New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Tourism Outlook</h2>
Being Brave While Industry Battens Down the Hatches
Inbound tourism growth through 2020 will be materially impacted by the coronavirus (COVID-19) outbreak, which hit during mid-peak season and threatens to depress tourist arrivals for the remainder of the year; however, we believe the market has over-reacted given the ~NZ$3.1bn hit to the combined market capitalisation of the four listed tourism related companies under our coverage. The share price reactions to the outbreak are both a function of the estimated financial impact (which remains very difficult to quantify), and emotion. The latter reflects investor sentiment that tends to at least initially over-penalise companies that are exposed, as has been the case in previous black swan events. This can create buying opportunities, as we believe is the case currently. Sector balance sheets have capacity, in our opinion, to absorb a meaningful downturn in tourism demand beyond the subdued earnings guidance provided for the remainder of FY20.
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/121/434/original/image_56447691841583367299121.png?1583367299" class="editor-image img-responsive" data-smartkarma-image-id="121434"></figure>
Tourism demand outlook dominated by&nbsp;COVID-19
2020 will be the toughest year for inbound tourism in recent memory. We expect a material decline in foreign arrivals. The current decline in airline capacity suggests a horror end to the 2019–20 peak season, which will continue through to mid-year. While current airline&nbsp;schedules suggest a return to normality from July, the risk of a prolonged impact from COVID-19 is reasonable.&nbsp;
Market over-reaction to demand outlook&nbsp;
Since 22 January 2020, when we first provided research commentary on COVID-19, the combined market cap decline of the four listed tourism related companies on the NZX is ~NZ$3.1bn. This equates to more than 4x the aggregate profit after tax for these companies from the year to June 2020. This appears an excessive overpricing of risk, in our opinion.
<div class="content-highlight">
In tandem with this report we have upgraded the ratings of each tourism sector company as follows:
<ul>
<li>Air New Zealand (AIR): OUTPERFORM from NEUTRAL</li>
<li>Auckland Airport (AIA): NEUTRAL from UNDERPERFORM</li>
<li>SKYCITY (SKC): OUTPERFORM from NEUTRAL</li>
<li>Tourism Holdings (THL): OUTPERFORM from NEUTRAL</li>
</ul>
</div>
Executive Summary
New&nbsp;Zealand&nbsp;been digesting the significant growth of inbound tourists of recent years with a flattening of the profile over the past 12 months. However, it now faces its largest challenges in recent memory with a significant drop in demand from the&nbsp;coronavirus&nbsp;(COVID-19) outbreak. This&nbsp;will have a material impact on sector performance through 2020, in our opinion.&nbsp;
Consequently, there is a significant degree of uncertainty in relation to the near term demand outlook, albeit our general rule of thumb is that the&nbsp;newsflow&nbsp;will get&nbsp;worse, before it gets better, as airline capacity reductions are extended beyond the end of June. Current schedules suggest a resumption of normal activity from July.&nbsp;
As investors we have to assess the risk associated with the demand outlook and determine whether share prices are appropriately pricing that risk. In this instance we think the market has over-reacted, as it often does in the earlier phases of black swan events, and therefore we now take&nbsp;a more positive view of the listed companies exposed to the tourism sector.&nbsp;
Implications for companies
In combination with this report we have upgraded the ratings of all tourism related companies under our coverage as we believe the market has overreacted to the risk associated by&nbsp;COVID-19.&nbsp;
Air New&nbsp;Zealand&nbsp;(OUTPERFORM):&nbsp;AIR's&nbsp;structural and balance sheet strengths leave it well placed to weather the&nbsp;COVID-19 storm. Our analysis shows that&nbsp;AIR's&nbsp;capacity cuts are deeper than its competitors and historically its responses to black swan events have been rapid and rational.
