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 1. Home
 2. Industries
 3. Earnings Watch


EARNINGS WATCH


THE BIGGEST RISK FACING INVESTORS THIS EARNINGS SEASON IS LURKING JUST BENEATH
THE SURFACE

Last Updated: Oct. 4, 2021 at 7:26 a.m. ET First Published: Sept. 30, 2021 at
12:00 p.m. ET
By

CIARA LINNANE

AND

TOMI KILGORE

  Comments


AN ANALYSIS OF THE FINANCIAL STRENGTH OF ONE ECONOMICALLY SENSITIVE SECTOR —
TRAVEL AND LEISURE — INDICATES THINGS ARE NOT NEARLY AS GOOD AS THEY MIGHT SEEM


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REFERENCED SYMBOLS


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LUV
+1.31%
DAL
-0.93%
BKNG
+0.15%
LVS
-3.33%
MAR
-0.53%
CCL
-2.87%

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The third-quarter earnings season that’s currently winding down has seen S&P 500
companies generate overall per-share earnings growth of more than 27% and sales
growth of more than 15%, numbers that suggest a robust recovery from 2020’s
pandemic lows.

But the high growth rates, coming off what was for many companies a very low
base, are masking underlying problems that do not bode well for the future. An
analysis of the underlying strength of companies in one economically sensitive
sector — that of travel and leisure — highlights the trend.

That sector, which borrowed heavily to survive during the worst of the pandemic,
was expected to enjoy a steep increase in demand for flights and hotel rooms in
the summer after the vaccine program kicked off in the spring. But that
expectation was dashed by the highly transmissible delta variant of the
coronavirus that has pushed cases, hospitalizations and deaths back to levels
seen in winter and discouraged people from leaving home.


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“The largest travel and leisure public companies are still on a knife’s edge,”
said James Gellert, CEO of RapidRatings, a company that assesses the finances of
private and public companies.

“For these companies, much of the pain has lasted over a year now, driven
largely by empty properties, unsold tickets, continued confusion around
lockdowns and quarantine policies, and an optimism that has yet to fully meet
reality.”

It’s not just the travel sector that is feeling the pain. Many industries are
struggling with inflationary pressures, supply-chain hassles, border closures
and quarantine measures, including automotive and retail, both of which saw big
changes in cash to current liabilities from 2019 to the end of 2020.



“People need to monitor all industries, and companies within them, carefully to
observe whether the ‘new’ liquidity gained over the past 4-5 quarters can
sustain companies or just prop them up for a while longer,” said Gellert.

See now: Hopes for a business-travel boost are dwindling for U.S. airlines as
September bump fails to materialize

DEEP DIVE

RapidRatings analyzes a company’s financials and assigns it a financial-health
rating, or FHR, and core health score, or CHS. The former is a measure of
short-term probability of default and the latter evaluates efficiencies in a
business over a two- to three-year perspective.

“‘The largest travel and leisure public companies are still on a knife’s edge.
For these companies, much of the pain has lasted over a year now, driven largely
by empty properties, unsold tickets, continued confusion around lockdowns and
quarantine policies, and an optimism that has yet to fully meet reality.’”

— James Gellert, RapidRatings

Both produce a number on a scale of 1 to 100, which is grouped in categories
based on risk, as a means to help a potential business partner, vendor or
counterparty determine how a company will perform over time. Only financial data
is analyzed, and not share price or other market data that would include
investor sentiment.


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policies and more impact you with real-time news and analysis from MarketWatch.

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As the chart below illustrates, a sample of companies in the travel and leisure
sector had mostly strong FHRs at the end of 2019, before the advent of the
pandemic. Southwest Airlines Co. LUV, +1.31% led the pack with an FHR of 91, but
that has fallen sharply to 48 at the end of the second quarter, placing it in
RapidRatings’ “medium-risk” category.


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Similarly, Delta Air Lines Inc.’s DAL, -0.93% FHR has tumbled from 87 at the end
of 2019 to 25 at the end of the second quarter, putting it firmly in the
“high-risk “category. Online travel site Booking Holdings Inc. BKNG, +0.15% FHR
has fallen to 53 from 86. Las Vegas Sands Corp. LVS, -3.33% has fallen to 24 at
the end of the second quarter from 86 at the end of 2019.


Source: RapidRatings

Core health scores have fared no better. Southwest’s has fallen to 18 from 84,
putting in the “very poor” category; Delta’s from 86 to 23, the “poor” category;
Booking’s from 81 to 31; and Las Vegas Sands to 20 from 83, all low scores that
imply high risk over the medium to long term. Only Marriott International Inc.
MAR, -0.53% has been spared a poor core health score, falling to 53 from 78 at
the end of 2019, to remain in RadidRatings’ “medium” category.


Source: RapidRatings

“While the holiday season might give many of these companies a revenue boost,
the hangover will be even more unpleasant come next year if the raw fundamentals
don’t show signs of improvement beyond the next quarter,” said Gellert.

CASH IS KING

The deteriorating numbers come after companies both public and private were
forced to borrow more, extend maturities and do whatever was needed to gain
short-term liquidity at the height of lockdowns and restrictions on movement in
2020.


