On Wednesday, the Fairfax Press reported that leading investment bank UBS sees Flight Centre Travel Group Ltd (ASX: FLT) as a "compelling opportunity" at current prices. The investment bank believes market pessimism is pricing in earnings attrition to perpetuity for Flight Centre shares, whereas UBS believes the issues are cyclical (rather than structural). Accordingly, the investment bank rates it as a buy for the medium term.
With the stock down almost 19% from its 2016 high, and peer Webjet Limited (ASX: WEB) continuing to reach all-time highs, I believe it's time to take a closer look at Flight Centre.
About Flight Centre
Flight Centre is a $3.7 billion behemoth, taking on the $6.6 billion Australian travel agent industry through its wholly-owned brands Flight Centre, Escape Travel and Student Flights (to name a few).
According to IBISworld statistics, Flight Centre is estimated to have a 20% stranglehold of the Australian travel agent industry, followed by listed competitor Helloworld Ltd (ASX: HLO) at 12%.
Other notable players in this space include global online travel giants Expedia, Inc. and Priceline Group, as well as Australian listed online travel agents (OTA) Webjet and Corporate Travel Management Ltd (ASX: CTD).
International market
Of course, the Australian travel agency market is a mere drop in the ocean in context of the $166 billion global travel industry.
Priceline and Expedia lead the way in this fragmented global travel market (with 8.8% and 4.6% market share respectively). However, UBS believes Flight Centre has an opportunity to win market share (from its current ~1%) and grow sustainably for the next five years.
In UBS's opinion, this opportunity is not priced in to Flight Centre shares at the current time. I tend to agree with its sentiment.
Company fundamentals
At Thursday's close of $36.52, Flight Centre shares trade on an undemanding price-earnings of 15x. If management achieves consensus forecast earnings growth of about 7%, current prices imply Flight Centre shares trade on forward price-earnings of a touch under 14x, by my calculations.
This compares favourably to Webjet and Expedia's price-earnings of 38x and 75x respectively (according to Google Finance), making Flight Centre shares cheap by industry standards.
Obstacles
The biggest obstacle for Flight Centre, and one which UBS touches on, is that Flight Centre is a capital intensive business due to its omni-channel model. With management having to operate some 2,900 store fronts, Flight Centre lacks scalability against OTA competitors, raising questions about the long-term stability of its business model.
Nonetheless, at current prices, I believe this risk is largely priced in given Flight Centre has clear options for growth through OTA acquisitions and expansion into vertical markets. Accordingly, with the company currently offering a fully-franked forecast dividend yield of about 4.4%, I believe investors are adequately compensated for these risks with potential capital growth and dividend returns.
Foolish takeaway
A big concern plaguing Flight Centre is its ability to continue growing earnings in an industry where competitors are moving online. The low barriers to entry for OTAs mean Flight Centre is at a disadvantage, with its capital intensive store fronts.
Nevertheless, the tailwinds of low interest rates, low oil prices (translating to cheaper airfares) and improving global sentiment should see demand for travel grow, meaning Flight Centre should be able to maintain earnings at a minimum. This is the scenario being priced in at current shares prices, in my opinion.
The best case scenario is growth through clever acquisitions and entry into new markets, meaning investors buying Flight Centre today are receiving this upside for free. This makes it a buy in my mind.