Auckland Airport&nbsp;(NEUTRAL):&nbsp;AIA&nbsp;is largely insulated to lower near term passenger numbers through (1) minimum annual guarantees (MAGs) in its retail business, (2) underlying growth in its investment property operations, and (3) the regulatory model that re-bases&nbsp;aeronautical pricing every five years (should demand stay lower for longer).
SKYCITY&nbsp;(OUTPERFORM):&nbsp;SKCs&nbsp;exposure to inbound tourism is moderate, although there is some risk to domestic visitation. The share price reaction appears dislocated from the risk, with valuation and an attractive yield providing downside protection.
Tourism Holdings&nbsp;(OUTPERFORM):&nbsp;THL's&nbsp;COVID-19&nbsp;exposure has amplified other challenges including the weak US vehicle sales market&nbsp;and the Australian bush fires. Earnings will be impacted by lower near term demand, particularly at&nbsp;Waitomo, while forward bookings for RV rentals remain relatively healthy. Last year's capital raise was well timed in hindsight.&nbsp;
Tourism growth outlook hampered&nbsp;
The growth in New&nbsp;Zealand&nbsp;inbound tourism has continued to slow from the peak cycle of 2015–16. Given the&nbsp;COVID-19 outbreak, we expect tourism growth to fall materially over the foreseeable future despite key macro-drivers being supportive.
Sector has been resilient to black swans historically&nbsp;
Historically the sector has been resilient to black swan events (SARS, 9–11, Christchurch earthquake etc.) and therefore we believe, once the virus is either (1) contained — through a vaccine or other public health measures, or (2) mitigated/managed — it becomes just another&nbsp;coronavirus&nbsp;like H1N1 in global circulation, there will be a recovery in inbound tourism demand. However, the timing of this is uncertain&nbsp;and therefore it may not be until at least 2021, in our opinion. The sector should be preparing for tougher times, at least over the next 6–12 months.&nbsp;
Other drivers supportive to ultimate recovery; particularly oil prices
While&nbsp;COVID-19 dominates the outlook for the remainder of 2020, we also consider other inbound tourism drivers, which may assist with an ultimate recovery, as follows: ​​​​​​​​​​​​​​
<ul type="disc">
<li>Oil prices&nbsp;represent a key driver of airline economics. Lower oil prices drive airline capacity additions, and vice&nbsp;versa. The decline in oil prices since October 2018 provides support for airline capacity growth (excluding&nbsp;COVID-19).&nbsp;</li>
<li>Slowing&nbsp;economic conditions&nbsp;in key source countries (most notably Australia and China) may dampen underlying demand.</li>
<li>Seat capacity&nbsp;growth is being dominated by North America. Seat capacity to/from Asia has declined with the exit of a number of airlines during 2019.&nbsp;&nbsp;</li>
<li>The&nbsp;price competitiveness&nbsp;of New&nbsp;Zealand&nbsp;as a tourist destination has deteriorated over the past five&nbsp;years, however, it still remains more competitive than Australia (although, the gap is narrowing).</li>
<li>The&nbsp;secular growth&nbsp;trend in tourism is long term. Over the past 40 years inbound tourists have grown at a compound annual growth rate (CAGR) of +6%. Prior to the recent boom, the long term&nbsp;CAGR&nbsp;was +5%.</li>
<li>The&nbsp;wealth effect&nbsp;of the rising middle class in emerging markets will help support ongoing tourism growth, in our opinion.</li>
</ul>
Flight shaming risk being overshadowed
The increase in consumer awareness&nbsp;around climate change and emissions has been substantial over the past 12 months. Flight shaming has become an accepted part of our vocabulary. While we expect it to be a feature over the longer term, it is unlikely to have the&nbsp;same short term impact as it is having in some European countries, including Sweden, where lower emissions alternative&nbsp;transport modes are available.&nbsp;&nbsp;
Chelsea Leadbetter CFA chelsea.leadbetter@forsythbarr.co.nz +64 4 495 5262&nbsp;
Andy Bowley andy.bowley@forsythbarr.co.nz +64 4 495 8246&nbsp;
Scott Anderson scott.anderson@forsythbarr.co.nz +64 4 914 2219&nbsp;
Matt Montgomerie matt.montgomerie@forsythbarr.co.nz +64 9 368 0124

