Vaccines and travel bubbles: Which stocks will benefit?

Additional reporting from Andrew Willis and Rentsje de Gruyter.

As vaccinations help put the end of the coronavirus pandemic in sight, and bubbles allow quarantine-free travel between Australia and New Zealand , it’s safe to expect a surge of globetrotters. Will this translate to growth for airline, booking and hotel companies? And which brands will do the best?

We look at what's in store for global travel players as pent-up vacation demand is unleashed.

Online booking agents see opportunity to strengthen their position

The time has passed when the four major online travel companies - Booking (BKNG), Airbnb (ABNB), Expedia (EXPE) and TripAdvisor (TRIP) - were undervalued on the stock market. While travel is still banned in most countries, these companies have managed to rebound since the share prices of the four stocks plunged a year ago due to the covid-19 pandemic. Three of the Big Four are now overvalued, according to Morningstar analysts, despite the fact it is likely to take three or four years for travel demand to fully recover.

Does this mean that investors should sell out of the online booking agent sector? Morningstar analyst Dan Wasiolek says the covid-19 crisis is an opportunity for these companies to strengthen their market position and, therefore, their value. The so-called network effect is key to a competitive advantage in this sector says Wasiolek.

Five key factors

To determine the strongest players in the online booking market, there are five key factors to consider:

1. the structural influence of the pandemic on the demand for the provider's services;
2. the player's position in the alternative accommodation market (i.e. everything outside of traditional hotels);
3. its offer in the so-called “experience" market compared to his competitors;
4. the benefit from traditional hotels; and
5. the extent to which its business is threatened by tech companies such as Google (GOOG), Amazon (AMZN) and Facebook (FB).

Based on these five factors, Amsterdam-based Booking.com has the strongest network benefits – simply because it has the most complete offering for the traveller. That is, both traditional hotels and alternative accommodation. The same applies to Expedia, but not to Airbnb, whose offer is, of course, does not include traditional hotels. Finally, TripAdvisor is under serious pressure due to competition from Google, as well as a rising threat from Amazon and Facebook.

All four (Booking, Airbnb, TripAdvisor and Expedia), however, have at least 10 golden years ahead of them driven by the highly effective virtuous circle from which all four online providers benefit: their customers post positive messages on their network about transport, accommodation and their personal experiences on location, which attracts more other travellers, thus leading to greater demand. That is the network effect in action and partly why Morningstar assigns all four a Narrow Moat status, indicating limited competitive advantages.

That effect can become even stronger if the demand for travel recovers. For smaller competitors, it's getting harder and harder to compete against this. After all, it requires capital to be able to invest in, for example, the IT and 24/7 customer service needed to retain your customers and attract new ones. Especially after the difficult past year with all covid restrictions and lockdowns, many smaller players in the travel world will have little financial leeway. The Big Four can benefit from this if they continue to develop their network, improving the user experience and increasing conversion.

Who are the Winners?

Alternative Accommodation

The strongest party in the field of alternative accommodation is Airbnb followed by Booking.com. Morningstar expects this part of the travel market to continue to grow rapidly; until the pandemic broke out, there was an increase in bookings of 20 per cent to 30 per cent a year. This will continue, despite the headwinds.

Sightseeing and Experiences

Experiences give a big boost to a player's network effect and this market is worth a whopping $171 billion per year. TripAdvisor is the market leader here, but booking, Airbnb and Expedia are increasingly gaining on it. It helps that there was still so much ground to be gained online; in 2019, only 20 per cent to 30 per cent of all experience outings were booked online, compared to around 45 per cent for online travel.

Morningstar expects that by 2025, up to 40 per cent of experiences will be booked online with one of the Big Four, at the expense of smaller providers. Market leader TripAdvisor along with Booking.com will benefit most from this development, says Wasiolek. The former strengthened its position as early as 2014 with the acquisition of Viator.

Traditional Hotels

Booking is the market leader in traditional hotels, followed by Expedia and TripAdvisor. But a strong presence in this market segment does not necessarily earn a stock an economic moat. That's because of the sheer size of the traditional hotel industry, with the number of bookings accounting for $548 billion a year. Compare that to the $144 billion that goes into the alternative accommodation, or the $171 billion spent on sightseeing and experiences.

Interestingly, the popularity of alternative accommodation does not seem to have affected the demand online for 'regular' hotels at all, which is still growing albeit at a slower pace than the more immature alternative accommodation market.

The Tech Threat

The biggest danger to these businesses comes from tech platforms such as Google, Amazon and Facebook. The biggest threat of the three is Google, because of its dominant position, with the ubiquitous use of Gmail, Google Maps, or a simple Google search for accommodation. Google’s acquisition of flight information software company ITA in 2010 has only solidified its position.

Still, analyst Wasiolek sees Google as a "manageable risk," including the impact of government regulation. Google's strength as an online search engine lies not in carefully developing a relationship with the customer, or as a service provider. Within the travel industry, the company focuses more on paid advertising on its site.

Source: Morningstar. Data as at 8 March 2021

-- Rentsje de Gruyter, a Morningstar freelancer based in the Netherlands

Trans-tasman travel bubble a lift for airlines and airports

The trans-Tasman travel bubble, allowing quarantine-free travel between Australia and New Zealand from April 19, 2021, is welcome news for the embattled air travel sector. Border restrictions decimated international travel, and with it, passenger revenue for airlines and airports. While travellers from New Zealand could enter most Australian states without mandatory quarantine from October 2020, Morningstar analyst Adam Fleck expect travel demand between the nations to pick up considerably, now quarantine is no longer required on the return journey.

