Oliver Mander: Investing in NZ’s tourism sector
In his latest deep dive into key New Zealand industries, business consultant and financial columnist Oliver Mander examines how New Zealand’s tourism sector is adapting to the sharp decline in international visitors—and what this means for investors.
Oliver was appointed as the Chief Executive of the NZ Shareholders’ Association (NZSA) in October 2020. This post was written before Oliver’s appointment and doesn’t necessarily represent the views of the NZSA.
Tourism is one of New Zealand’s largest sectors—it’s also been one of the hardest hit by the global COVID-19 pandemic.
There aren’t many tourism-focused organisations that have their shares listed on the New Zealand Stock Exchange (NZX). But in general, COVID-19 has had a negative impact on them all—and created an existential crisis for many.
Plenty of stats outline the issue, but the most stark was highlighted by a graph included in Auckland International Airport’s latest annual report. It showed that international visitors to New Zealand have reverted to the level of the early 1950s.
International visitors are the lifeblood of most tourism-focused organisations in NZ. International visitor arrivals approaching 3.9 million in 2019 compares favourably with our own population of around 5 million. For the year ended March 2019, they spent an eye-watering $17.2 billion%20to%20%2423.7%20billion.) in New Zealand ($4,400 per person).
But Kiwis also contribute through domestic tourism. In addition to the $9 billion we spent on overseas holidays in 2019, 72% of us spent around $23 billion on domestic tourism activities. Spread that over the 45 million domestic trips we made, and that’s around $500 for each trip.
Of course, the sector doesn’t want to lose any of that existing spend. While $9 billion is less than $17 billion, they would love it if Kiwis switched their spend on overseas holidays to trips in New Zealand instead.
Auckland International Airport (AIA)
Long-term, inter-generational infrastructure assets have proven to be a relatively safe haven for tourism sector investors—although right now, ‘long-term’ is the key phrase.
Those types of assets have always been held in high regard—think NZX-listed Auckland International Airport (AIA). Over the last five years, its share price has increased as investors valued the solidity and steady growth of its underlying business. Just prior to the real impact of COVID-19 started to be known (January 2020), AIA’s share price had risen to over $9.00 a share.
Now, however, the reality is different. Even those highly regarded infrastructure assets are likely to be operating at break-even levels at best, regardless of value. That means that investors buying AIA at today’s share price ($7.50 as at 13 October 2020) are doing so for the long-term—the REALLY long-term!
AIA’s profits took a big hit in 2020, but was saved to some extent by the unrealised revaluation in its property assets. When this is excluded (but one-off COVID-19-related costs of $112.5 million are included) the profitability for 2020 was only $71 million (compared with $274.7 million the year before).
AIA would argue, correctly, that the COVID-19 costs are not part of an ‘underlying profit’. But unlike property, it’s a real cost in terms of cash that can never come back to investors.
For 2021, AIA isn’t likely to earn a significant profit at all (according to consensus analyst forecasts). And according to its own latest annual report, it's unlikely to return to 2019 passenger activity levels for another 3–4 years.
Compare that to three years ago—investors could buy shares in AIA for $6.23 (as at 13 October 2017). Back then, AIA had expectations of both significant future growth and expected underlying profit after tax of over $260 million for the upcoming year.
AIA was initially slow to react to the COVID-19 pandemic, signalling only a small change in their full-year profitability (to 30 June 2020) in late February. However, they made up for lost time over the following weeks by slashing costs, cancelling their dividend, halting capital investment, restructuring their long-term debt, suspending their profitability outlook completely (as in, they had no idea what it would be), and completing a mammoth $1.2 billion capital raise—the largest-ever in New Zealand’s secondary market.
Phew! A busy few weeks.
All of that’s aimed at preserving cash to ‘ride out’ a period of near-zero demand in their international terminal operations and reduced operations through their domestic terminal.
AIA’s other major revenue stream is from the development and rental of commercial property around the airport precinct. Both their ‘unrealised’ gain, and potentially any rental revenue, is likely to be heavily impacted by the lack of people on the airport campus who would normally make use of those assets.
At first blush, AIA looks expensive at its current share price. Looking deeper though, the underlying strategic narrative hasn’t changed. The airport is an advantaged asset in a country that people from around the world love to come to.
That narrative reflects well on AIA’s future. It’s essentially a place to park money for a while (a loooong while), in anticipation of normal service being resumed and the share price rising again at that point. And while interest rates are low, and potentially heading negative, that may look attractive compared to the alternative.
