Boeing’s Stratocruiser airliner summed up what air travel was all about in the 1950s. With a VIP lounge, double beds and ‘one-family state rooms’, it meant luxury for the few. A transatlantic flight cost the equivalent of a month’s salary for a lawyer. With air travel restricted to the elite, the international travel industry was tiny. In 1950, just 25 million cross-border tourist trips were made around the world – and most were by land or sea.
But in the last 40 years the travel industry has enjoyed incredible growth. Today, there are almost a billion international trips (‘arrivals’, in the industry jargon) made for business or tourism purposes every year (this includes all forms of transport, not just aviation). Thanks to emerging markets, the boom could just be beginning. Experts reckon international arrivals will hit 1.6 billion a year by 2020.
One factor behind this staggering growth is technological innovation. If you stripped out some of the beds, the propeller-powered 1950s Stratocruiser could seat 100 people, making it the largest passenger plane of its day. But advances in jet-engine technology soon doomed the Stratocruiser to the scrap yard. By the 1970s, Boeing’s 747 was capable of carrying more than four times as many passengers, far more quickly, at a fraction of the cost. Commercial deals between airlines, market liberalisation and the birth of low-cost carriers also helped to bring down costs and so make air travel affordable for a wider range of people.
Another important factor in the rise of air travel was the growing wealth of Americans and Europeans. In 1950, much of Europe was still impoverished and in ruins following World War II. But peace paved the way for a half century in which large parts of western Europe and America enjoyed unprecedented prosperity. And many spent their new wealth on holidays.
Tourism’s relentless growth
But isn’t tourism a hugely cyclical industry? Certainly, the intuitive view is that when times are good, people take holidays, and when they are hard up, they don’t. Yet the trend for the last 50 years has been one of almost constant growth.
The UN World Tourism Organisation notes that, “in spite of occasional shocks, international tourist arrivals have shown virtually uninterrupted growth: from 25 million in 1950, to 277 million in 1980, to 435 million in 1990, to 675 million in 2000, and the current 940 million.”
Within those figures, the rise of the aeroplane was particularly noticeable. Air travel now accounts for more than 50% of international arrivals and its share is rising. Indeed, the number of kilometres travelled by fare-paying passengers on aeroplanes has grown by more than 800% since 1970. As The Economist notes, there appears to be “an iron law of aviation: rising numbers of urban middle-class people will mean rising demand for air travel, whatever short-term blips the economy suffers”.
That’s all well and good. But with the era of rising American and western European prosperity now grinding to a halt, can international tourism continue to grow?
The next big wave of tourists
Yes. Because now plenty of Russians, Chinese and Brazilians are ready to do battle for the best sun lounger by the pool. In the last 20 years, tourists from emerging markets have played an increasingly important role in swelling tourism numbers. Japan was the first country outside of North America and Europe to make a serious impact on the global industry. That was partly due to the country’s spectacular economic growth during the 1980s, when the Japanese government launched a “Ten Million Programme” to double outbound tourism departures between 1986 and 1991.
A decade later, South Koreans began enjoying the fruits of their country’s progress. More recently tourists from China have joined the fray. Asia and the Pacific now sends 149 million more tourists abroad than it did 20 years ago. That’s pushed up the region’s share of total international arrivals from 13% in 1990 to 21% today, overtaking the Americas.
Unsurprisingly, China has been a major driver in that growth. In the last ten years alone, China’s spending on international tourism has quadrupled to $55bn, making it the third-highest tourism spender in the world. Moreover, China looks set to climb further up the table. The World Travel and Tourism Council (WTTC) estimates the Middle Kingdom will send an extra 125 million travellers abroad and generate an extra $100bn in overseas spending between now and 2021. As The Economist puts it, “Chinese tourists seem to be everywhere, yet the Chinese tourist boom is only just beginning.”
Russia has also become a major source of international tourists. Russia’s spending on tourism grew by 27% in 2010, making it the world’s ninth-biggest spender on tourism. The willingness to travel isn’t just about spending money. Until a few short decades ago, most Chinese and Russians were not allowed to travel abroad. The growth in emerging-market tourists is as much about political freedom as economic wealth.
Emerging markets as destinations
But this is not just a story about Chinese tourists flocking to the other side of the world to take pictures of Big Ben. Around 80% of international journeys start and end in the same region. That means that as areas such as Latin America, Africa and Asia grow wealthier, they will also experience growth in tourist arrivals as people from neighbouring countries come to visit. Boston Consulting Group estimates that, by 2050, 25% of international tourists to Japan and South Korea will come from China.