"We maintain our NZ$2.00, $5.00, NZ$6.50, and $6.20 fair value estimates for shares in Air New Zealand (ASX:AIZ), Qantas (ASX:QAN), Auckland Airport (ASX:AIA), and Sydney Airport (ASX:SYD), respectively," he says.

"By and large, this development tracks our expectations for international air travel to continue to rebound in both countries, albeit not again reaching 2019 levels until fiscal 2024. We continue to expect the recovery of air travel to be highly volatile, with outbreaks and snap lockdowns (as recently as Brisbane in March 2021) likely."

Fleck believes the bubble is particularly influential for AIZ, with flights between Australia and New Zealand representing around 20 per cent of pre-COVID-19 passenger revenue, but only around 5 per cent for QAN. Virgin Australia, he says, won't bring forward trans-Tasman capacity, instead focusing on getting its Australian business up to speed.

"We expect competition to remain sharp between QAN and AIZ, particularly in the near term as both airlines have latent capacity amid a lack of flying elsewhere," he says. "By contrast, narrow-moat SYD and wide-moat AIA enjoy competitive advantages as the only airport in each major city."

Of the airports, Fleck say AIA benefits most from the bubble. "In calendar 2019, Australia was AIA's second-largest country of international arrival by residency, representing roughly 16 per cent of total arrivals during the year. New Zealand also remains an important source market for SYD, representing 5 per cent of international arrivals in the year-ending June 2019."

Source: Morningstar. Data as at 8 March 2021

Hotels set for full rebound

Hotels have been busy behind the scenes in 2020, repositioning themselves for the return of travellers and strengthening their brands and business models. The winners will emerge with economic moats, or a strong competitive advantage.

“Our long-term outlook assumes a full recovery in hotel revenue per available room, by 2023,” says sector strategist Dan Wasiolek. “We don’t see the pandemic posing a long-term threat to the hotel industry.

"We’ve already seen evidence that the pandemic did not damage the appetite for hotel visits, and we think this stands to persist.”

Portfolio manager Tony Genua agrees. He added Hilton (HLT) to his AGF American Growth Class Series F portfolio last year, as well as Wyndham (WH) in his AGF Global Select and AGF US Small-Mid Cap funds.

“The growth and improvement in the hotel industry over the next several years is very promising,” says Genua, adding that the guest mix could look a little different going forward.

“While we believe that leisure travel will rebound strongly, business travel may see a more tempered recovery, as some elements of this past year’s working conditions (work-from-home hybrid model, more video conferencing, etc.) remain with us post-pandemic,” says Genua.

Who will attract the most guests?

With the return of customers, investors should then look to who’s best positioned to be fully booked. Wasiolek looks to two key ingredients for a competitive advantage: “We see brand intangible asset and switching cost advantages as the main drivers of economic moats for hotel operators.”

Brand power and switching costs are interrelated as guest loyalty is accumulated and franchisees become less willing to leave. “Hotel brand intangible asset advantages take time and money to develop,” explains Wasiolek.

“A hotel operator in its infancy needs to self-fund development to support unit growth of its brand and prove that the concepts can perform before third-party owners gain enough confidence to commit their own capital and join the company’s portfolio as franchisees.” This is combined with the fact that contracts are often 20-30 years for a franchisee and it’s expensive to change brands, putting voluntary attrition for strong franchises in the low-single-digits come renewal.

Wasiolek finds franchisee loyalty and economic moats are particularly influenced by guest loyalty programs in the hotel space. “We believe it’s important to analyse industry loyalty exposure to help gauge moats,” says Wasiolek, “The reason loyalty programs influence hotel intangible asset and switching cost advantages is that third-party owners look at the immediate demand channel these provide when considering joining one of the chains. In our view, Marriott’s (MAR) and Hilton’s loyalty presence offers a strong incentive to third-party hotel owners to join their brands.”

Wasiolek’s fair value for the companies currently sees them trading an 8 per cent and 24 per cent premium, respectively, but he notes they are the clear loyalty leaders in the industry.

Big but light Is Best

Genua also looks for a strong brand in his hotel picks, along with asset-light (franchisee) business models, and exposure to leisure travel.

"In the case of Hilton, the company is a well-run, asset-light, fee-driven brand powerhouse with a global footprint," he says.

"The company has a portfolio of 18 global brands, that includes more than 6,400 properties in 119 countries. It has a greater focus on franchising v. managing and an asset-light model – and its resiliency was on display last year when Hilton’s pipeline grew 11 per cent amidst the worst demand environment for hotels in history, with independent boutique hotels continuing to convert to branded hotels for access to the scale, negotiating leverage, and a larger pool of customers that comes with being a Hilton branded hotel. 

"Finally, Hilton has lower exposure to luxury across its portfolio compared to its peers – we believe lower-end hotels are well-positioned in the near-term given the higher propensity for road trips and lower exposure to the business segment, though Hilton did note in its recent quarter that corporate demand had begun to improve.”

“Similarly, Wyndham (WH) also has a franchise-heavy exposure,” says Genua.

“Its platform consists of 20 brands operating in 80 countries, mostly at the low-end which accounts for approximately 90 per cent of rooms. Wyndham has also been trading at a valuation discount relative to its peers, and recently posted its best month of occupancy in January since the pandemic began, driven by the successful capture of leisure travel.”

Source: Morningstar. Data as at 8 March 2021

-- Andrew Willis, content editor, Morningstar.ca