Summer’s not cancelled

The feasts of Christmas, Easter and Whitsun were formally abolished in England in 1647 and weren’t legalised again until the restoration of the monarchy in 1660.

While no one in government has made a serious attempt to ban Christmas since then, there were murmurings towards the end of last year that it would be as good as cancelled, with the cost-of-living crisis dominating headlines and the Bank of England announcing in November we were set to enter one of the longest and deepest downturns since the war.

In the end, Christmas wasn’t cancelled, and neither was Easter, with the Bank of England now forecasting we will avoid a recession completely this year.

Consumer confidence is rising...

And, while newspaper headlines have become ever more pessimistic and sensational as the focus has moved from the cost-of-living crisis to the pain caused by rising interest rates, consumer confidence rose for the fifth month in a row in June¹. Summer is well and truly under way.

Why the disconnect between perception and reality?

It is worth remembering only about 30% of households in the UK have a mortgage². In addition, a significant number of homeowners fixed their mortgages when rates were low, meaning it will take time for the impact of monetary tightening to filter through. The Bank of England may have just increased the base rate to 5%, but the average figure paid by a UK mortgage holder is just 2.83%³.

And the rise in interest rates is not bad for everyone: anyone with cash in the bank and no debt to service will be better off in nominal terms. It is worth remembering that more people in the UK own their home outright than via a mortgage.

People who find themselves in a surprisingly comfortable financial position as the weather gets warmer and the evenings longer are likely to start thinking about a trip abroad – based on our analysis of current spending patterns, it would appear that the UK consumer now views a summer holiday as an essential, rather than a discretionary cost.

Airlines such as IAG are in a good position...

In the Artemis UK Select Fund, we’re also thinking about holidays, although we’re more interested in the mode of transport than the final destination, holding airlines IAG – the parent company of British Airways, Iberia, Aer Lingus and Vueling – and Jet2.

• We view IAG as a landlord sitting on valuable real estate – in the case of British Airways, it is its slots at Heathrow. The airline has a set of joint ventures which together control 83%⁴ of connections to the highly profitable North Atlantic region. British Airways’ market share of these routes has grown since the onset of Covid.
• Iberia, meanwhile, is dominant in South America – with many of its competitors running into trouble during the pandemic, its market position and profits have improved significantly. It announced its best Q1 performance ever this year.
• The wider company has also improved its cost base over this time, mainly through retiring expensive-to-run old planes such as 747s and replacing them with more fuel efficient and smaller A350s and Boeing 787s.

This is a theme that has been seen across the industry: globally, there are now 14.3% fewer⁵ wide-body long-haul planes than there were in 2019, causing a supply/demand mismatch that has pushed up airfares. Replacements take a long time to build, meaning this imbalance is likely to persist. A fall in the price of fuel, IAG’s biggest cost, will only be positive for its bottom line.

As a result, we predict a faster recovery than the market is pricing-in: although the company has already upgraded its guidance for full-year profits once this year, we think it has been overly cautious, and will do so again. This will allow it to clear the debt it built up during Covid and remove any lingering concerns over its balance sheet.

Owning an airline doesn’t come without risks – recessions, terrorism and pandemics are three obvious ones. Another one to emerge in recent years is the change in attitudes towards heavy polluters. We lobbied IAG in 2019 to improve its climate statistics, and while we didn’t think it took this request seriously enough at the time, it now has a clear glidepath to net zero, with a position on the prestigious CDP A-list for Europe.

This won’t protect against the threat from recessions, terrorism or pandemics. But we feel a price/earnings ratio of 7.5x, falling to 5.8 next year and 5.1 the year after⁶, more than compensates for these risks.

As an airline that offers budget package holidays, Jet2 operates in a different niche to IAG, but again it is exceeding expectations, delivering impressive growth in what was once seen as a mature industry. In January, it upgraded its full-year earnings guidance from £317 million to between £370 million and £385 million⁷, yet both forecasts proved too pessimistic, with the final figure standing at £390.8 million⁸. 

Jet2 recently increased the number of holidays in its ATOL licence. On that basis, it is likely to be the UK’s number-one tour operator this summer.

You don’t need to worry about anyone cancelling summer, but that doesn’t mean you shouldn’t make the most of it while it lasts. The same goes for attractive valuations in airlines.