Thomas Cook analysts torn by wide spread of risk-reward

The FTSE 250 group said that full year earnings before interest and tax were now expected to come in around £30m lower than previously guided, suspended its dividend and revealed net debt that was around £100m higher than forecast at £389m. Winter bookings were down 3% and Summer 2019 had seen a "mixed start".

Morgan Stanley downgraded to 'equal weight' from 'overweight' and pulled its price target as it saw a very wide risk-reward price spread of 20p all the way up to 130p.

On the one side, current trading looks weak for Winter 18/19 and the company noted a mixed start to Summer 2019. With just £20 of EBIT per holiday for all major tour operators, "a 5% shift in booking patterns can lead to a 20% profit headwind".

Analyst Jamie Rollo feels 2019 could be another late booking year, "with Brexit causing not only consumer uncertainty but also possibly 'scare stories' in the media about travel delays, visa issues, and increasing travel expenses".

He said the suspension of the dividend was "a surprise" as it only saves £9m of cash, so "could conceivably be seen as a sign of tightening liquidity", though he accepts that the company assured it has plenty of headroom, has received support from its lenders and has no debt maturities before 2022.

"With more upside to our bull case than our bear case, the shares already seem to be pricing in a lot of risk and appear attractive. But we have little confidence in our forecasts, and less so in our FCF forecasts," the Morgan Stanley man concluded.

Barclays also worried that bank terms could be breached. While the company said it was "trading on the basis of having 20% headroom", without knowing the banking covenant hurdles, the bank "cannot be sure if this implies the risk of a breach has increased".

"With concerns around the UK economy, and with significant operating/financial leverage, earnings may continue to disappoint," said analyst Patrick Coffey.

Coffey said he was also worried by the "extremely high" level of exceptional items, which arguably flatters the tour operator business, while he also worries about Thomas Cook's "competitive position, execution and yield management versus peers".

All in all, Coffey said: "We want to get off the fence but the investment case remains binary and opaque" and so he felt forced to keep his rating at 'equalweight', but said the "binary nature" of the investment warrants a lower multiple, cutting his target price to 46p.

He dangled the prospect that, at its current "cheap valuation provides ground for optimism" and could see the group split its tour operator from its airline.

Mark Brumby at Langton Capital, while noting that Thomas Cook shares were above 145p only six months ago, said while there has been disappointment on trading more than once the drop in the shares, to 35p at one point, should be taken in context.

"TCG is much-changed over recent years and its finances have been overhauled. It has relied a little on ‘exceptional charges’ that had begun to look a little less than exceptional but underlying trading had been improving."

In the wake of the Patisserie Holdings scandal, discussions with auditors may have been a little more forthright, with non-executive directors maybe also feeling "a little more compelled to suggest that some non-trading items were put through the P&L in the normal way" and for the interpretation of already-disclosed information to be treated a little differently from now on.

Brumby said that management said its work to fundamentally improve the quality of its income is ongoing and it is differentiating its product, while the plan to reduce capacity next year "cuts the risk that the group will need to discount".

"Earnings are under review – not least which number ‘earnings’ should be derived from," he concluded, "but travel remains an aspirational product, TCG is well-positioned and the shares do seem to have dropped a little further than might be warranted."

Broker Numis said that with a covenant relaxation from its lenders and better than expected working capital outflow, "the risk of a balance sheet event has reduced, which will be the main focus for investors".

Trading on 5.5 times full year earnings per share, at a circa 70% discount to its global peers, and on trough multiples, it saw the shares a 'buy'.