Weakening consumer demand, strong currency and overcapacity create challenging outlook for tourism

Deteriorating hotel cash flow another concern for banks

Davy says that the credit crisis is spreading into the real economy globally. This has implications for an Irish economy already crippled by a severe property correction that has illuminated the problems associated with excessive private sector leverage. One sector where external factors have an obvious impact is tourism. The possibility of an inflection point for tourism does not just affect employment and diminish the spending multiplier; it may also exacerbate the problems for the banking system.

Davy says that the Irish tourism industry has enjoyed a decade of strong growth. Receipts from visitors to Ireland jumped from €2.3bn in 1998 to over €4.4bn last year, an increase of 92%. Including the spending from Irish holiday makers, tourism is worth about 4% of GNP per annum. But the industry is facing three problems: weakening external and domestic demand, unfavourable foreign exchange movements and overcapacity.

Rossa White says that consumer spending is slowing globally. Ireland's key tourist markets are visitors from the UK, US, Germany and France in that order. UK retail sales growth slowed to a two-and-a-half year low of 2.2% in June. So far, that slowdown has not been sharp. However, that will change: the labour market is set to weaken significantly due to the lagged fallout in financial and business services. Meanwhile, mortgage equity withdrawal – a key prop of consumer spending in recent years – is no longer an option. US consumers were given an adrenaline boost through tax rebates, but the effect is fading. Household balance sheets still need repair: that begets higher savings and, by definition, a reduced proportion of income for spending.

German consumer spending failed to pick up during the economic upswing despite the huge decline in unemployment. It is already declining as cyclical conditions deteriorate. France's households are geared into their own housing correction. The negative wealth effect and tighter credit may mean that household expenditure actually contracts in the second half of the year.

"Looking at averages is too superficial for all of these markets. American visitors to Ireland tend to be affluent and, crucially, older than those from other markets. They may be affected by a negative wealth effect, but their disposable income is probably not being pinched as much as British visitors for example. British visitors tend to be younger and stay for shorter periods, particularly for weekend breaks," Rossa White said. "We cannot forget domestic issues either. The market for Irish tourists who stay at home is sizeable. It grew a massive 60% to €1.55bn in the four years to 2007. Unfortunately, the economy is in recession: retail sales have dropped 6% since the end of last year. It is hard to see how growth can be generated from domestic holidaymakers in the short term," he added.

Situated on Dublin's Spencer Docks site, the 2,000-capacity National Conference Centre will cost about €380m in 2007 money, in an arrangement over 25 years and is being built by a Treasury Holdings/Irish Rail consortium. Last year, it was announced that a major international medical conference with over 1,000 delegates has already been booked for 2011. It has been claimed that the Centre will create up to 250 full-time equivalent jobs and up to 300 part-time positions when open and will also support in excess of 2,000 jobs indirectly in the business tourism sector. However, the international conference market is a very competitive one and in 2007, the World Bank said Ireland's economy was the fourth most expensive in the world.

The Davy Research report says that the strength of the euro has been a concern for the industry for some time. But the year-on-year (yoy) change in 2008 is still notable, particularly for UK tourists visiting these shores. In May-July, the first three months of the peak season, one pound sterling bought 15% fewer euro than in the same period last year. The equivalent loss of purchasing power for American visitors was 13%.

Despite the demand and exchange rate problems, tourist numbers were fairly resilient in the first five months (we only have official data to end-May). Visitors to Ireland rose 4.1% compared with the same five months of last year. UK numbers increased by exactly the same percentage as the total, but growth in US visitors lagged somewhat.

However, the report says that while expenditure figures for April and May are not yet available, total expenditure increased 0.6% yoy in the first quarter, but that was due to higher visitor numbers: spending per capita fell 3.6%.

That spending per capita comparison suggests that purchasing power is hurting and demand in Ireland's salient tourist markets has really only taken a major dip since May.

Davy Research says that the latest survey from Fáilte Ireland – the official state tourist body – painted a gloomy picture. In its "Tourism Barometer" for June (which covered the period of activity froom January-May), the turnaround from last year was remarkable.

The results are reported as balances, where the choice is between an increase/decrease/or no change in activity compared with a year ago.

Hotel bednights showed a balance of -26, i.e. 27% of hotels reported an increase, 53% noted a decline and the rest unchanged. That -26 balance of respondents compares with +20 in June 2007. Results were similar for other accommodation types, with the deterioration marked in all cases.

Crucially, when asked the question about what is negatively affecting the market, 52% of respondents cited either the economic downturn (nationally or globally) or unfavourable exchange rates. That compares with just 6% 12 months ago.

If that trend continued into the summer, which anecdotal evidence suggests it has, then Ireland is likely to see the first drop in tourist revenue for four years. More importantly, the tourism industry seems now to have a supply/demand mismatch. It may have reached an inflection point with implications not just for employment, but also for the banks.

Davy says that hotels were an often unnoticed part of the building boom over the past decade or more. According to WM consultancy, bedroom numbers jumped from 26,000 in 1996 to 64,500 this year, an increase of 150%.

In the same period, tourist numbers rose just over 70%. The boom in tourist numbers alone clearly does not explain this phenomenon. Cheap credit and tax breaks fill the gap.

"Tax incentives for hotel development have been generous. In effect, many investors could claw back income tax at their marginal rate at the end of seven years. That amounted to a return on investment over that period of 45-47% in most cases. Values were rising too due to easily available credit, so the final kicker was even greater," Rossa White said. "One problem is that, as the lock-up period ends, the supply of hotels for sale is set to rise significantly due to the amount of building over the past ten years.Sales are problematic because there isn't much of a bid in any segment of the property market right now."

FinfactsReport - July 31, 2008: Survey of the Irish hotel industry shows profit levels in Dublin have fallen by 8.2%