Tourism Outlook
Being Brave While Industry Battens Down the Hatches
Inbound tourism growth through 2020 will be materially impacted by the coronavirus (COVID-19) outbreak, which hit during mid-peak season and threatens to depress tourist arrivals for the remainder of the year; however, we believe the market has over-reacted given the ~NZ$3.1bn hit to the combined market capitalisation of the four listed tourism related companies under our coverage. The share price reactions to the outbreak are both a function of the estimated financial impact (which remains very difficult to quantify), and emotion. The latter reflects investor sentiment that tends to at least initially over-penalise companies that are exposed, as has been the case in previous black swan events. This can create buying opportunities, as we believe is the case currently. Sector balance sheets have capacity, in our opinion, to absorb a meaningful downturn in tourism demand beyond the subdued earnings guidance provided for the remainder of FY20.

Tourism demand outlook dominated by&nbsp;COVID-19
2020 will be the toughest year for inbound tourism in recent memory. We expect a material decline in foreign arrivals. The current decline in airline capacity suggests a horror end to the 2019–20 peak season, which will continue through to mid-year. While current airline&nbsp;schedules suggest a return to normality from July, the risk of a prolonged impact from COVID-19 is reasonable.&nbsp;
Market over-reaction to demand outlook&nbsp;
Since 22 January 2020, when we first provided research commentary on COVID-19, the combined market cap decline of the four listed tourism related companies on the NZX is ~NZ$3.1bn. This equates to more than 4x the aggregate profit after tax for these companies from the year to June 2020. This appears an excessive overpricing of risk, in our opinion.

In tandem with this report we have upgraded the ratings of each tourism sector company as follows:

Air New Zealand (AIR): OUTPERFORM from NEUTRAL
Auckland Airport (AIA): NEUTRAL from UNDERPERFORM
SKYCITY (SKC): OUTPERFORM from NEUTRAL
Tourism Holdings (THL): OUTPERFORM from NEUTRAL