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The airline sector, hammered when travel ground to a halt last spring, begged
for a government bailout to boost liquidity, which came with onerous terms. Some
airlines issued bonds backed by their own loyalty programs as grounded flights
caused them to burn through cash.

The cruise sector was further hampered, when the Centers for Disease Control and
Prevention mandated shutdowns for more than a year, and as companies fought with
the state of Florida over their policies to require COVID-19 vaccinations for
crew and passengers.

Carnival Corp. CCL, -2.87%, which had the lowest FHR score among the sample
companies, has said that, by the end of 2021, nearly 22 months after the
COVID-19 breakout was declared a pandemic, its goal was to have 65% of its
global cruise capacity back on line.


Source: RapidRatings

At Booking.com, survival meant a host of actions from raising $4.1 billion in
fresh debt, negotiating amendments to its revolving credit facility,
restructuring activities, participating in government aid programs including
wage support programs, suspending share buybacks and nonessential travel,
reducing marketing spending and selling investments, according to its 2020
annual report, published in February.


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“Cheap and easy access to capital provided an incredible Band-Aid to companies
strong and weak,” said Gellert. “The big question is whether these companies can
improve from pandemic trauma with this cash or whether it will run out prior to
their return to health and when they need to pay the piper for the increased
borrowing and future debt maturities that they may, or may not, be able to
satisfy.”

FORGETTING FUNDAMENTALS

One factor that is making a difference is how much cash companies raised in 2020
that is now helping to see them through the current hardship. For example, Delta
and Carnival raised cash even as they added leverage, and that’s now giving them
more resilience than Las Vegas Sands.

All three have suffered steep declines in revenue, decreasing profitability, or
a swing to losses, and higher leverage. But Las Vegas Sands saw the biggest drop
in FHR “in part because, contrasted with the others, the increase in debt was
not accompanied by the resilience created from more liquidity. The other two
have bought time with their cash,” said Gellert.

For investors, the market performance of many travel-related stocks looks highly
disconnected from the RapidRatings data. Many have more than doubled from their
pandemic lows, even as fundamentals show the companies are struggling.

Delta shares, for example, have rocketed about 125% off their closing low of
$19.19 on May 15, 2020. Deutsche Bank analyst Michael Linenberg recently
launched a “catalyst call buy” on the stock in anticipation of increased travel
demand, saying Delta was one of the “highest-quality names in the sector.”


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See also: More than a quarter of Nasdaq-100 stocks are in bear markets, and Wall
Street sees a buying opportunity

So far, investor confidence seems to be based on what people believe will
happen, rather than what the realities of the air carrier’s quarterly results
and balance sheet have shown.

Delta reported a return to net profitability in the second quarter. Its net
earnings of $652 million represented the first profit since the pre-pandemic
fourth quarter of 2019. But that profit resulted from the inclusion of $1.5
billion in benefits related to government payroll support programs; excluding
that benefit, Delta recorded an adjusted net loss of $678 million.

The total adjusted net loss for the first half of 2021 was $2.94 billion, not
much better than the $3.14 billion loss suffered in the first half of 2020,
while payments on debt and finance lease obligations during those periods have
swelled more than 80% to $3.1 billion.

And yet the stock has more than doubled, even though the ratio of debt to assets
has soared to the highest levels seen since before Delta last emerged from
bankruptcy in April 2007.




FactSet, MarketWatch

As the chart above shows, the stock price and the debt-to-asset ratio tend to
move in opposite directions.

      




READ NEXT


READ NEXT


AMAZON'S STOCK DROPS TOWARD LONGEST LOSING STREAK IN MORE THAN TWO YEARS

Shares of Amazon.com Inc. undefined slid 2.9% toward a sixth straight loss in
afternoon trading Monday, as part of a broad stock market selloff in which
technology sector was the hardest hit. The e-commerce and cloud behemoth's stock
is on track to suffer the longest losing streak since the eight-day stretch
ended Aug. 5, 2019, according to Dow Jones Market Data. The stock, which is
headed for a six-week low, has now tumbled 14.5% since closing at a record
$3,731.41 on July 8. The selloff comes as the S&P 500 undefined slumped 1.5% and
the SPDR Consumer Discretionary Select Sector ETF undefined shed 2.8%. Amazon
announced earlier Monday that Prime members will be able to send gifts on its
mobile app with just the recipient's mobile number or email address. Amazon's
stock has lost 2.1% year to date, while the S&P 500 has gained 14.2% and the
consumer discretionary ETF has rallied 13.3%.


MORE ON MARKETWATCH

 * Barron's: These Stocks Raised Their Dividends Last Week
 * Facebook’s very, very bad day: Services go dark and stock plunges in wake of
   whistleblower revelations
 * ‘How much?’ — Twitter’s Jack Dorsey jokes about buying the Facebook domain
   amid outages
 * Barron's: Why Facebook Stock Is Still a Buy Despite Controversies


ABOUT THE AUTHORS

Ciara Linnane


Ciara Linnane is MarketWatch's investing- and corporate-news editor. She is
based in New York.

Tomi Kilgore


Tomi Kilgore is MarketWatch's deputy investing and corporate news editor and is
based in New York. You can follow him on Twitter @TomiKilgore.


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