Rising Covid Cases Hang Heavy Over the Travel Industry, Again. How to Play the Stocks Now.
By Lawrence C. Strauss
Royal Caribbean’s Celebrity Edge, pictured docked at a port in Mexico, set sail from Florida in June—the first sailing out of a U.S. port among the major cruise operators since the pandemic began. / Eva Marie Uzcategui/BloombergRoyal Caribbean Group CEO Richard Fain had been prone to break into song on his company’s blog, crooning “Oh, What a Beautiful Mornin’ ” in late June after the cruise line launched its first ship from U.S. waters since the pandemic sidelined the industry for more than a year.
Fresh off that maiden voyage and with the industry’s restrictions falling by the wayside, Fain gave an encore in mid-July, singing “I Can See Clearly Now.”
Not so fast, says the Delta variant.
While the mutated Covid-19 strain has been spreading for months, the highly contagious variant seized headlines over the past week or so as cases and deaths climbed—particularly among the unvaccinated—and concerns grew that governments might reimpose restrictions on crowds and business operations.
The progress that has been made in containing the disease, and in returning to life and business as normal, is now threatened.
Travel and leisure stocks, many of which rode the promising Covid vaccine news last November and became textbook reopening plays, have been veering off course for months.
The Dow Jones U.S. Travel & Leisure Total Return Index is down 0.5% since the beginning of March, after notching a 25% gain over the previous four months.
The Delta variant just adds more question marks as companies in the sector get set to report earnings over the next few weeks.
“What’s the No. 1 thing the market in general hates?” asks Chris Woronka, a hotel and leisure analyst at Deutsche Bank. “Uncertainty.”
And the travel and leisure industry has uncertainty in spades.
Cruise operators still have to contend with regulators, most notably conditions outlined by the Centers for Disease Control and Prevention on matters such as the percentage of passengers that must be vaccinated on a vessel.
Another potential barrier: a court battle over a Florida law that forbids companies from requiring customers to show proof that they have been vaccinated for Covid.
Many hotels are open for business, but business and group travel has lagged leisure as corporate America is in the early phases of reopening.
Airlines, too, have been left in a holding pattern amid concerns about renewed travel restrictions and a slower-than anticipated recovery if countries delay border reopenings.
And for every travel and leisure sector, a labor shortage remains a concern.
While investors navigate the shifting daily Covid headlines, there are other crosscurrents buffeting travel and leisure sectors, including the broader market’s rotation back into growth stocks and the concern that some travel names had gotten too pricey.
And industries within travel are at different stages in their respective recoveries.
Take the cruise industry, roiled like perhaps no other by the pandemic.
Carnival (ticker: CCL) and Royal Caribbean Group (RCL) recently resumed cruises out of U.S. ports after 15 months sitting idle, though at well below normal passenger capacity thanks to health protocols and fleet capacity constraints given the challenge of staffing up and getting these titanic ships ready for the seas.
Carnival said this past week that it plans to operate up to 75% of its global fleet capacity by the end of the year—an ambitious target given the headwinds.
Lodging companies, meanwhile, are further along in recovery, as are casino operators, timeshare firms, and car rental companies.
These businesses weren’t restricted the way cruise operators were and so they’ve been benefiting from Americans’ pent-up demand to return to their favorite pastimes since vaccinations began rolling out earlier this year.
At the same time, 2022 and 2023 earnings estimates across the travel and leisure subsectors have been rising.
“Cruise lines and hotels and gaming have different factors affecting them,” says Robin Farley, an analyst at UBS.
And the recent headline risk stemming from the Delta variant creates “an opportunity to re-engage with some of the reopening names that have pulled back a little bit.”
Whether it’s cruise lines, casino resort operators, timeshare companies, hotel companies or lodging real estate investment trusts, most of these stocks have lagged behind the broader market this year and are in negative territory in some cases.
MGM Resorts International (MGM), for example, is up about 2% since March 1, versus a 12% gain for the S&P 500.
Shares of Carnival, the largest cruise operator, have fallen 14%.
Marriott International (MAR) is off 7%.
Timeshare company Hilton Grand Vacations (HGV) is down 5%.
And Avis Budget Group (CAR) is down about 20% from its all-time high of around $94, set in mid-June.
Yet while the initial reopening rally lifted most boats, the latest leg of the reopening play will require investors to be more discerning and do a bit more due diligence—and the pandemic to cooperate and come more fully under control.
