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Leisure & Recreation Services Outlook: Near-Term Ennui Obvious

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The Leisure and Recreation Services industry, representing companies providing recreational services such as outdoor events, cruises, travel etc., primarily thrives on consumer spending. Demand for such 'discretionary' services is relatively elastic as any significant change in the general market often tampers with consumers’ preference for such services. A steady rise in wages, lower unemployment and upbeat consumer confidence indicate that the industry stands to rake in handsome gains.

However, on taking a closer look, we find that consumer sentiment was at a six-month low of 97.9 in July 2018, according to The University of Michigan research. Despite expectations of higher income and job availability, consumer spending can be affected by the anticipation of higher inflation and interest rates in 2018. Also, concerns over Trump’s tariff policy accelerated in July when a survey revealed that 35% of respondents have shown clear signs of apprehension regarding the impact of the tariffs.

However, the tariff might substantially curtail consumer spending on leisure services. Moreover, Trump’s stringent policies on immigration and tourist visas seem to have impelled international visitors to rethink their vacation plans to the United States. Evidently, there has been a continued slowdown in U.S.-bound air travel bookings ever since Trump took charge. Also, online searches by prospective travelers to the United States have declined sharply.

Industry Lags on Shareholder Returns

Looking at shareholder returns over the past year, it is apparent that investors are not particularly expecting the industry to gain from the broader economic recovery. As it is, the industry is highly dependent on the overall business cycle and recent tariff concerns are likely to affect consumer demand.

The Zacks Leisure and Recreation Services Industry, within the broader Zacks Consumer Discretionary Sector, has underperformed both the S&P 500 and its own sector over the past year.

While stocks in this industry have collectively lost 2.1%, the Zacks S&P 500 Composite and Zacks Consumer Discretionary Sector have rallied 16.2% and 7.2%, respectively. 

                   One Year Price Performance

Stocks in Industry Trading Pretty Cheap

Since most of the companies in the Leisure and Recreation Services industry are capital intensive and therefore debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric considers not just equity but also the level of debt. For capital-intensive companies, the EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and it ignores the effect of noncash expenses.

The leisure service space looks fairly undervalued now, thanks to its underperformance over the past year. The S&P 500’s forward 12-month EV/EBITDA ratio is 11.2X while the industry is currently trading at 7.7X. However, the industry’s valuation looks slightly undervalued when compared with its own range. The industry’s current forward 12-month P/E ratio is just beneath its median level reached over the past year. When compared with the one-year high of 8.7X, there is apparently not much upside potential left.

                   Forward Enterprise Value/EBITDA Ratio Compared With S&P

Comparison with the broader sector also ensures that the group is trading at a decent discount as the consumer discretionary sector is currently trading at 15.7X.

             Forward Enterprise Value/EBITDA Ratio Compared With Sector

Underperformance May Continue Due to Bleak Earnings Outlook

The most pressing concern that can affect consumer spending now is the tariff war. We note that, so far, overall inflation and commodity price increases have been checked by a relatively stronger dollar. However, household wages, which have started to tick up, have not significantly gone up to combat the expected inflationary pressure. This puts the leisure industry in a tricky position now.

As it is, what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the above ratio analysis shows that there is a fairly value-oriented path ahead, one should look for convincing factors raising chances of a rebound in the near term.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences the performance of its stock.

One could get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year’s reported number, but an effective measure could be the magnitude and direction of the recent change in earnings estimates.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line shows the same for 2018.

                   Price and Consensus: Leisure and Recreation Services Industry

This becomes clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $2.91 EPS estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Leisure and Recreation Services industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings per share of the industry for 2018, but how this number has evolved recently.

                   Current Fiscal Year EPS Estimate Revision

As you can see here, the EPS estimate for 2018 is down from $2.92 at the end of July 2018 and $3.09 at the end of February 2018. In other words, the sell-side analysts covering the companies in this Zacks industry have been steadily lowering their estimates.

Zacks Industry Rank Indicates Solid Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates outperformance in the near term.

The Zacks Leisure and Recreation Services industry currently carries a Zacks Industry Rank #186, which places it in the bottom 27% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Industry Promises Long-Term Growth

The long-term EPS (3-5 years) growth prospects for the industry look appealing when compared with the broader Zacks S&P 500 composite. The group’s mean estimate of long-term EPS growth rate has been increasing since May 2018 to reach the current level of 16.2%. This compares to 9.8% for the Zacks S&P 500 composite.

                Mean Estimate of Long-Term EPS Growth Rate

In fact, the basis of this long-term EPS growth could be a steady top line that the Zacks Leisure and Recreation Services industry has shown since 2016.

Bottom Line

The near-term fate of the industry reflects the increasing anxiety over the negative impact of the imposition of tariffs. Per the recent report by Bureau of Economic Analysis, disposable personal income increased 4.5% in the second quarter of 2018, down from the 7% increase in the first quarter.

However, the Federal Reserve’s latest forecast calls for economic growth of 2.8% for 2018 which is likely to support growth for the leisure industry. Moreover, according to Cruise Lines International Association (CLIA), the cruise industry is expected to continue growing significantly in 2018 with 27.2 million passengers likely to cruise. This figure is 5.4% higher than projected for 2017. Coming to the global luxury travel market, ITB World Travel Trends Report 2017/2018 forecasts strong worldwide travel trends. The consultancy anticipates worldwide outbound trips to increase 5% with strongest growth in Latin America and Asia.  Holiday trips, city trips and Sun and beach holidays are expected to grow 6%, 16% and 9%, respectively.

Therefore, the leisure space might not be able to tide over the broader challenges in the near term. So, it may not be a good idea to bet on this space right now. However, keeping the long-term expectations in mind, investors could take advantage of the cheap valuation and bet on a few such stocks that have a strong earnings outlook.

While none of the stocks in our leisure and recreation service space currently hold a Zacks Rank #1 (Strong Buy), below are three that are projected to see earnings growth in 2018 and carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Royal Caribbean Cruises Ltd. (RCL - Free Report) , a leading cruise company, operates a combined total of 50 ships, with an additional 12 on order as of Jun 30, 2018. The ships operate on a selection of diverse itineraries worldwide that include roughly 540 destinations on all seven continents. Earnings estimates for the current year have increased 0.8% over the past two months to $8.90. This suggests that earnings per share will grow 18.2% year over year in 2018.

SeaWorld Entertainment, Inc. (SEAS - Free Report) owns and operates U.S. theme parks, including the popular SeaWorld(R), Busch Gardens(R) and Sesame Place(R) brands. Earnings estimates for the current year have moved up 2.7% over the past two months to 38 cents, suggesting an increase of 81% from the prior year.

Vail Resorts, Inc. (MTN - Free Report) , one of the leading resort operators in North America, has not seen any estimate revision for the current year over the past two months. However, the Zacks Consensus Estimate for 2018 earnings is pegged at $9.01, suggesting a 72.6% year-over-year increase.

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