast earnings per share year ended 30/09/01 consensus 24.6p, lowest 23.0p
• Price to earnings (P/E) ratio historical 8.9; on 00 lowest forecast 13.2; on 01 lowest forecast 9.5
• Yield on historical dividend 3.8%; on 01 forecast 4.5%
• Price/Book 5.0
• Gearing -42.2% (i.e. net cash, as at 30/09/00)
• One year relative strength -43.7% (ie. negative)
• Directors own 10%, other institutions own 49%.

Not an asset play then. You would not expect one in what is primarily a service industry: package holidays, air travel and the like.

The share price has collapsed from this year's high of 404p, following the profits warning, but my point is that if the 2001 forecasts are met, then it appears that a strong recovery is on the cards and that 2000 would have been a blip. In fact earnings per share has been growing very strongly in recent years, from 10.8p in 95 to 24.7p in 99 along with a similarly powerful rise in turnover from £1.3bn in 95 to £3.3bn in 99.

Comparing EPS with turnover, you can see that margins have slipped slightly as volume has grown.

The company has net cash, according to the latest figures, although they are seriously out of date. The year end of 30 September 2000 has just passed and the latest results should be out in November. However the package holiday industry normally works on net cash, because customers have to put up a deposit well in advance, with the balance due some time before departure. However not all that cash held by the company has to be laid out immediately to its suppliers, so it tends to be a holder of net cash. This is confirmed by looking at the figures over the last five 30 September year-ends, at which it held net cash every time.

Margins are very slim in the package holiday game because of its highly competitive nature and the need to offer cheap packages and air travel to the punters to get the business. Because of the low-margin nature of the business, the high gearing factor implied by having large costs in relation to turnover means that profits are very sensitive to a small change in those costs. This adds further risk because it does not take much of a rise in costs to make a dramatic hit to profits. Equally, a modest reduction in costs can create a sharp improvement to profits.

Looking at directorspeak, in August the chairman said: "We expect to see significant benefits from these changes next year [2001]." He was referring to certain reorganisations within the company to improve its efficiency. In September, just a few days ago, he said: "we are well placed to deliver increased profits in future years."

One must, though, consider these comments in the light of the following:

In May he said "bookings are progressing satisfactorily and are in line with our expectations". In July he said "profits below our original expectations for the year".

The latter was the profit warning for the year just ended, to 30/09/00.

There have in fact been some serious changes. The company has just disposed of a 50% interest in a business for £350m cash, a lot of money in relation to the capitalisation of around £1b, and has in recent months invested in hotel and travel businesses in Germany and Majorca.

Looking back over the last few years, whilst the company was growing earnings per share rapidly, the average P/E was around 20 or so. After the profit warning, we are looking at a highest forecast P/E of 9.5 for 2001. Now this lower P/E is of course justified if the company has gone ex-growth. To the value player looking at this low P/E, the question is whether growth will be resumed at all and consequently whether a recovery will take place. No doubt once the 2000 results are out in a few weeks, analysts will revise their 01 forecasts and may issue those for 02. I have little faith in forecasts two years out, but they serve a purpose in affecting market perception.

Given the nature of the industry in which Airtours operates, with its low margins, this is quite a high risk proposition, not exactly a typical widows and orphans play, but if there is a decent chance of recovery for 01 and beyond, there might be some mileage here. It doesn't need an actual recovery, merely that the market perceives a recovery on the way sufficiently well to mark up the shares accordingly. That is enough for us as value investors to make our exit.

Where Next?

• Value Investing discussion board
• What is a pyad share?