“New investors are looking at valuation, and they are a little bit pickier about where they enter the group,” says Bill Crow, managing director of real estate research at Raymond James.
He notes that lodging stocks’ run-up extended through early March around when fourth-quarter earnings releases were wrapping up.
“There was a lot of excitement among management teams, maybe more than there should have been at that point, given where fundamentals were.”
Crow maintains that lodging fundamentals have continued to improve since then, and he chalks up the underperformance since early March to the Delta variant, the market’s recent pivot to growthier names, and more scrutiny of valuations.
Raymond James recently upgraded the lodging REIT sector to Overweight.
In shunning many of these stocks, the market hasn’t distinguished between domestic leisure travel, which has rebounded impressively since around March, and corporate travel, which continues to lag behind.
This could mean opportunity for investors.
Cruise and timeshare companies, for instance, focus on leisure customers, while other sectors, such as lodging, are more reliant on business travelers.
In a recent interview with Barron’s, Marriott International finance chief Leeny Oberg said that business travel for the company is “still clearly behind where leisure travel is but making steady and solid improvement.”
In normal times, business-related customers account for roughly two-thirds of the company’s overall business.
How quickly group and corporate travel will rebound is a major question mark for investors, and analysts have varying views on the timeline.
“There’s some pent-up demand for corporate travel in the same way there is pent-up demand for leisure travel,” says Woronka.
“As long as the Delta variant is not causing problems in the U.S., you’ll see some of that corporate travel come back post-Labor Day.”
Asked about the Delta variant, Oberg was optimistic but measured.
Marriott has been paying close attention to “vaccination rates and CDC travel guidance, and watching to see how things unfold,” she says.
One way investors can keep tabs on the unfolding impact of the Delta variant is midweek hotel activity, which is when most business travel occurs.
On July 6 and 7, a Tuesday and Wednesday, hotel occupancy in the U.S. averaged 62.7%, up from 53.8% on May 4 and 5, according to hotel data provider STR and Raymond James research.
It’s an imperfect indicator, however, as Crow notes that some of the increased midweek demand likely isn’t entirely attributable to a pickup in business travel.
He points to a “distinct increase” in midweek hotel demand “in markets like San Diego, Miami, Tampa, and Orlando [that] are really driven by leisure travel” and not in business travel hubs like New York, Chicago, and San Francisco.
Crow, however, remains upbeat about the prospects for business travel improving in the third quarter, though it hinges on offices reopening and children getting back to school.
Still, it’s hard to handicap what’s going to happen over the next few months.
The wild cards are manifold.
The Delta variant. Reopening regulations and renewed pandemic restrictions.
Customer reticence and a labor shortage.
And more.
As Woronka says: “When you have multiple factors impacting stocks, it means that underperformance is more prolonged.”
For the travel and leisure sectors writ large, then, investors can expect the choppiness to continue while mining for longer-term winners.
Here are six recommendations, based in part on interviews with analysts who follow these stock groups.
Wyndham Hotels & Resorts
Shares of this hotel-franchising company, which focuses on midscale and economy brands such as Super 8 and Days Inn, have returned 7.1% since March 1. That’s not market-beating, but it’s a solid performance compared with more upscale lodging companies such as Hyatt Hotels (H), which is down 12%.
Wyndham Hotels & Resorts (WH), with its emphasis on locations outside of big cities, has benefited from relying heavily on leisure customers, which accounted for about 70% of its business before Covid, according to Truist Securities.
What’s more, the company’s tilt toward no-frills midscale and economy brands is paying off. Those tiers of the lodging market have been bouncing back faster than more upscale tiers. During the week ended July 17, revenue per available room for U.S. midscale hotels was up 5.2% compared with the corresponding period in 2019 before Covid hit. Luxury hotels’ RevPar, as the metric is known, was down 14.4% over that same period.
Another plus for Wyndham’s stock: It has continued to pay a quarterly dividend even as many travel and lodging names suspended their payouts during the pandemic. Wyndham, which did cut its dividend last year from 32 cents to 8 cents, boosted it in March to 16 cents a share.
Hilton Worldwide Holdings
Long-term fortunes for Hilton Worldwide Holdings (HLT) are tethered to group and business travel, which accounts for about 80% of the company’s business in normal times, according to Truist Securities. That makes for a risky play as the recovery of those two segments could be delayed by weak demand exacerbated by the Delta variant.
While Hilton’s business is largely dependent on group and business travel, its operating model provides investors with some protection. Above, Canopy Hilton Hotel in Washington, D.C.