Executive Summary
New&nbsp;Zealand&nbsp;been digesting the significant growth of inbound tourists of recent years with a flattening of the profile over the past 12 months. However, it now faces its largest challenges in recent memory with a significant drop in demand from the&nbsp;coronavirus&nbsp;(COVID-19) outbreak. This&nbsp;will have a material impact on sector performance through 2020, in our opinion.&nbsp;
Consequently, there is a significant degree of uncertainty in relation to the near term demand outlook, albeit our general rule of thumb is that the&nbsp;newsflow&nbsp;will get&nbsp;worse, before it gets better, as airline capacity reductions are extended beyond the end of June. Current schedules suggest a resumption of normal activity from July.&nbsp;
As investors we have to assess the risk associated with the demand outlook and determine whether share prices are appropriately pricing that risk. In this instance we think the market has over-reacted, as it often does in the earlier phases of black swan events, and therefore we now take&nbsp;a more positive view of the listed companies exposed to the tourism sector.&nbsp;
Implications for companies
In combination with this report we have upgraded the ratings of all tourism related companies under our coverage as we believe the market has overreacted to the risk associated by&nbsp;COVID-19.&nbsp;
Air New&nbsp;Zealand&nbsp;(OUTPERFORM):&nbsp;AIR's&nbsp;structural and balance sheet strengths leave it well placed to weather the&nbsp;COVID-19 storm. Our analysis shows that&nbsp;AIR's&nbsp;capacity cuts are deeper than its competitors and historically its responses to black swan events have been rapid and rational.
Auckland Airport&nbsp;(NEUTRAL):&nbsp;AIA&nbsp;is largely insulated to lower near term passenger numbers through (1) minimum annual guarantees (MAGs) in its retail business, (2) underlying growth in its investment property operations, and (3) the regulatory model that re-bases&nbsp;aeronautical pricing every five years (should demand stay lower for longer).
SKYCITY&nbsp;(OUTPERFORM):&nbsp;SKCs&nbsp;exposure to inbound tourism is moderate, although there is some risk to domestic visitation. The share price reaction appears dislocated from the risk, with valuation and an attractive yield providing downside protection.
Tourism Holdings&nbsp;(OUTPERFORM):&nbsp;THL's&nbsp;COVID-19&nbsp;exposure has amplified other challenges including the weak US vehicle sales market&nbsp;and the Australian bush fires. Earnings will be impacted by lower near term demand, particularly at&nbsp;Waitomo, while forward bookings for RV rentals remain relatively healthy. Last year's capital raise was well timed in hindsight.&nbsp;
Tourism growth outlook hampered&nbsp;
The growth in New&nbsp;Zealand&nbsp;inbound tourism has continued to slow from the peak cycle of 2015–16. Given the&nbsp;COVID-19 outbreak, we expect tourism growth to fall materially over the foreseeable future despite key macro-drivers being supportive.
Sector has been resilient to black swans historically&nbsp;
Historically the sector has been resilient to black swan events (SARS, 9–11, Christchurch earthquake etc.) and therefore we believe, once the virus is either (1) contained — through a vaccine or other public health measures, or (2) mitigated/managed — it becomes just another&nbsp;coronavirus&nbsp;like H1N1 in global circulation, there will be a recovery in inbound tourism demand. However, the timing of this is uncertain&nbsp;and therefore it may not be until at least 2021, in our opinion. The sector should be preparing for tougher times, at least over the next 6–12 months.&nbsp;
Other drivers supportive to ultimate recovery; particularly oil prices
While&nbsp;COVID-19 dominates the outlook for the remainder of 2020, we also consider other inbound tourism drivers, which may assist with an ultimate recovery, as follows: ​​​​​​​​​​​​​​

Oil prices&nbsp;represent a key driver of airline economics. Lower oil prices drive airline capacity additions, and vice&nbsp;versa. The decline in oil prices since October 2018 provides support for airline capacity growth (excluding&nbsp;COVID-19).&nbsp;
Slowing&nbsp;economic conditions&nbsp;in key source countries (most notably Australia and China) may dampen underlying demand.
Seat capacity&nbsp;growth is being dominated by North America. Seat capacity to/from Asia has declined with the exit of a number of airlines during 2019.&nbsp;&nbsp;
The&nbsp;price competitiveness&nbsp;of New&nbsp;Zealand&nbsp;as a tourist destination has deteriorated over the past five&nbsp;years, however, it still remains more competitive than Australia (although, the gap is narrowing).
The&nbsp;secular growth&nbsp;trend in tourism is long term. Over the past 40 years inbound tourists have grown at a compound annual growth rate (CAGR) of +6%. Prior to the recent boom, the long term&nbsp;CAGR&nbsp;was +5%.
The&nbsp;wealth effect&nbsp;of the rising middle class in emerging markets will help support ongoing tourism growth, in our opinion.

Flight shaming risk being overshadowed
The increase in consumer awareness&nbsp;around climate change and emissions has been substantial over the past 12 months. Flight shaming has become an accepted part of our vocabulary. While we expect it to be a feature over the longer term, it is unlikely to have the&nbsp;same short term impact as it is having in some European countries, including Sweden, where lower emissions alternative&nbsp;transport modes are available.&nbsp;&nbsp;
Chelsea Leadbetter CFA chelsea.leadbetter@forsythbarr.co.nz +64 4 495 5262&nbsp;
Andy Bowley andy.bowley@forsythbarr.co.nz +64 4 495 8246&nbsp;
Scott Anderson scott.anderson@forsythbarr.co.nz +64 4 914 2219&nbsp;
Matt Montgomerie matt.montgomerie@forsythbarr.co.nz +64 9 368 0124

Tourism Outlook: Being Brave While Industry Battens Down the Hatches