While these stocks are varied in nature, the performance of each depends on discretionary consumer spending. When consumer confidence and incomes are high and rising, optional expenditure on trips abroad and evenings out typically moves in-line.

A positive environment

There are a number of current market factors that are supportive to the travel and leisure industry. In key economies such as the UK, US and Europe, wages are rising, meaning consumers have more disposable income to spend.

The weakness of the euro against the pound and dollar has fuelled tourism to the continent, and the price of oil remains low and falling, making ticket prices cheaper. Tour operators, hotel chains, travel agents, airlines, bus and rail operators and stocks with European operations have all benefitted.

Ian Forrest, investment research analyst at The Share Centre, says the current underlying picture is extremely positive for travel stocks. He favours the airline EasyJet, tour operator Tui and cruise conglomerate Carnival.

EasyJet is of particular interest, having increased net profits in each of the last five years. In the year from September 2014, easyJet passenger numbers increased by 6 per cent overall, with 6.6 million passengers ferried in September 2015 alone (a 7.6 per cent increase year-on-year). The airline is also expanding the number of routes it operates, suggesting traffic could rise further in future.

“Pockets of the hotel sector are doing well out of cheap flights and increased consumer spending too,” Forrest says.

“We particularly like PPHE. The firm have hotels all over, the shares are good value and they pay a reasonable dividend,” he says.

Steve Davies, lead manager of the Jupiter UK Growth fund, is similarly bullish on airlines and the travel agent Thomas Cook. In addition to arranging package holidays, the company owns airline Condor and booking website Hotels4U.

Davies also tips WHSmith, a stock which has benefitted secondarily from the increase in travel expenditure. Outlets are a fixture of most UK airports, and after a period of decline, these operations have returned to growth, with gross margins increasing and new outlets opening.

International expansion

Another theme driving the success of the travel and leisure sector in recent years has been the expansion of wealthy middle classes in emerging markets, particularly in China.

Davies notes the “explosion” is Chinese tourism that has resulted, both nationally and internationally. The concept of cruising is new to Chinese consumers, meaning operators such as Carnival stand to benefit.

However, while this gives a domestic boost to UK travel and leisure stocks, it has also created a fertile environment for these stocks to expand into China.

One such stock is Merlin Entertainments, owner of tourist magnets Legoland, Madame Tussauds, Sea Life Aquariums, Thorpe Park, Chessington World of Adventures, the London Eye and more.

The group’s ownership of Legoland is of particular note, as sales of Lego in Asia have increased dramatically in recent years. Lego’s profits jumped by a quarter to £455m in the first half of 2015, driven by double-digit sales growth in the region.

“Merlin will expand significantly into Asia over the next decade, with Legoland sites scheduled to open in Dubai, Japan and South Korea in the near future,” Davies says.

“There will also be five Legolands in China in total when they’re finished, but construction hasn’t begun yet. There’s no reason the opportunity there won’t be at least as big as the US market.”

Despite this promise, Merlin’s standing suffered in June 2015, when a tragic accident at Alton Towers left four visitors seriously injured.

“The company dealt with the accident responsibly, but visitor numbers have reduced as casual visitors are put off,” Davies states.

Risks

Unforeseen events are a major risk for travel and leisure stocks.

“Geopolitical events around the world  can impact shares,” says Joel Dungate, investment analyst, Redmayne-Bentley.

“Travel shares all suffered setbacks at the end of last year as news broke that a Spanish nurse fell ill with Ebola, and concerns mounted the virus could spread.”

“Black swans – those events that are a total surprise, and have a major effect – can and do happen,” says Keith Bowman, equity analyst at Hargreaves Lansdown.

“They can be company, sector or even country-specific, and by definition they come out of nowhere.”

In Merlin’s case, a profit warning was issued, with potential losses of £47m speculated, and shares slid 14 per cent in response to the calamity. While supportive of the company’s handling of the event, Davies acknowledges it could take Merlin between 12 and 18 months to return to previous levels.

Travel and leisure stocks are among the most cyclical in the market, as they almost invariably suffer to some degree in a downturn, when falling confidence results in consumers cutting spending.

Changes in regulation can also hurt the industry. For instance, in 2007 alcohol sales in pubs declined significantly following the introduction of the smoking ban. The outlawing of online gaming in certain markets has resulted in a progressive shrinkage in the sub-sector.

The current boom in the travel and leisure industry is also partially dependent on rock-bottom oil prices. A rise could mean higher travelling costs and ticket prices, and less spending on tourism as a result. Davies acknowledges prices won’t remain at current levels forever, but he isn’t worried for the time-being.

“I’m reasonably certain they will stay down at around $45-60 a barrel for a long time,” he explains.

The prospect of rising interest rates on both sides of the Atlantic is a concern for Forrest, as this will mean higher borrowing costs, and the prospect of reduced discretionary spending – the fundamental driver of the sector. How damaging an impact this will have on consumer wallets depends on the scale of the rises, and how rapid they are.

“Foreign exchange movements are also a risk to tourism-related stocks – a weak currency means people are less likely to travel, a strong currency means people are less likely to visit,” he concludes.

Dungate notes a rise in interest rates is also likely to increase costs for travel and leisure stocks (such as breweries) which own a lot of property.

Due to this inherent precariousness, Bowman recommends accessing the market through a sector-specific exchange traded fund, which allows investors to exit if an unforeseen event, or worsening economic conditions, reverse the sector’s fortunes.

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