Will Newton/Hilton
But Hilton’s asset-light operating model, which eschews owning hotels and relies on franchising and management fees, provides some flexibility and downside protection. Farley, the UBS analyst, also likes the company’s strong net unit growth as it continues to expand its global network of hotel rooms. “If business travel restarts a little bit later than people think, they are still going to be in a fine position in terms of liquidity,” Farley says.
UBS has a Buy on the stock, which is down 0.4% since early March.
Royal Caribbean Group
In late June, Royal Caribbean’s Celebrity Edge set sail from Fort Lauderdale, Fla.—the first sailing out of a U.S. port among the major cruise operators since the pandemic idled the industry in March 2020 and forced multiple rounds of capital raising amid billions of dollars in lost revenue.
The company has since launched other sailings from U.S. harbors, and the broader industry is regaining its sea legs, but there’s a solid argument that Royal Caribbean enjoys some longer-term advantages over its peers.
For one thing, Royal Caribbean “has the least amount of equity dilution in terms of capital raising” during the pandemic, says Farley, who has a Buy rating on the stock, which is down about 15% since March 1.
Another plus: The company opened Perfect Day at CocoCay, its private island in the Bahamas, in 2019—a $250 million project.
The island’s amenities include a big water park, beaches, swimming pools, and restaurants.
The pier can accommodate large ships, meaning customers don’t have to use tender boats to get there.
And it’s not that far from Florida, making it an easy hop from U.S. ports.
“All the cruise lines have private destinations and private islands,” says Farley.
“But Royal has a very differentiated product.
Most private islands are a nice beach and some cabanas.”
Travel + Leisure
Trading as Wyndham Destinations heading into 2021, this company is the product of a merger/rebranding that reflects a desire to diversify beyond its core timeshare offerings.
In addition to its signature magazine and other media platforms, Travel + Leisure (TNL) brought with it several travel clubs.
“They are trying to essentially make it easy for people to book a vacation in one or two clicks through their platform,” says Deutsche Bank’s Woronka.
“That person is not necessarily going to buy a timeshare, but TNL is still going to profit from that transaction.”
What’s more, the company’s legacy timeshare business depends on leisure customers, not business travelers—a relatively good place to be.
By Woronka’s calculations, the company’s enterprise value was trading recently at 8.3 times estimated 2022 earnings before interest, taxes, depreciation, and amortization, at the low end of its historical range since the business entity was created in 2018.
He has a Buy on the stock, which is down 3.3% since March 1.
MGM Growth Properties
The REIT was formed in 2016 as a way for MGM Resorts to sell some of its assets while continuing to operate them.
That paid off throughout the pandemic for the REIT, which continued to collect rent from the casino properties it owns.
The REIT’s portfolio of properties includes Mandalay Bay and Park MGM on the Las Vegas Strip as well as some regional facilities such as the Borgata in Atlantic City, N.J.
MGM Growth Properties (MGP) was set up as a triple-net lease REIT, meaning it doesn’t have to pay for maintenance or capital expenditures.
Those fall on the MGM Resorts, which operates the properties.
“The triple net lease structure was new to the gaming industry in the last couple of years, and it hadn’t been through a significant downturn,” says Farley, who has a Buy rating on MGP.
The company has made it through the pandemic in solid shape with its dividend intact, most recently at 51.5 cents a share on a quarterly basis.
“The pandemic has really proven that business model,” Farley says.
The REIT, with a recent yield of 5.5%, is widely viewed as an income play. But it has returned 14.1% since March 1.
Host Hotels & Resorts
Lodging REITs had a difficult time during the pandemic as a lot of business dried up.
Host Hotels & Resorts (HST) was no exception, as evidenced by its decision last year to suspend its quarterly dividend and share buybacks.
However, the company’s strong balance sheet is paying dividends of a different sort: three major acquisitions announced this year that will add to earnings.
The company does have properties in markets hit hard by Covid such as New York and San Francisco, but it also has exposure to resorts in Florida and other states that have performed better this year.
Woronka has the stock at a Buy, and says it’s relatively cheap.
By his calculations, Host Hotels’ enterprise value was recently trading at 12.4 times its estimated 2022 Ebitda, in the middle of its historical range.
The stock is down 3.1% since March 1.
“If you believe we are early in a new lodging cycle, which is my opinion, you want to be buying things early in the cycle because you’re going to benefit from more years of cash-flow growth,” says Woronka.
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