Thomas Cook Group PLC (LON:TMG) could be split into two separate businesses, Barclays Capital suggested after the travel company issued a fresh profit warning.
On Tuesday, the company said it would suspend its dividend and cut its profit guidance in an unscheduled trading update, just two days ahead of its full-year results statement.
Thomas Cook said an unusually hot summer in the UK had hurt demand while earnings were also hit by £28mln in legacy and one-off charges.
READ: Thomas Cook scraps dividend and issues another profit warning two days before full-year results
The company will report underlying earnings (EBIT) of £250mln for the year to September 30, down from the reduced forecast of £280mln it posted in a September trading update and £58mln lower than the prior year on a like-for-like basis.
Profit in the tour operating business dropped £88mln but airline profit increased £35mln.
Investment case remains 'binary and opaque'
Barclays maintained an ‘equal weight’ rating on Thomas Cook but slashed its target price to 46p from 120p, saying a cheap valuation provides grounds for optimism but the investment case remains unclear.
“We want to get off the fence but the investment case remains binary and opaque,” it said.
Looking at the bigger picture, Barclays said Thomas Cook could split its tour operator business from its airline division. The bank said this move would potentially lead to a re-rating and lower debt.
Exceptionals remain extremely high but trading will improve, Barclays expects
Barclays predicts pick-up in trading next year. It expects the tour operator division to improve earnings by £31mln in 2019 with a £24mln recovery in the UK business.
“That said, exceptional items are extremely high, which worries us (>60% of underlying EBIT),” the bank said.
However, the company has committed to reducing exceptional costs by at least £50mln in 2019. Barclays said this means the group may more prudently account for items, which previously were classified as exceptionals.
“Elsewhere we worry about TCG’s competitive position, execution and yield management versus peers.”
Risk of breaching debt covenants
Barclays also said the company is at risk of breaching debt covenants. Thomas Cook recently received support from banks, giving it more flexibility. The group has said it is trading on the basis of having 20% headroom.
Net debt stood at £389mln at the end of the 2018 financial year, which was higher than expected.
“The key question is ‘will TCG breach covenants?’,” Barclays said.
“There are two covenants: leverage and fixed charge cover. TCG remains highly seasonal (>140% EBIT generated in Q4) and covenant hurdles are not disclosed. There is no guidance for FY19. We see a big increase in adjusted leverage in Q119 (4x vs. 3.3x in Q118), but without knowing TCG’s hurdle rates, we 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.”
Shares in Thomas Cook fell 6.1% to 35.27p in mid-morning trading.