Indeed, this process is already well established. Between 2000 and 2010, international arrivals to emerging markets grew at an average annual rate of 5.6% compared to a measly 1.8% in the advanced economies. The WTTC reckons the ongoing economic woes in Europe and America “will only serve to accelerate the rise of the emerging markets relative to the developed world. Unburdened by debt and ageing populations as in many advanced nations, travel and tourism investment will soar and entrepreneurship will flourish to realise industry growth rates well in excess of those in established destinations.” The effects of this rebalancing should be more noticeable by 2020, when, “for the first time ever, the advanced economies – the EU, US and Japan – will generate only a minority of (global) travel and tourism industry GDP.”
Winners and losers
While international arrivals are set to grow, it’s clear that not everyone will be a winner. Traditional European tour operators, such as Thomas Cook and TUI, have struggled so far. That’s partly because tourists in their source market, Europe, have seen a squeeze in living standards.
It’s also because they have failed to capitalise on the incoming emerging market tourism boom. Boston Consulting Group thinks that traditional tour groups misunderstand their new customers. “Only a handful of companies understand the needs of Chinese travellers, 95% of whom claim they are poorly served on both the domestic and the international front.” Meanwhile, online travel businesses are booming. Consultancy PhoCusWright estimates that online sales account for 30% of the total global travel market and are growing twice as fast as sales from ‘bricks and mortar’ operations.
New specialist operators are also setting up in growing market niches, such as medical tourism. The market for patients travelling abroad for treatment that is either better or cheaper (or both) than what’s available in their home country is growing by 10% a year and will be worth $8.5bn in 2013.
Business travel is also performing strongly. It already accounts for around a quarter of the industry and is growing at 6.1% a year, compared to the 3.8% annual growth in leisure travel. “The 2012 global forecast from Egencia, the online travel operator, points to noticeable, if not exactly stunning, growth for several business travel destinations,” says Roger Blitz in the Financial Times. While a full-blown recession would be bad for business travel, it seems the current turmoil is actually helping. “Many companies try to get through tough times by seeking new business, which gives the travel industry hope,” adds Blitz.
The upturn in business travel is good for the luxury tourist market, says Canadian daily newspaper, the Edmonton Journal. “With corporate profits on the rebound, more travel managers are lifting restrictions and approving premium-class travel, which was cut deeply after the 2008 financial collapse.” More European and American firms are now allowing their employees to travel in business or first class. The luxury doesn’t stop when employees step off the plane. “Higher-end hotels are also seeing a pickup as companies feel less pressure to avoid ostentatious settings for sales conferences or for rewarding incentive travel for employees. Revenue per room for luxury hotels in the US – such as Ritz-Carlton, St. Regis and Four Seasons – rose 16.9% in mid-September, outpacing other types of hotels.”
Play the trend
The uptick in top-end tourism is also part of a wider trend as luxury brands across a range of sectors have performed strongly since the financial crisis. That’s partly because of a ‘two-tiered recovery’ in the West, where the fortunes of the rich bounced back more strongly than those of the middle classes. It’s also because luxury products benefit from pricing power, says William McVail at Turner Investments. “The reason why they can raise prices is that their customers – the growing ranks of the affluent worldwide and the middle class in emerging nations – are willing to pay up for prestigious, status-conferring products.”
Boom times ahead for aircraft makers?
Aircraft makers are convinced that they will benefit from the emerging-market travel boom. Boeing expects the number of kilometres travelled by fare-paying passengers to triple between now and 2030. If the US firm is right, the worldwide fleet will nearly have to double to meet demand. Including replacements, that should mean 33,500 new passenger and freight planes, with a total investment cost of $4trn. Meanwhile European rival Airbus reckons that the number of “megacities”, whose airports handle more than 10,000 long-haul passengers per day, will more than double during the next 20 years.
Such bullishness seems incongruous with the gloomy economic mood surrounding Europe and America. But it’s worth remembering that, between 2000 and 2010, air travel was hit by the dotcom crash, terrorism, war in the Middle East, the Sars outbreak, Avian flu, and a financial crisis – yet passenger flight hours still increased by 45% over the course of the decade.
The World Travel and Tourism Council believes that flight numbers will also get a boost from the move by holidaymakers to taking shorter, more frequent leisure trips, rather than a few, or a single, longer annual break. “With travel becoming so much more accessible, in terms of destination and product choice as well as price, the ten years between 2000 and 2010 spurred a rapid increase in travel frequency, with the growth in short breaks not surprisingly outpacing that of longer leisure trips.” Moreover, this “trend has spread to Asia, where the rising new middle classes have also been quick to take advantage of the new opportunities to travel abroad”.
