By David Sterman
As we head toward the Memorial Day weekend, summer travel plans are being discussed around many kitchen tables.
Americans are hitting the road again, packing hotels in major cities as some national parks brace for a record number of visitors. Many conversations in foreign languages will be heard in these places as well, as international tourists are trekking to the United States in record numbers.
For investors, the ability to profit from the resurgent travel and tourism sector can be a bit tricky.
Popular stocks such as Disney
) trade near all-time highs, already reflecting the bright outlook in place. Looking purely at Disney's price-to-earnings/growth
(PEG) ratio, the stock looks fairly valued. For example, profits are projected to grow 11% to 12% in both fiscal 2013 and 2014, while shares are trading for around 15 to 16 times projected 2014 profits.
It's always best to find stocks that sport earnings growth higher than the price-to-earnings (P/E) ratio. That doesn't make Disney a bad investment. It's just that you should focus on long-term price appreciation potential and not on near-term gains.
Yet there are some clear values if you are willing to dig a little deeper into this sector. Here are a few to consider.
Six Flags Entertainment
): Although shares of this amusement park operator have also performed quite well, the 5% dividend yield is among the best in the sector. This is a company more focused on generating profits than growth, as few amusement parks are opened in any given year. Still, rising consumer spending is a clear catalyst.
"We have successfully executed price increases across our parks and are still seeing very strong season-pass sales growth coming into the season," said Jim Reid-Anderson, chairman, president and CEO of Six Flags.
That pricing power is translating into impressive free cash flow, fueling stock buybacks and that solid dividend. Six Flags currently has another $114 million in planned spending on a current buyback plan, and Goldman Sachs analysts say they "would not be surprised if they announce a new authorization" after the current one is completed.
Is this dividend safe? Well, Goldman expects free cash flow to rise from $270 million in 2013 to $310 million in 2014 and 2015. Keeping the payout ratio constant, this dividend might rise another 10% to 20% in the next year or two, especially after stock buyback programs are completed.
Full Hotels = Higher Prices
The U.S. lodging industry is also feeling the effects of rising travel spending. Analysts note that revenue per available room is trending 8% higher this year than in the comparable period a year earlier. That's the result of a more muted pace of construction activity during the past half-decade, which has kept supply tight in many markets (as anyone traveling to New York City can attest).
Still, it's wise to focus on hotels that aren't too exposed to somewhat weaker lodging markets outside the United States.
"We reiterate our year long call of preferring U.S. exposed hotel companies vs. global companies as U.S. trends continue to outperform," Merrill Lynch analysts said. They think that some industry operators such as Starwood Hotels & Resorts
) are seeing their results dampened by poorly performing international locations.
Merrill prefers Marriott International
), "given its 75% U.S. exposure and best-in-class cash flow that is driving a significant return of capital," and Host Hotels
), as it appears to be the value play in the sector. Each of Host's rooms is valued at $270,000 (market value divided by the number of rooms), compared with an industry average of $330,000. That leads Merrill's analysts to suggest that Host Hotels would be prime buyout fodder in a rapidly consolidating industry.
Airline Stocks Get a Tailwind
Although airline stocks have posted solid gains in recent quarters, more gains may still lie ahead.
Not only are airline carriers continuing to show great discipline when it comes to capacity, but the recent drop in crude oil prices should help these carriers to post lower jet fuel costs in 2013.
Still, it's fair to wonder what kind of value these stocks have after such strong gains. In the past few years, I have repeatedly noted that airline stocks P/E and cash flow multiples were absurdly low, reflecting too many fears of an industry reversion back to bankruptcies and losses.
Do these carriers still sport low multiples? For the most part, yes.
) and Southwest
) don't appear to be compelling bargains, but the rest of the pack does. U.S. Airways
) is an intriguing opportunity, as its pending merger with AMR
) could lead to major synergies, as was the case with Delta's
) merger with Northwest
) merger with Continental
. It will be several quarters before analysts understand the profit gains that can accrue from the U.S. Airways deal, but history shows those gains could be pretty significant.
About a month ago, I spelled out why Delta remains my favorite sector play. I still hold that view. Delta's cash flow is impressive, and its management team has proved to be savvy. This stock could easily end up in the mid-$20s before the next economic cyclical peak.
Risks to Consider: These companies depend on foreign tourists to an extent; and though global tourism is rising, both Europe and China continue to show signs of economic weakness. If those economies worsen, then tourism spending will be affected.
Action to Take: Although share prices for many travel and leisure stocks have moved higher from their early 2009 lows, the broader macro environment suggests that more gains lie ahead. Spending on travel by consumers and businesses is growing at a fast pace. If the broader economy manages to strengthen in 2014 and 2015, as many economists expect, then this sector's growth prospects should remain quite robust into the middle of the decade.
David Sterman does not personally hold positions in any securities mentioned in this article.
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