Positive sentiment around the nationwide vaccine rollout and economic re-opening have driven up the shares of UK-listed companies in the travel & leisure sector in recent months.
However, this could be pricing in expectations that are too high, according to Ed Wielechowski and Stuart Widdowson, managers of the £127m Odyssean Investment Trust.
Indeed, shares in recovery trade stocks such as FTSE 250-listed Wetherspoons and All Bar One-owner Mitchells & Butlers are up over 30 per cent and 50 per cent year-to-date.
With this in mind, Widdowson and Wielechowski highlighted the prices of UK-listed companies in the travel & leisure sector as a whole relative to their sales and earnings.
They looked at what the sector was trading on average in the five years up until the end of 2019, before the coronavirus pandemic struck, compared with what it is trading at relative to its first year of unreported earnings (2021), second year of unreported earnings (2022) and third year of unreported earnings (2023).
Source: Odyssean Investment Trust
The Odyssean managers found that shares in the sector are trading well above what their average had been in the five years before the coronavirus pandemic.
“Our takeaway from this is that the sector now is trading on what the average rating was, but of earnings two to three years out effectively,” Wielechowski said.
“That implies that markets are pricing in a pretty flawless progression across those expectations for those next couple of years and you are kind of already paying for that upside today. We look at that and think ‘well, that probably means there's less to come from that area than there are in other parts of the market’.”
This contrasts to some of the recovery opportunities that the managers of the trust are seeing elsewhere, outside of the travel & leisure sector.
The managers of the UK small-cap focused trust believe that one benefit small-cap investors have is the abundance of options and choices to look outside of popular ‘in-vogue’ sectors for opportunities.
Widdowson said: “If you look at the general ratings of markets, you've got to be really selective in finding companies where you think they're going to deliver well.
“You can either overpay for growth, and a lot of growth companies are still quite expensive now.”
When it comes to value and recovery stocks, he believes a lot of them have turned into momentum stocks where “there isn't the obvious underpin”.
“We think the best thing about small-cap is you can find these specific opportunities of companies where they're under researched and quite often the earnings recoveries are not really in forecasts at all,” he said.
“You can find these companies where you're going to get a very, very good return. Whereas in a lot of large-cap companies, they've got analysts crawling all over them and a lot of them are priced pretty efficiently.
“Now is a really interesting time because we think there are these asymmetric risk return situations where you've got Covid recovery potential and self-help where it's not priced in.”
He said two examples of this are FTSE 250-listed specialty chemicals and personal care business Elementis, and AIM-listed Flowtech FluidPower - a hydraulic and industrial product supplier.
Share price performance of Elementis and Flowtech over 1yr
Source: FE Analytics
“I think Elementis is a fantastic risk reward opportunity,” Widdowson said. “If you believe inflation is coming back it's a very rare industrial that actually owns its own source of raw materials.
“And in inflation it is a fantastic place to be - you control your own raw material pricing, and few of your competitors do.
“I think we see the opportunity of the new product development generating revenue growth over and above the recovery, and if you compare it to recovery ratings on retail and leisure companies, this stock has the potential to do pretty well.”
Elementis is the trust’s biggest holding. It has a 10.6 per cent weighting to the stock.
Flowtech is the fourth biggest holding in the Odyssean Investment Trust, with a 7.3 per cent weighting.
Speaking about Flowtech, Wielechowski said: “They enjoy a great position in the market and it's cyclical – so certainly going to benefit from the Covid recovery as that comes through.”
Additionally, he highlighted the change that's gone through regarding the firm’s management, which is now strategically focusing more on the core business.
“They're extracting the cost efficiencies from the back end and with the digital opportunity on the front end, it makes us really quite excited for where that can go in the next couple of years,” he added.
“It feels like it's a business that's now got a really strong team in place and is getting itself really motoring again.”
Since inception, the Odyssean Investment Trust has delivered a total return of 40.89 per cent compared to 32.57 per cent from the IT UK Smaller Companies sector.
Performance of the trust v sector since inception
Source: FE Analytics
The trust is trading at a 1.3 per cent discount to net asset value (NAV), is 0 per cent geared, and has ongoing charges of 1.51 per cent according to the Association of Investment Companies (AIC).