Thomas Cook – what happened?

Thomas Cook has gone under. Bankrupt. No longer trading. In liquidation. Cooked.

Its planes are grounded, its guests have been kicked out of their hotel rooms because although they paid Thomas Cook, Thomas Cook stopped paying the hotels.

For such a major household name to sink under is a telling reminder. History and experience are no guarantee if you fail to keep up with the times, or make bad decisions. 

There’s a lot of speculation flying around about Thomas Cook. The employees who had no idea the company was in trouble, the guests kicked out of their hotel rooms, the credit-holders, suppliers, customers and counterparties who are all, you could say, cooked.

How has this happened?

Some say it’s Brexit, simple as. Ah, well not quite.

Or they say it’s the model – no one’s going on package holidays now that Airbnb and comparison sites have made it so much cheaper to do it yourself. Well again, not quite.

It’s the government’s fault. Might be on to something here.

There’s no clear picture, but thankfully a friend who works in the aviation industry managed to clarify a few things up for me.

What’s the story?

Here’s the basic story of the last decade.

In 2011 Thomas Cook made UK retail outlet acquisitions, ignoring the prevalence of online booking systems, preferring to think that the appeal of walk-in travel bookings would survive.

It merged with two co-operative travel groups, adding 460 stores to its existing 780.

It sank into losses in 2011 and didn’t see a profit again until 2015.

It then started offering a dividend in 2016, having announced a new strategy backed by Chinese tourism firm Fosun.

The new model failed to turn the company around though, and margins stayed low while restructuring costs rose.

In 2017, it announced that it had closed 45% of its stores since the 2011 merger. Shockingly it turns out that people preferred the simplicity of booking online.

Profits, if any arose, were tiny relative to revenues – single figure millions next to 8-9 billion in revenue.

The hot summer last year reduced demand as more people stayed in the UK, then Brexit anxiety compounded that. Winter is a leaner period for travel companies anyway. Thomas Cook entered negotiations for refinancing this year, and in the end it was in trying to raise £200 million to get it through this winter that it fell short.

The Brexit scapegoat is too simplistic

The key point with both of the main arguments – Brexit and business model, is that Tui, Jet2, and others are running similar businesses in the same environment. And although their share prices aren’t doing brilliantly, their businesses are in decent shape.

While their share prices have followed a similar pattern, look at their profits. They have decent margins, more consistency, despite coping with the same challenges Thomas Cook had. So it must be overly simplistic to stop at Brexit and the package holiday business model when looking at Thomas Cook.

In terms of the business model though, there is one thing to point out. Thomas Cook booked hotel and travel space months in advance, before selling it on to customers.

Last year in the UK we had a heatwave, which meant many more people stayed domestic for their holidays.

Brexit did affect consumer demand. But Thomas Cook was impacted to a greater extent than its rivals, such as On The Beach or Jet2. It was committed to pay for rooms too far in advance, while its competitors were more flexible and nimble, and could respond more easily to falling demand.

For me one of the big things that stands out is management decisions, such as the above. Also, the decision to spend big acquiring retail outlets in 2011 ignored the advance of technology. Online booking was seen as the way forward by all its competitors who are still operating today, partly as a result.

But Thomas Cook went for floor space, and paid the price.

Its debts were also partially to blame – management took on too much relative to its earnings. It was significantly more indebted, relative to net income, than Tui, for example. Its debts were what caught it out in the end. The failure to raise more money meant that the company could no longer meet its obligations.

Thomas Cook’s interest payments on its debt were 10x its net income in 2016 and 2017, and pushed its net income into negative territory again in 2018.

One final factor is currency. Thomas Cook had a lot of USD-denominated debts, but its earnings were predominantly in pounds and euros. This meant that as the pound fell in 2017 after the Brexit vote, its share price actually doubled, because investors saw its euro-earnings becoming more valuable in pounds.

The problem is that as the pound fell, its dollar-denominated debt rose, relative to its value in pounds. So while the share price benefited in the short term, the business suffered as the pound fell, again because of heavy indebtedness.

It’s all too late to change that though, but one possible option theoretically remains: a government bailout, or protection.

Look at other government responses to aviation bankruptcies. Condor, the German airline owned by Thomas Cook, has already been bailed out by the German government with a €380 million bridging loan.

In the US, Chapter 11 bankruptcy allows creditors to be kept at bay while the company sorts itself out – how many US airlines haven’t been through it? None, basically.

The travel industry is subject to short-term difficulties like seasonal patterns, shifts in consumer confidence, or in this case Brexit. But like the tide these things ebb and flow, and Thomas Cook may well have been able to recover, with better management and an improved capital structure.

All very interesting.

The big fallout will come when its lenders have to markdown huge losses in their next earnings reports, when suppliers lose business, airport owners lose gate revenues, hotels lose customers.

Demand was weak because the pound makes travelling expensive, Brexit has made people uncertain, and consumer confidence is waning.

Now add in a failed travel operator, and the picture is looking bleak. I doubt this is the last we’ll hear on this topic.

All the best,

Kit Winder
Investment Research Analyst, Southbank Investment Research

Category: Commodities

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