Commentary

A strong balance sheet the recipe to avoid capital loss

September 8, 2022

Following on our last commentary featuring Samsonite (1910 HK), more travel statistics were released confirming the increase in travel. July data shows that Europe, South America and the United States (U.S.) travel spending now exceeds the previous peak of July 2019.

Hotels in Europe saw their revenues per available room (RevPAR) in July grow 78% year-on-year, exceeding July 2019 by 19%. Occupancy rates are still below 2019 by above 5%, but average prices are 25% higher.

Meliá Hotels (MEL SM)

One holding that is very exposed to the European and Caribbean travel market is Meliá Hotels. Meliá is one a leading European hotel groups; it owns and/or manages more than 316 hotels and resorts in 33 countries, mainly in America and Europe, for a total of over 83,772 rooms, 11,854 of which are owned. Of the rooms, 63% are in Europe, 30% in the Caribbean, and 7% in Asia, which is the main reason for future room growth. Resorts account for 60% of hotels (i.e., 100% leisure), with the other 40% are urban, of which half are bleisure (business and leisure) in cities like London, Paris, Rome and Madrid.

Covid has been a huge challenge for companies, particularly in the travel and hospitality business. An important item we look at before investing in any company is the strength of the balance sheet. We want a strong balance sheet with little debt, even if it may appear as not the optimal capital structure. In times of stress, however, that strong balance sheet creates opportunities.  

Let’s contrast two world-class companies in the travel sector — Meliá and Carnival Cruise Line (CCL US):

 Meliá12/201912/2021
Number of hotels326316
Company owned4337
Total rooms83,77883,772
Number of shares outstanding (million)229.7220.5
Total net debt (excl. leases) €M5551,244
Stock price€7.86€6.06 (31/08/2022)
 Carnival Cruise Line11/201911/2021
Number of ships in service105105
Capacity per day248,790248,790
Number of shares outstanding (million)6901123
Total net debt (excl. leases) $M US10,98424,087
Stock price$45.08$9.54 (31/08/2022)
Source: Global Alpha

We can see that Meliá has the same number of rooms and less shares outstanding than at the end of 2019.  The debt, although higher, is still manageable, especially considering that the over 11,000 rooms Meliá owns could be sold and the company could eliminate most or all of the debt outstanding.  As a result, Meliá’s earnings per share, which were €0.64 in 2018, should be higher in 2024.

Meliá’s stock price, although down 23% since the end of 2019, has rebounded 121% since March 18, 2020, and should continue to rebound as results improve.

Carnival Cruise, on the other hand, had to more than double the number of shares outstanding and take on very expensive debt.  As a result, earnings per share, which were $4.49 in 2019, may never reach that level again.  Its stock price has gone down 81% since the end of 2019 and has only rebounded 2.5% since March 18, 2020, most likely a permanent loss of capital.

As investors, we are looking at per share growth. We think like business owners. If we owned the whole business, we would look to grow profits. When we buy shares, we become co-owner of the business and look for the sales and profits attached to each share we own.

Let’s look at this concept of growth per share. Every business is cyclical to a certain extent. What we want is higher highs and higher lows, and we want to avoid a permanent loss of capital.

Brunswick Corp (BC US)

A company we have followed for the last 20+ years and own in our U.S. small cap fund is Brunswick Corp.  Founded in 1845, the company has been manufacturing many recreational products over the years, from pool tables to bowling alleys, before focusing on boats, such as Boston Whaler, Lund or SeaRay and Mercury marine engines.

Source: Bloomberg

Looking at sales figures above, we can see that total sales have only increased slightly since FY2006.

However, shares outstanding have decreased as a result of strong free cash flow used to reduce the number of shares.

Source: Bloomberg

As a result, revenue per share has also increased.

Source: Bloomberg

And so have earnings per share.

Source: Bloomberg

And despite the global financial crisis of 2008 and the Covid pandemic of 2020, owning the shares has been rewarding investors.

Source: Bloomberg