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By Warren Miller

As we begin the second half of 2010, the outlook for the travel and leisure economy is a bit more tenuous, as most indicators have reached pre-recession levels but are no longer on a strong upward trajectory.

Where Are We Now?

Consumer confidence is one of the most important leading indicators for the travel industry, and we gauge it using the University of Michigan Consumer Sentiment Index. Although the index has shown consistent year-over-year growth since May of 2009, the rate of growth has been slowing ever since March of this year, indicating that most of the gains in consumer discretionary spending are behind us. Still, confidence has reached pre-recession levels.

When consumers become more confident, it shows up in two ways. First, they tend to spend more. It's no secret that feeling safer about one's job reduces one's willingness to save and increases the desire to consume. But an often overlooked behavior that gives a nice boost to travel and leisure companies in times of increasing confidence is that consumers plan their travel and leisure purchasing decisions further in advance. That is, it feels safer to book a Caribbean cruise six months in advance when your job is secure than when you may be laid off in a week. This effect boosts cash flow for travel and leisure companies even though they can't recognize the revenue until the travel and leisure services are complete. For any travel and leisure companies in precarious debt situations--and there are many--this can be a lifesaver. In addition, earlier bookings give travel and leisure companies greater visibility into future demand, allowing them to plan purchasing decisions and operational expenses with more information.

It's also important to note why people feel more confident so we can be sure that the rug won't be pulled out from under the positive sentiment with a dip of the financial markets. Household net worth increased 2% sequentially from the fourth quarter of 2009 to the first quarter of 2010, and grew 13% from the first quarter of 2009 to the first quarter of 2010. This was the fourth quarterly sequential gain in a row. In addition, while unemployment levels remain at very high levels, the employment situation seems to have improved over the last several months.

So how have these underlying economic improvements affected travel so far? First, vehicle miles driven has significantly improved. According to the Federal Highway Administration, vehicle miles driven had increased 6% by May 2010 since the low in May 2009 (a marked improvement compared to the near free-fall this series saw in 2008). In addition, the Bureau of Transportation Statistics cites a near 10% improvement in air passenger enplanements worldwide since the low in February 2009. Both of these indicators foretell trends in other travel spending such as cruise vacations, rental car bookings, hotel bookings, or leisure activities.

Where Are We Going?

We believe that the travel economy will remain flat for the remainder of 2010, and slow growth will pick up in 2011. Most of the gains to be had from increased consumer willingness to spend were achieved in the recent past; gains from ability to spend are much more slow to arrive and will only be reached as the employment situation improves. Still, we do not expect a dramatic decline in travel volumes of the magnitude we saw throughout 2008.

Oil prices present a risk to the rejuvenated travel and leisure industry. Fuel costs can affect travel either directly via gasoline prices or indirectly via ticket surcharges that cruise companies or airlines charge their passengers to hedge the increase in their operating costs. When such costs are passed on to the consumer, demand suffers. A rise in fuel prices is not an unlikely outcome considering the large amount of liquidity pumped into the system by the Federal Reserve and Congress during this recession. Gasoline prices, as of August 2, 2010, had risen 69% over their trough price in December 2008 according to the U.S. Department of Energy.

Conclusion

While travel and leisure trends have improved in recent months, most of the growth appears to be behind us, with a much slower trajectory ahead. Unfortunately, aside from International Speedway, there are few cheap stocks in this sector. Still, the stocks mentioned below are well-positioned to weather any future developments in the travel and leisure industry and, at the right price, would represent a good way to leverage the trends mentioned above.

Stocks to Watch (Click to enlarge)

International Speedway (NASDAQ:ISCA)

International Speedway is our only 5-star stock that we think is poised to take advantage of the travel and leisure improvement. As an added bonus, the company enjoys a wide economic moat as the leading owner of motorsports race tracks in the country due to its solid asset base and strong ties with NASCAR. Although the company has had a rough year due to a weak consumer and tightened corporate sponsorship budgets, we think the future of International Speedway is very promising as it experiments with new ways to increase the utilization of its race tracks.

Priceline (NASDAQ:PCLN)

Priceline continues to outmaneuver its competitors. The company's international growth is astounding considering the lack of appetite for travel over the last year. Priceline has leveraged its fixed costs to significantly improve profitability as well. Although Priceline is still half the size of its larger competitor, Expedia, we think it has very strong brand recognition thanks to innovative products and advertising strategies.

Expedia (NASDAQ:EXPE)

Expedia is the largest online travel agency. As such, we award it a narrow moat, because its ability to deliver a large number of "eyeballs" to travel suppliers' inventory affords it negotiating power when dealing with travel suppliers. Still, Expedia has not executed its strategies as well as Priceline. In addition, sites such as Kayak.com--which put Expedia on the same playing field as other online travel agents as well as travel suppliers--are a negative toward Expedia's moat.

Carnival (NYSE:CCL) (NYSE:CUK)

Cruise companies were bruised and battered in the recession, and Carnival was no exception. Still, we think the future is bright for the company, as its current fleet expansion will allow it to reach untapped markets around the world. In addition, cruising is one of the highest value vacations available, making it an attractive choice for consumers just barely working up their courage to go on vacation again.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes. Tim handles their stock strategist posts (separate feed) if you need help formatting or have other Morningstar-related questions.