Thomas Cook Group PLC (LON:TCG) shares declined as UBS initiated coverage of the stock with a ‘sell’ rating, citing intensifying competition, rising costs, higher capital expenditure and fewer working capital tailwinds.
“Moreover, we believe free cash flow is peaking, and we forecast £130m per annum in financial years 2019 and 2020, about 45% below Reuters consensus,” UBS said.
“We initiate coverage with an anti-consensus sell rating and a price target of 85p.
Competition and rising fuel costs to squeeze margins
UBS said while it acknowledges management’s positive initiatives to improve the business, it believes a competitive environment and higher fuel costs are likely to generate headwinds for Thomas Cook’s already thin margins.
Thomas Cook could improve pricing on some of its main routes this year but it faces threats from rising supply and new entrants, UBS added.
In the UK tour operator business, UBS expects pricing pressures as Jet2 and easyJet PLC (LON:EZY) attempt to upsell holiday packages to airline customers.
READ: Thomas Cook’s pre-tax loss narrows as bookings grow ahead of busy season
UBS expects capital expenditure to rise on plans to invest in IT and hotels over the next years, as well as higher finance leases to support fleet renewal.
"Last but not least, our in-depth analysis of working capital trends indicates more limited cash inflows than in the past," it said.
In May, Thomas Cook revealed its losses shrunk in the first half on the back of higher revenues. For the second half, UBS expects profits will benefit from improved pricing, but sees continued downward pressure on the UK tour operator business.
The broker’s estimate for earnings per share in 2019/20 is 15% below the consensus forecast.
Shares fell 1.7 % to 90.6p in midday trading.
UBS cuts target price on TUI
Separately, UBS also took a look at fellow travel operator TUI AG UK (LON:TUI).
It maintained a ‘neutral’ rating on the stock but lowered its target price to 1,600p from 1,720p, sending the shares down 1.4% to 1,613p.
Similarly to its analysis of Thomas Cook, UBS believes TUI’s UK tour operator business could come under pressure from tough competition.
"Our downside scenario (1,250p per share) is predicated on significant capacity additions in the tour operator/airline markets putting pressure on pricing and margins," UBS said.
"Furthermore, pressure on hotel occupancies and cruise yields could weigh on profitability."
READ: TUI maintains full year guidance as it narrows second quarter loss
The upside scenario of 1,900p per share assumes higher tour operator margins, supported by the company's customer relationship management initiatives and/or consolidation in some of the main markets.
"In Hotels, upside could come from higher openings and increased occupancy, while in Cruises upside could come from yield, on-board spend improvement and cost efficiencies," UBS said.
UBS lowered its expectations for the tour operator arm but upgraded its forecasts for profits in the hotels and cruises divisions.
Overall, the broker has cut its earnings (EBITA) estimates for fiscal years 2019 and 2020 by 3% and 2% respectively.