Sector Screener: two consumer stocks tipped to extend rally

The travel and leisure sector’s recent performance has been underwhelming. It has risen by just 2% since the start of the year, thereby lagging the wider FTSE 350 index’s 6% gain.

Investors, it seems, remain somewhat cautious about the prospects for travel and leisure companies. This is wholly unsurprising, given the existence of an uncertain economic environment over recent months that was largely brought about by a rapid rise in interest rates. A restrictive monetary policy contributed to a recession in the second half of 2023 and, although the UK economy expanded by 0.7% in the first quarter of 2024, the unemployment rate has risen by 40 basis points to 4.4% year-to-date.

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While inflation’s recent return to the Bank of England’s 2% target means pressure on disposable incomes is now less acute than it once was, consumer sentiment nevertheless remains relatively weak and is only just beginning to return to pre-Covid levels. When combined with elevated political uncertainty that has been present over recent months, this all means that consumer demand for discretionary purchases, notably travel and leisure items, has been relatively weak.

Near-term difficulties

In the short run, the prospects for the travel & leisure sector could remain challenging. Even though inflation has been on a downward trend for several months, the Bank of England has adopted a cautious stance regarding the prospect of interest rate cuts. The central bank’s current forecasts even assume that inflation will rise slightly in the second half of the current year, thereby making the chances of a dovish pivot less likely in the near term.

Even if interest rates are cut in the coming months, it is likely to take many more months for them to have their desired impact on the economy’s growth rate due to the existence of time lags. This means that there is a realistic prospect of a further rise in the unemployment rate, continued weak consumer sentiment and greater pressure on disposable incomes that, together, weigh on demand for travel and leisure activities in the near term.

Source SharePad. Data as at 15 July 2024. Past performance is not a guide to future performance.

Source SharePad. Data as at 15 July 2024. Past performance is not a guide to future performance.

Long-term potential

Investors, though, should not necessarily assume that the prospects for travel and leisure stocks will worsen before they improve. Economic forecasts can, after all, be inaccurate – especially over limited time frames.

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Moreover, investors should view the market’s anticipation of short-term challenges for the sector as an opportunity to buy high-quality stocks at discounted prices. Several firms have generated relatively sound financial performance in spite of tough operating conditions over recent quarters, with their financial positions being sufficiently robust to overcome any further difficulties.

Furthermore, while interest rate cuts will take time to have their desired impact on the economy, ultimately they are set to reduce mortgage costs, boost employment prospects and improve consumer sentiment. This means that the long-term outlook for travel and leisure companies is upbeat, with consumers likely to raise their non-essential spending, notably on travel and leisure items, as their financial prospects improve.

A global focus

Of course, many travel & leisure sector incumbents operate internationally. Airlines and hotel chains, for example, are global firms that are not wholly reliant on the UK.

Encouragingly, the European Central Bank has already begun to implement a more dovish monetary policy, with interest rates cut by 25 basis points at its June meeting. And while US inflation has proved to be somewhat sticky, the Federal Reserve still expects to cut borrowing costs once this year and four times next year. This should have a positive impact on the global economy, thereby creating more favourable operating conditions for firms that rely on discretionary spending from consumers.

Clearly, stocks operating in the travel & leisure sector could prove to be somewhat volatile in the short run. Investor sentiment remains downbeat vis-à-vis other sectors, especially with an uncertain near-term economic outlook. But as interest rates fall, the financial performance of sector incumbents should improve. This is likely to prompt rising share prices, as well as stronger investor sentiment, that means now is an opportune moment to purchase high quality travel and leisure stocks that trade at attractive prices.

Source: SharePad as at 16 July 2024.

IAG

British Airways owner International Consolidated Airlines Group SA (LSE:IAG) currently trades on a prospective price/earnings (PE) ratio of just 4.6. This suggests that it offers a wide margin of safety and significant capital growth potential. Its shares have a dirt-cheap market valuation despite having risen by 12% since they were first featured in this column in May last year. In doing so they have outperformed the FTSE 350 index by around three percentage points.

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The company has delivered an improving financial performance over recent months. In its latest full year, for instance, the firm’s earnings per share rose ninefold. Meanwhile, its latest results showed that operating profit rose to €68 million in the first quarter of the year. This compares with a figure of just €9 million in the same period of the previous year, with the firm experiencing growing demand from passengers.  

A rise in load factor of 1.6 percentage points, when combined with a 7% increase in capacity, meant that the firm’s passenger numbers were 8.6% higher in the first quarter of the current year. And with the company continuing to improve its financial position, as evidenced by a 15% rise in total liquidity over the past year to €13.3 billion, IAG is well placed to outlast any potential economic weakness in the short run.

With demand for air travel rising by 11% in April, according to the International Air Transport Association (IATA), the company’s operating environment is strengthening. With global travel now fully reopen following the pandemic, and passenger numbers across the world having recently surpassed 2019 levels, the firm’s financial prospects are set to improve. Alongside its sound financial position and low market valuation, this means the stock still offers investment appeal.

InterContinental Hotels

Travel & leisure sector peer InterContinental Hotels Group (LSE:IHG) also offers long-term capital growth potential. Although the global hotel operator recorded a sharp slowdown in revenue per available room (RevPAR) growth in its latest quarterly results, down from 7.6% in the prior quarter to just 2.6%, this was largely due to a disappointing performance in the Americas. The region’s performance was negatively affected by the timing of Easter, with the company reporting an improvement in growth in the first part of the following quarter.

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Of course, the firm’s operating conditions are set to strengthen as interest rates fall and the outlook for the global economy improves. InterContinental Hotels’ broad range of brands and geographies means it is well placed to capitalise on stronger consumer demand across a wide variety of price points and locations. Meanwhile, a pipeline of new rooms that amounts to nearly a third of its current estate could act as a further catalyst on its financial performance.

Although the company’s net debt increased by 23% last year, its net interest cover remained above 20. This suggests it has the financial means to overcome potential economic uncertainty prior to the impact of interest rate cuts being felt. And while a PE ratio of 25.3 is relatively high, the firm’s long-term growth potential means it still offers good value for money despite recording a share price rise of 18% since the start of the year.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.