It’s one thing to have a good recovery plan in place, but investors can still be disadvantaged. In this case, thanks to the immediate actions taken by AIA’s management team when the crisis broke, they look more likely than not to be able to ‘ride out’ the storm without any further cost to current investors.
Air New Zealand (AIR)
“If you want to be a millionaire, start with a billion dollars and launch a new airline.”
So said Richard Branson, when discussing the airline JetBlue following the September 11 attacks in 2001. Suffice to say, airlines have long been the bane of investors.
It’s an industry characterised by a high requirement for capital (for aircraft), volatile cash operating costs (for fuel), high staff costs, high competition and if that wasn’t enough, government interference and protectionism.
It turns out they’re impacted by pandemics as well.
Air New Zealand (AIR) has transformed itself since the government chose to bail it out in the national interest back in 2001. AIR is now respected around the world for the underlying quality and profitability of its operations.
Like AIA, AIR has taken a range of actions since March 2020, including sharply reducing the costs of its head office and flight operations, cancelling its dividend, securing a $900 million line of credit from its 51% shareholder (the NZ Government), deferring purchase of new aircraft, parking up existing aircraft, and refocusing its business on cargo.
According to its Annual Financial Results for 2020, this has resulted in its operational ‘cash burn’ reducing to between $65–$85 million each month, compared with $175 million immediately prior.
Despite the enormity of these actions, it’s difficult to find value at AIR’s current share price of $1.53 (as of 13 October 2020). Its 2020 result showed a strong first six months (to December 2019), with post-tax profit of $101 million. At the time of the announcement (late February 2020) the airline was forecasting a reduction in earnings of between $35–$75 million for the full year.
However, by the end of the financial year (June 2020), this had degraded to a $454 million loss (its first in 18 years). Albeit, this was after allowing for $338 million of non-cash write-offs relating to the value of its long-haul aircraft and further one-off costs of $203 million associated with organisation and fuel hedge restructuring. Its pre-tax loss for the full year (excluding the one-offs) was $87 million.
The pain won’t be limited to just this year. AIR’s woes are continuing into 2021, with the airline itself stating that it expects further losses in 2021.
Nonetheless, the airline will be pleased that domestic travel is rebounding strongly. While international services supported the bulk of AIR’s revenue, it's likely that the domestic network offered AIR more profitability (at least on a per passenger basis). This is unlikely to affect the outlook for 2021 however.
Beyond 2021, the future is more uncertain. The best possible outcome for shareholders is a smaller, domestic-focused airline that has right-sized its fixed costs to suit. That means profitability—albeit at much lower levels than before.
What AIR has not done (yet) is ask its shareholders for more cash equity. The airline already had a relatively high debt load pre-COVID, mostly consisting of long-term lease commitments for the portion of the aircraft fleet it did not directly own.
While the $900 million credit line provided by the government was welcomed by the airline, it’s unlikely to be used in full. The 7–10% interest rate is prohibitive—the first $600 million is set at 7–8%, the next $300 million at 9%, and if it’s drawn down, the interest rate increases by 1% after 12 months. Using the credit would push the total debt level of AIR to uncomfortable levels.
The agreement allows the government to convert its debt to equity at some point in the future—an option that’s likely to be favoured by the airline.
This adds some risk for current shareholders. In any future capital raising by the airline, shareholders may need to provide more capital to ‘match’ the new equity provided by the government. Or if the company doesnʻt provide an option for existing shareholders to provide new capital, they may suffer ‘dilution’.
An announcement by the company on 25 September 2020 indicated that the outcome of their ‘capital structure review’ should be known in early 2021—that date should provide more certainty for investors.
Tourism Holdings (THL)
Tourism Holdings Ltd (THL) operates and rents (or sells) motorhomes across New Zealand, Australia, and the USA. The company also has a joint venture that manufactures motor homes and operates a portfolio of tourism activity attractions, including ‘Discover Waitomo’.
Pre-COVID, the company had suffered from a problematic investment. It had expanded its US presence by developing a digital-based joint venture (known as Togo Group) with a large US-based motorhome provider, Thor Industries (NYSE: THO). The venture required more cash and created less profitability than expected, but THL will continue to benefit from the software developed under the joint venture.
The venture had weighed heavily on THL’s share price. It went from highs of around $6.80 in June 2018, to $2.45 at the time of the half-year results (to 31 December 2019) announcement on 27 February 2020.
THL also announced that it was reviewing its involvement with Togo Group, with a subsequent ‘managed exit’ announced in early April 2020.
