At times of equity market volatility, most investors will be focused on companies with dependable earnings and some degree of downside protection.

While companies that are reliant on discretionary spending may remain under pressure in the short term, there are opportunities in a few of these for investors who are able to look beyond the current market turbulence.

Time for leisure
In the travel and leisure sector, recent market weakness has left a number of names trading on undemanding ratings, and for investors who can take a longer-term (12 months or more) view, value is beginning to appear.

Despite poor share price performance over the past month, one of our favoured companies is FirstGroup. While we cannot deny that bus and rail travel is impacted by economic cycles, FirstGroup is at the lower end of cyclicality.

FirstGroup’s rail franchises are not up for review for at least four years, which provides stability. The acquisition of Laidlaw in the US increases growth prospects and
the proportion of profits and cash flows from the school bus segment, which should make the company more defensive.

Regarding the company’s Great Western rail franchise, a plan has now been agreed with the government to help improve the reliability and punctuality of Great Western services. This involves an additional £29 million investment and added costs of around £3 million to £4 million per annum.

The added investment is welcome as it will remove some of the negative sentiment and should help to improve the longer-term profitability of the franchise.

All in all, these developments leave FirstGroup well placed to benefit from the growth of rail and bus travel in the UK, while Laidlaw provides an element of downside protection, even if the US economy does slow in 2008.

Gambling on the future
Another stock within the travel and leisure sector that also shouldn’t be too adversely affected by a consumer slowdown is bookmaker William Hill. The company’s results for 2007 were in line with consensus expectations, with earnings per share up by four per cent. In the first seven weeks of the current year, gross turnover has grown by four per cent, against a strong comparative period, but consensus forecasts anticipate another year of lower operating profits due to increased costs.

Nonetheless, William Hill remains a highly cash-generative business and will continue its share buy-back programme. The shares are substantially undervalued on a 2008 price-to-earnings (PE) ratio of less than nine, and offer an attractive dividend yield of over six per cent, twice covered by earnings.

Broader horizons
Finally, Tui Travel’s valuation certainly warrants a closer look. Tui Travel was formed following the merger between First Choice Holidays and Tui AG’s tourism operations in September 2007. We think consumers are more likely to cut back on other spending (e.g. eating out) than they are to forsake an annual holiday.

Over the past year, the European tour operating industry has consolidated into two major groups, Thomas Cook and Tui Travel. Within the travel and leisure sector, we believe both groups offer above-average growth prospects as earnings are boosted by merger synergies and capacity rationalisation.

We favour Tui because the group has strong positions in faster-growing, higher-margin niche areas of the travel industry, such as specialist holidays and online services, as well as a strong management team. Historically, tour operators suffered a lack of profit transparency, with costs being front-end loaded and the majority of revenues not being generated until the final quarter of the fiscal period.

Over the next few years, however, we expect margins to improve due to capacity rationalisation and less aggressive pricing. Tui Travel’s present share price offers good upside potential to our fair value estimate, which is equivalent to a PE ratio of 14.5 times calendar 2008 earnings forecasts.

Henk Potts is equity strategist at Barclays Wealth