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One of the advantages of being in the investment business for as long as I have is that, in times of incredible market distress, I get to invoke that wry and somewhat misleading saying, “Well, this isn’t my first rodeo.”
Another advantage is that my past was full of so many research assignments that I often unearth some helpful bits of industry knowledge from deep in my memory to inform some present analysis. And this brings me to my current fascination with the fate of the sectors worst-hit by the coronavirus: airlines, hotels, and casinos.
I have observed the evolution of these businesses over the decades. I’ve watched their tremendous expansion driven by commercial globalization, and their strategic initiatives toward shedding costly real estate and fleets of the largest passenger planes, such as 747’s. The result has been higher profit margins, built on leaner operations with less cushion, defined by extra employees, planes, or room ownership.
As COVID-19 has inflicted near-mortal wounds on the travel and leisure industries, managements have invoked retention of their workers as a key consideration in their appeal for help. According to recent data, the airline, casino, and hotel industries employ about 450,000, 750,000 and 2.3 million people, respectively, or over 2% of the American workforce.
The government has listened, including in the Federal bailout package, or CARES, a $25 billion provision for the airline industry and $454 billion targeted to large employers in distress, a term easily applied to both hotels and casinos. At the same time, some political leaders and investors have criticized some managements of these companies for their use of cash to repurchase shares over the past few years.
Hilton, with a current market value of $16.1 billion, has spent $4.1 billion over the past three years on share buybacks, and American Airlines purchased nearly $12 billion of shares since 2015 on a market cap that sits at only $4.3 billion today.
How should investors assess these and other actions in light of the dire COVID-19-related predicament? It helps to examine some of the calculated risks at airlines, hotels and casinos that have both contributed to the growth in operating margins but also put them at greater risk should the economy shift down dramatically.
In the past ten years, as interest rates have fallen to record low levels, businesses have been incentivized to use cheap money to expand.
As might be expected, long-term, debt-to-equity for these sectors has risen. Hilton has $9 billion of long-term debt and no equity; Marriott, after its $13 billion acquisition of Starwood, has $10.8 billion in long-term debt against $0.7 billion of equity; and Wynn Resorts‘ comparable numbers at $10.2 billion of debt and $1.7 billion of equity. Several airline bankruptcies in the Great Recession wiped out airline debt, so their balance sheets appear cleaner than their growth would suggest.
Whether corporations own, lease, or franchise their planes, hotels and casinos, the major players have expanded their scope significantly. Airline available seat miles, for example, soared, figuratively, up 140% since 2011, while revenue per average seat mile for the domestic carriers has remained within a tight range.
To cover their higher annual debt or lease payments, the travel and lodging industries have needed to fill more seats and rooms. Sure enough, load factor for the airline industry has risen from the mid-70% range in the early 2000’s to 85% recently while occupancy for US hotels has climbed from around 59% at the start of the millennium to 66% last year.
When the state of Massachusetts decided to legalize casinos, Wynn jumped at the chance. It proposed an extravagant casino/hotel in a densely populated neighborhood of a town adjacent to Boston, difficult to reach and without ample parking. Their early outlook, suggesting close to $220 million in first full year operating profits, will prove wildly optimistic, even in a normal environment.
In the aftermath of Covid-19, closing all leisure facilities across the country, Wynn has appealed to the state of Massachusetts and federal government for tax relief and bailout assistance, citing its hefty 5,000-person workforce. As Wynn’s management might have badly miscalculated the payoff for the project, should its share of a bailout be judged primarily on the size of its staff? Likewise, should some other criteria be used for Hilton, whose share repurchase followed its spin-out, with abundant debt, from Blackstone, or American Airlines after its jumbo-jet-sized share purchase?
At first glance, I thought there should be some penalty right now for imprudent risk-taking prior to this crisis, based on measures of debt, liquidity, stock repurchases, etc. But I’ve since changed my mind.
Hopefully, this is a once-in-a-lifetime experience. Those workers need to receive income from Wynn, Delta Air Lines, and Marriott by way of the bailout, or they will get it another way, straight from the government. Call it a transfer payment, a shifted wage responsibility, or unemployment insurance, but we need to do it and it is easier to have them stay within the company.
In addition, the federal government should learn from Treasury’s Troubled Asset Relief Program in 2008, which successfully ventilated the entire financial system that was imploding under the weight of some very risky behavior. TARP handed out $442 billion, and, basically, broke even, despite the list of beneficiaries that a Who’s Who of banking giants.
The government should attach some financial and operating strings to this bailout so taxpayers ultimately profit in the rebuild, particularly with the large corporations in the many industries left vulnerable when people can’t go anyway.
When they reopen the Encore in Las Vegas, I’ll be there.
Karen Firestone is chairman, CEO, and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.