For investors, THL’s experience is a lesson on expanding beyond core capabilities. Nonetheless, unwinding its investment in Togo Group comes with an upside at a time when cash is critical. THL received a US$6 million payment for its share of the joint venture and has also retained a dividend cash flow of a further US$0.6 million per annum for 4 years. It also retains rights to some assets held in the joint venture.
Of course, it also ends any further cash investment required by THL.
Like others, THL announced the suspension of its dividend in late March 2020, together with cost-saving measures, a reduction in capital expenditure and its foray into providing ‘self-isolation’ campers as governments in Australia, New Zealand, and the US reacted to the spreading pandemic. By May 2020, THL had begun the process of restructuring, deepening staff cuts across all its businesses. And by June 2020, THL announced that it had reached arrangements for restructured debt funding with its bankers. Late in June 2020 (only five days before the end of its financial year), it also signalled expected annual profitability to be in the region of $17–$19.5 million.
Way back in February 2020, THL had signalled an expected after-tax profit of $24 million for its full-year to June 2020. In the wider market dip that followed the global realisation of COVID-19 impacts, THL’s share price dipped as low as $0.95 per share as investors feared the worst.
The company and its operations have benefitted from the government wage subsidies in the markets in which it operates—totalling around $5.3 million. THL has also worked hard to stimulate domestic demand in each market. On 18 September 2020, the company announced a full-year underlying profit of $20 million (excluding the benefit from the Togo Group sale)—above its earlier guidance. But even with the wage subsidy, THL recorded a $5.5 million loss in the last four months of the year.
Critically, THL demonstrated significant flexibility in its operating cash flow by deferring the purchase of new rental campervans. That saw an increase in operating cash flow to nearly $70 million, versus $10 million the previous year. This leaves THL with a healthy $35 million cash to ride out future impacts—part of a healthy reduction in net debt levels by over $100 million over the last 18 months. THL expects to remain cash-positive in 2021.
Millennium & Copthorne Hotels NZ (MCK)
Millennium & Copthorne Hotels NZ (MCK) own and operate a chain of hotels around New Zealand. The NZX-listed entity is substantially owned by a Singaporean investor. Like most hotels, the chain is suffering from reduced occupancy and return on rentals. Some of their hotels (including the near-new Grand Millennium in Auckland) are being used as managed isolation and quarantine facilities.
MCK owns a controlling stake (66%) in NZX-listed property developer CDL Investments (CDI). At first blush, MCK’s 6-month after-tax profitability (to June 30th 2020) looks healthy, at a touch over $34 million. However, $20 million related to a one-off, non-cash taxation gain created by the government’s business continuity package, allowing companies to claim more tax through faster depreciation of non-residential buildings. Of the remainder, $9 million is MCK’s share of CDI’s profit and $2.4 million related to a further property development gain.
It’s telling that the actual hotels only made $2.7 million after-tax for the 6-month period, compared to $12.8 million for the same period last year.
Serko (SKO) has only a limited exposure to tourism. They are a developer of travel-related software, mostly focused on business bookings. The same factors that have impacted tourism have also impacted the business travel sector (Zoom, anyone?). Despite that, after its recent admission to the S&P/NZX 50, a well-timed capital raise completed in 2019, and a sharp reduction in operating costs as a reaction to the crisis, the company appears to have escaped the worst of the post-COVID travel meltdown.
SKO is currently in the process of undertaking another capital raise, seemingly aimed at enhancing their cash position further and providing flexibility for future acquisition activity.
Cash reigns supreme
In this COVID-19 era, when demand is low or non-existent, companies need to have enough cash to pay the fixed cost of their operations, make plans to reduce their variable costs to the bare minimum, and secure access to funding. All until such a time as demand recovers.
The organisations discussed above are rolling out their own version of ‘respond’, ‘reset’, and ‘recover’. Their ability to access cash and make it last for as long as possible underpins their future success.
What this means for investors
Investment in this sector is currently best regarded as adventurous.
But it’s critical to understand who’ll be able to come out the other side of what will be an extended period of significantly reduced tourism activity in New Zealand.
Operators may have survived 2020, but the extent to which NZ domestic tourism dollars (usually spent overseas) can replace foreign tourism is not yet a known quantity. It’s likely to be of lesser value—simply put, Kiwis have a different suite of options when holidaying within NZ that don’t need to involve air travel or a campervan.
As the end of the wage subsidy nears—and households batten down the hatches for a tough 2021—it might be that the discretionary domestic tourism dollars dry up faster than a Canterbury aquifer in a dry year.
Ok, now for the legal bit
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