Since the start of the year, shares in easyJet (LSE:EZJ) and International Consolidated Airlines Group (LSE:IAG) are up around 13%. Neither stands out to me as one of the best UK stocks to buy at the moment though.
Despite buying shares in four of the largest US airlines, Warren Buffett has been wary of the industry for some time. I agree and think there are better opportunities for investors looking for stocks to buy.
Airlines
Since April 2020, easyJet’s market-cap has increased from £1.7bn to £4.6bn. But investors who bought the stock four years ago are still waiting for a return from the underlying business.
Over the last four years, the company has burned through more cash than it has generated, resulting in a net outflow of £1.27bn. The stock might have gone up, but the business has been losing cash.
Created at TradingView
Something similar is true of IAG. The market value of the company grew from £3.4bn to £9.5bn, but anyone who invested in the business in 2020 has since seen it lose £3.57bn in free cash.
Created at TradingView
Airlines have clearly been through an unusually difficult time. But there are still ongoing issues to content with, notably high capital intensity, intense competition, and the risk of exogenous events.
Hotels
Shares in InterContinental Hotels Group (LSE:IHG) have outperformed the airlines. The stock is up 200% since April 2020 and 16% since the start of the year.
There’s a good reason for this. The company’s market-cap has increased from £4.2bn to £13.5bn, but it has generated £1.72bn in free cash since then.
Covid-19 travel restrictions were an issue for hotels as well as airlines. But InterContinental has shown itself to be more resilient and its shareholders have benefitted as a result.
This is due to the hotel business having significantly better economic characteristics than the airline industry. And I think this means investors will do significantly better with InterContinental shares going forward.
Economics
The key difference between airlines and hotels is in capital intensity. Both easyJet and IAG have expensive aircraft to maintain, as well as significant costs for fuel and staff.
InterContinental’s different. It operates a franchise model, leaving the costs of running the hotels in its network to individual owners and makes money through taking a fixed percentage of revenues.
When it comes to cash generation, the difference is clear. Since adding hotels to its network costs almost nothing, a much larger percentage of InterContinental sales become free cash available to shareholders.
Created at TradingView
It’s not an accident that the shares have done well over time. It’s the result of an attractive and efficient business model that generates returns for shareholders.
Long-term investing
The downside to InterContinental Hotels Group – and there is one – is that the stock market knows it’s a business with attractive economics. As a result, it trades at a price-to-earnings ratio of 23.
That’s high, especially by UK standards, and it’s probably the main risk with the stock. With UK interest rates at 5.25%, an earnings yield of 4.35% needs growth from the underlying company.
Even with an attractive business model, growth’s never guaranteed. But I’d still rather invest my money in a company like this than try my luck in the airline sector.
