When people feel that times are tough, they cut back on non-essential spending and this includes holidays. Unfortunately for Flight Centre Travel Group Ltd (ASX: FLT), Australia's largest retail travel company, this appears to be the case right now.
On 18 December, it released an earnings downgrade to the market citing weakness in its Australian leisure business. Flight Centre's poor fortunes are further compounded by the weakening dollar, which makes it more expensive for Australians to travel abroad.
Three factors counter these problems:
- The company has a diverse service offering with 30% of sales coming from the corporate sector, which is typically less cyclical in nature. For instance, Corporate Travel Management Ltd (ASX: CTD) operates purely in corporate travel and appears unscathed by the current economic climate in Australia.
- Flight Centre runs profitable businesses in 10 countries around the world including the U.S., U.K., China, India, Canada and New Zealand. This provides it with some welcome protection from Australian consumer sentiment. For example, economic conditions in the U.S. are currently strong and management is expecting a 50% growth in profits as a result. There is also a foreign exchange benefit when overseas profits are translated into Australian dollars.
- Cheaper oil prices should lead to lower air fares benefiting consumers.
On the surface, it may seem that the rise of online travel companies poses an additional threat. In particular, giant international operators such as Bookings.com and TripAdvisor have the ability to offer better prices and more choice due to their sheer scale.
In reality, they are not direct competitors. Flight Centre is a niche provider competing on service rather than price. It has a website where customers can book online, but its strength is its global network of more than 2,500 shop fronts that affords it a formidable brand presence. Purely internet-based travel companies such as Webjet Limited (ASX: WEB) are more likely to be under threat from international online competition.
Last year, the Australian arm of Flight Centre represented just 57% of group revenue but 76% of profits, and is therefore far more profitable than its foreign counterparts. One reason for this is that as an older more established business, it can harness greater economies of scale. For example, mature businesses often have significant pricing power over both customers and suppliers, and fixed costs can be shared over a large revenue base.
The flip side is that the same benefits are yet to be unlocked in Flight Centre's foreign subsidiaries. The costly and difficult task of gaining a foothold in these territories has already been achieved. Therefore as investment continues through store rollouts and acquisitions, the company should see improved profitability and a higher return on investment.
Flight Centre generates strong cash flows, enabling management to pay high dividends whilst continuing to grow the business without having to use debt for funding. Customers pay in advance and the cost of opening new shops is small so capital requirements are low. Management has been able to grow company net cash by 200% to $431 million over the past four years. This is impressive since it also increased the dividend from 70 cents to $1.52 per share during this time.
As a valuation tool, I prefer to use the enterprise value-to-net profit after taxes (EV/NPAT) ratio rather than the price-to-earnings (P/E) ratio because the former adjusts for debt. On this basis, Flight Centre is currently trading at under 12 times the latest earnings guidance. Interestingly, last year's statutory profit included over $50 million of non-cash, one-off costs relating to goodwill write-downs. Consequently, the company appears more expensive on a historical P/E basis and despite the recent downgrade should deliver growth in statutory NPAT of around 25% this year.
Should you buy?
Notwithstanding short-term cyclical headwinds Flight Centre seems to have a bright future, particularly if it can capitalise on the rise of consumerism in Asia through its Chinese and Indian businesses. It has a low-cost, highly scalable business model that generates strong cash flows. With a forward looking EV/NPAT of less than 12 and dividend yield of around 4.5%, investors could do much worse than buy shares in Flight Centre today.
