US Travel & Leisure Industry Outlook

In a recession, both consumers and businesses look to cut expenses, and that’s bad news for travel and leisure companies. While we don’t expect the demand picture to change anytime soon, some operating expense relief may ease the pain felt during the downturn.

OUTLOOK

In the lodging sector, we expect that revenue per available room (RevPAR) will decline meaningfully in 2009. Although new construction starts have slowed considerably in recent months, new hotels that were planned during the time of cheap, easy credit continue to enter the system. This extra capacity will only exacerbate the problem of slowing demand.

We anticipate that the hotel companies will, for the most part, seek to maintain room rates as much as possible, as opposed to cutting rates in an attempt to boost occupancy. Changes in average daily rate (ADR) have a more significant impact on the bottom line than do changes in occupancy. This stems from the fact that, unlike increases in ADR, there are additional expenses associated with higher occupancy levels. Further, when hotel companies cut ADR, it is harder to return to higher room rates once demand improves. As such, we would expect hotel companies to cut ADR only when all other measures have been taken.

In general, we expect that the lodging companies will weather the current downturn better than would have been expected in years past. The combination of a weakening economy at the beginning of this decade along with a dramatic decline in travel following the terrorist attacks of 2001 forced the lodging companies to become more efficient in their operations. The lessons learned in that downturn should prove valuable in navigating through the current recession.

That said, we project that the operating environment during 2009 will be extremely challenging for the lodging companies, as demand weakens from both business and leisure travelers.

Unlike the lodging industry, the cruise line companies are solely dependent upon leisure travelers for their business. The cruise lines had been fortunate for much of the year in that top-line demand remained relatively strong even as the economy deteriorated. Booking trends had remained favorable, and occupancy rates continued to be solid.

However, the cruise lines reported that advance bookings began to weaken in early October, as the stock market crash impacted consumer spending decisions. We continue to believe that many consumers would prefer to cut back on other day-to-day expenditures as opposed to forgoing an annual vacation, and that the perceived value offered by the cruise lines remains high, relative to other potential vacation trips. However, we expect to see some price erosion along with lower occupancy rates from the cruise lines in the coming quarters.

OPPORTUNITIES

While we have lowered our expectation for near-term operating results in the Travel & Leisure industry, many of these stocks have already fallen by a substantial margin. We currently have a Buy rating on shares of Royal Caribbean (RCL), based on valuation.

Although we anticipate weakness in booking trends, much of the negative impact will likely be offset by the dramatic declines in fuel prices realized in recent months. As one might imagine for ships of such enormous size, the price of fuel is by far the most significant operating expense in the cruise line industry. As fuel prices rose over the last year, the operating margins of the cruise lines were pressured.

If we were to see demand weakening while fuel prices remained at those historically high levels, the outlook for the cruise lines would be dire. But the fact that crude oil has fallen by nearly two-thirds from its peak this summer should significantly reduce the company’s operating expenses going forward. We do not believe that this reality is currently reflected in RCL’s share price.

WEAKNESSES

In the lodging industry, we would advise investors to pay close attention to the occupancy and ADR figures released by the hotel companies. While we expect RevPAR to decline meaningfully, we anticipate that the majority of the declines will stem from occupancy losses, while the companies attempt to hold ADR as steady as possible. If, however, we see room rates declining significantly, we would then expect the downturn to be deeper and more prolonged that currently anticipated.

We would avoid lodging companies such as Marriott International (MAR) that have both exposure to lower-end hotel chains and significant exposure to the time-share industry, given the poor fundamentals in residential real estate.

Companies with weak balance sheets, or even limited financial flexibility, will likely have a harder time navigating the challenges created by the recession. We note that Carnival (CCL), (CUK) and Royal Caribbean both recently suspended their common stock dividend in order to ensure that liquidity would not become an issue even if the operating environment deteriorated significantly from the already challenging levels. We viewed these proactive moves positively. Other companies in the travel and leisure industry, however, may not have such options available.

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Comment by John A. Smith

2009-01-09 20:37:24

Actually, this may cause the domestic US travel industry to re-define itself in the way it takes message to market. I for one expect a pooling of marketing resources among former competitors into marketing associations, where none existed before. It will be interesting to see who survives. Interesting thing about human beings we all seem to need to vacate, recession or not.

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