The high oil price is also helping aeroplane manufacturers. This may seem counter-intuitive at first, until you realise that fuel now accounts for about half of an airline’s operating costs. Roughly speaking, a 1% improvement in fuel efficiency knocks $1m off an airliner’s fuel bill over its lifetime. So “even slight gains in efficiency quickly pay off”, says The Economist. In other words, high oil prices encourage airliners to replace old planes with newer, more efficient versions. This is also good for innovative component manufacturers. When building its new 787 ‘dreamliner’ airliner, Boeing replaced metal with plastic where possible to create a lighter craft that uses about 40% less fuel per passenger than its 1970s aircraft. Now Airbus also plans to use plastic frames for its new aircraft.
The best ways to invest in travel
When we last looked at the travel sector back in August 2010, we advised you to steer clear of tour operator TUI. With the firm’s shares down 20%, we’ll stick with that advice. We also tipped Intercontinental Hotel Group (LSE: IHG), owner of the Holiday Inn and Crowne Plaza brands, among others. The hotelier’s shares performed well, rising 33% before being dragged back down by the market crash this summer. It’s now 1.5% above the level that we tipped it and, thanks to improved earnings, looks even better value on a forward p/e of 13.6.
One of the best things about Intercontinental is that it manages and franchises hotels, rather than owning them directly. That means it doesn’t need to raise huge amounts of finance to expand. It also makes the group less vulnerable if property prices fall. Intercontinental also enjoys a solid head start in emerging markets. It was the first international hotel company to open in China, in 1984, and says that one in four of the hotel rooms that it opens globally over the next five years will be in China. The recent third-quarter results showed that it’s in good health. Sales were up 11% and operating profit 33%. Crucially, revenue per available room (revpar), which is a key indicator for hotels, was up 6.4%. Its hotels in Greater China performed even better with revpar up 10.6%.
Despite the boom in air travel, we’re not keen on investing in airlines directly. Over the last 30 years, a combination of high capital expenditure and fixed costs, endless regulatory interference and uncertain fuel costs mean they have rarely performed for shareholders and we don’t see that changing anytime soon. Instead, we favour firms that will profit as more aircraft are needed. Like hotels, they should benefit from both business and leisure travel.
Boeing (NYSE: BA) has had a tough couple of years. First its European rival Airbus brought out a new super jumbo jet to eclipse Boeing’s 747. Then Boeing’s new 787 Dreamliner was delayed and over budget. Finally, Airbus’s smaller single-aisle planes succeeded in taking orders from long-time Boeing customers such as American Airlines. But in the last few months the US giant has fought back. The 787 has made its first commercial flight and Boeing is producing 1,100 more. If all of the orders are met it will be the fastest-selling airliner in history. Boeing has also confirmed its dominance of the wide-bodied plane market by securing its highest-ever order in this week’s Dubai Airshow. Air Emirates committed $26bn to buy up to 70 777s and criticised Airbus’s wide-body offering.
Boeing seems to have learned its lessons from the Dreamliner debacle. It had been planning an all-new version of the 737. Now it’s changed tack, admitting “customers wanted more efficiency now and they wanted certainty of delivery”. It will put a more fuel-efficient engine on the 737 and relaunch it “sometime mid-decade”. Longer-term, the 787 has given it a lead in the carbon-composite technology that will become commonplace in the next generation of commercial planes. That should help it fend off small but growing competition from government-backed rivals in emerging markets. JP Morgan analyst Joseph P Nadal rates it a buy: it “beat Q3 earnings expectations handily this year and laid out an improved outlook for financial results this year”. It looks decent value on a forward p/e of 13.8.
The most direct way to invest in tourism is to buy a holiday apartment in an area that will benefit from emerging market tourism. Of course, this is risky, and you need to take professional advice on local property laws and taxes. However, if you like the idea, one exotic option to look at is Nicaragua. The tiny Central American state is the safest country in the region and home to ancient ruins, fantastic beaches and jungle. Due to its volatile political history – it spent most of the 1980s in civil war – foreign investors have steered clear until recently and land is much cheaper than in neighbouring hotspots, such as Costa Rica.
However, tourist numbers have been steadily rising and last year went past the one million mark, with the industry as a whole growing by an average of 17% a year between 2006 and 2010. With two-thirds of visitors coming from neighbouring countries, Nicaragua is a play on rising emerging-market fortunes. Its exclusive beach resorts also tap the growing luxury holiday market. A number of local and foreign investors are building high-end resort complexes. For more on how to invest, contact the investment agency PRONicaragua on: info@pronicaragua.org.
• This article was originally published in MoneyWeek magazine issue number 564 on 18 November 2011, and was available exclusively to magazine subscribers. To read all our subscriber-only articles right away, subscribe to MoneyWeek magazine.