This travel company is priced to go – up, or bust!
The turmoil at Thomas Cook (LSE: TCG) hasn't been far from the front pages of late. So it is no surprise that it suffered in the recent (or current, depending on when you read this and what happens in the market) sell off. So fast are the markets moving that the title of this article has changed since I started writing it.
But I was still surprised to see how far Thomas Cook had fallen. The share price now discounts a considerable risk of failure. But if you don't lose your money, there's a decent chance of recovery value too.
Now this observation comes with the mother of all health warnings. Like many Fools, I see the bear market as a window of opportunity to buy quality stocks while they are going cheap.
And Thomas Cook isn't a quality stock. It's not top of my picks. My approach was to go through a list of FTSE 100 stocks, picking out companies that I already know, which have good franchises and management and diversified earnings which will not be too hard hit by a double-dip recession.
From those I've picked out the ones which look cheap on fundamentals and which have dropped in price over the past 30 days. These are the companies which I think have been oversold. There's plenty of them, they're mostly defensive stocks, and unsurprisingly they are much the same as fellow Fools such as Maynard Paton and Alan Oscroft have written about.
Then I did the same with the FTSE 250. That's given me a shopping list which I'll work my way through. It's a moot question how long the window of opportunity to buy cheap shares will last: it could be hours, days, weeks, months or years. Judging when to buy is a balance between fear and greed.
Currently I'm working on the basis of having most of August to buy. At least some of the market's behaviour can be put down to thin trading volumes, and absent politicians, during the holiday period. Those traders who followed the adage of "Sell in May and go away" may still be able to pick up bargains when they return to their desks.
I might miss the best bargains by taking my time, but I might miss buying before another market dip. August is a month for some pound cost averaging.
So I shall ponder Thomas Cook in that time. It's easier to list the company's woes than its bull points:
- the sector has been hit by a succession of exceptional problems: unrest in the Middle East, volcanic ash etc. It's a sector which has recurring exceptional items;
- holiday spending is discretionary. People holiday at home when money is tight. Times of austerity and recession are bad for the industry;
- the process of booking holidays is moving online. It is unclear how well the big operators are capitalising on their natural franchise in the sector;
- management has lost its way, with the CEO departing part way through a strategic review prompted by a profits warning and a late realisation of operational problems; and
- it has a ton of debt: £900m, against a market cap of £500m.
It's the debt that worries me most. Financial risk bites more quickly than business risk, and when the bankers have a bigger stake in the business than shareholders, things can turn nasty.
But despite all these woes, there is a good core franchise. And the company has some clever initiatives. It is merging with Cooperative Travel to consolidate its strength on the high street, which is still responsible for 65% of package holiday sales. And it has acquired a majority of the former Russian state monopoly tourist organisation Intourist. That's a massive potential market.
There's still a reasonable cash flow, £232m in the nine months to 30 June, 2.6 times interest costs. And a £200m asset disposal process is set to reduce debt. The company is in a poor state but it may be premature to write it off.
Meanwhile, its interim CEO must be envious of rival Tui Travel (LSE: TT). Its results for the nine months to 30 June reveal strong trading for the Summer 2011 season and a confident prediction it is on track to meet full year expectations, helped by strong economic conditions in Germany (though its French operations were also impacted by the Middle East riots).
Now that rioting is the new stay-at-home leisure activity, maybe it's time to take a foreign holiday.
More from Tony Reading: