The market loves these UK stocks! I think investors can do better

High capital requirements, intense competition, and external events mean Stephen Wright thinks UK investors can do better than buying airline stocks.

| More on:

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

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.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended InterContinental Hotels Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young Black man sat in front of laptop while wearing headphones
Investing Articles

Investing just £10 a day in UK stocks could bag me a passive income stream of £267 a week!

This Fool explains how investing in UK stocks rather than buying a couple of takeaway coffees a day could help…

Read more »

Investing Articles

A cheap stock to consider buying as the FTSE 100 hits all-time highs

Roland Head explains why the FTSE 100 probably isn’t expensive and highlights a cheap dividend share to consider buying today.

Read more »

Investing Articles

If I were retiring tomorrow, I’d snap up these 3 passive income stocks!

Our writer was recently asked which passive income stocks she’d be happy to buy if she were to retire tomorrow.…

Read more »

Investing Articles

As the FTSE 100 hits an all-time high, are the days of cheap shares coming to an end?

The signs suggest that confidence and optimism are finally getting the FTSE 100 back on track, as the index hits…

Read more »

Investing Articles

Which FTSE 100 stocks could benefit after the UK’s premier index reaches all-time highs?

As the FTSE 100 hit all-time highs yesterday, our writer details which stocks could be primed to climb upwards.

Read more »

Investing Articles

Down massively in 2024 so far, is there worse to come for Tesla stock?

Tesla stock has been been stuck in reverse gear. Will the latest earnings announcement see the share price continue to…

Read more »

Young Caucasian woman with pink her studying from her laptop screen
Dividend Shares

These 2 dividend stocks are getting way too cheap

Jon Smith looks at different financial metrics to prove that some dividend stocks are undervalued at the moment and could…

Read more »

Investing Articles

Is the JD Sports share price set to explode?

Christopher Ruane considers why the JD Sports share price has done little over the past five years, even though sales…

Read more »