Stocks to Watch · Thu 15 December 2016 12:00 PM

Takeover targets update

By Tony Featherstone

Would Flight Centre Travel Group be worth more in the hands of an international travel giant that can invigorate the Australian company’s online offering?

That question will occupy global travel groups and private equity firms if Flight Centre’s share price keeps falling and its online presence, especially in Apps, disappoints.

Flight Centre has slumped from almost $55 in March 2014 to $31.65. The company’s earnings guidance downgrades, most recently in November, reinforced market fears that the move from shopfront travel retailers to online providers is quickening.

Chart 1: Flight Centre Travel Group

Source: Yahoo7

Short sellers are betting that Flight Centre will follow the path of traditional media companies and department stores as it loses ground to online rivals. Were that to happen, its golden run could be ending.

Flight Centre is still a great business with a great brand. It is highly profitable, has a growing international footprint and excellent balance sheet. Most companies would love its double-digit revenue growth and $1.52 billion in global cash and investments.

But Flight Centre’s recent growth has been below market expectation. Competitive threats are piling up as local and international operators disrupt the industry and as the company potentially pays a price for its relatively late entry into mobile technology, such as Apps.

Growth in online travel bookings is not new. The market has long speculated that Flight Centre would lose market share to insurgent online operators. To its credit, the well-managed company has defied the sceptics for much of the past decade.

That could change as technology reconfigures consumer behaviour in travel bookings. It was not so long ago that consumers started booking domestic flights online and used bricks-and-mortar travel agents for recommendations and more complicated bookings.

Today, those recommendations often come from TripAdvisor and other international behemoths that provide holiday reviews. I’m sure many reading this column have used these and other sites to read customer reviews about a resort or travel package.

As consumers become ever more comfortable with e-commerce, they are booking larger holidays online and bypassing travel agents. Increasingly, they  are using mobile travel Apps, on smartphones or computer tablets, to search for holidays and book them.

Flight Centre’s strategy involves building a “blended” travel offering that combines its massive network of stores with a strong online travel offering.  This plan has merit as more consumers combine online and offline resources to book their holidays. But the strategy relies on a powerful online presence – something Flight Centre does not yet have.

Playing catch-up in planet of the Apps

Flight Centre’s mobile technology strategy is arguably its biggest weakness. App usage, highly advanced in Australia, is a sticky business. Getting a spot on smartphone “prime real estate” (the front screen) – is critical. Consumers often stick to a dozen or two key apps, making it harder for new entrants to break through in App land.

Flight Centre’s App is number 45 in free travel App rankings, based on App Annie data. AirBnB, TripAdvisor and Booking.com have a spot in the top five. Skyscanner, Webjet and Trivago are in the top 20 and Wotif.com is the 25th most popular travel App.

In fairness, Flight Centre’s App, only released in October 2016, has already climbed 10 spots in the rankings and should rise further as it attracts user star ratings. Still, Flight Centre has given its online rivals a huge head start.

Flight Centre’s new online brand, Aunt Betty, is another gamble. Released earlier this year, the site was designed to halt market share losses in domestic holiday bookings. Launching a site that does not use the prominent Flight Centre brand, without an App, is perplexing.

Hopefully, Aunt Betty will be a huge success. But playing catch-up with an unknown online brand, in an intensely competitive online travel market, could be a strategic error that Flight Centre can ill-afford, given its surprisingly low ranking in travel Apps.

History shows that companies late to online platforms often struggle to catch up – or never get near the leaders. Successful early entrants develop formidable competitive advantages through their network size and scale.

Flight Centre could struggle to meet its total transaction value (TTV) growth targets if its online strategy fails to gain traction.

I suspect the market will ask more questions about Flight Centre’s internal online capabilities. Nobody doubts it is a terrific shopfront travel retailer, here and overseas. But there’s not enough evidence yet that Flight Centre can become an online leader in travel.

Adding online weapons

Flight Centre could be a neat fit with a global online travel giant that combines its online presence with the Australian group’s vast shopfront travel network and customer base. Greater consolidation in travel, an industry that relies on scale, seems inevitable.

Flight Centre’s cashflow is another attraction. It expects FY17 total transaction value to top $20 billion, with underlying profit of $320-$355 million. Debt is minimal.

A predator would get a business with a rapidly growing presence in four of the world’s five largest travel markets, and a strategy to enter the top 15 markets by 2022. Flight Centre is also growing its corporate travel business, with more than $6 billion in turnover.

The timing looks right for industry consolidation. The global tourism industry has terrific growth prospects as an ageing population travels more, and as the coming boom in middle-class consumption in emerging markets drives new travel demand.

Local companies, such as Webjet and the revitalised Helloworld, have enjoyed stellar share-price gains this year, as have other stocks exposed to tourism tailwinds. Flight Centre is going against the trend with a negative 17% total return over one year.

Flight Centre’s growth slowdown is not only because of structural factors, such as growth in online travel and the threat of Airbnb as more consumers use the “share economy” for low-cost accommodation. Shorter-term cyclical factors, such as airline discounting (which affected Flight Centre’s margins in FY16) and Britain’s proposed exit from the European Union (which affected sales in Flight Centre’s UK operations), have weighed on growth.

The market has mixed views on Flight Centre. Three of 12 broking firms that cover the stock have a buy recommendation, seven a hold, and two a sell, based on consensus analyst forecasts. A median price target of $33.37 suggests it is a touch undervalued. The share-valuation service, Skaffold, values Flight Centre at $43.25 in FY17.

Nevertheless, the odds favour Flight Centre heading lower rather than higher in the next 12 months as its online challenge intensifies. That might be the catalyst for a predator to swoop and get the share price flying again.

From a charting perspective, Flight Centre needs to hold above $30, a point of share-price support that has been tested a few times on its price chart in the past few years.

Either way, Flight Centre remains one of Australia’s best mid-cap companies and potentially a quality portfolio addition as better value emerges in the next six months.

Portfolio update

Some longstanding members in the Switzer Super Report are making big moves. South32 is up 174% and WorleyParsons has surged 106% over 12 months. Gains in Africa-focused gold explorer Perseus Mining and beaten-up online policy provider iSelect were other highlights.

The large materials stocks look overvalued – an argument I have made in recent editions of this report – but they keep their spot in the takeover portfolio for now.

Spark Infrastructure is another worth watching as the market pays greater attention to the sector’s takeover prospects after this month’s takeover bid for Duet Group.

Infrastructure is another worth watching as the market pays greater attention to the sector’s takeover prospects after this month’s takeover bid for Duet Group.

Source: Morningstar (one-year return), Standard and Poor’s (S&P/ASX 200 total return). * assumes dividend reinvestment. Prices at Dec 6, 2016.

Content provided by Switzer Super Report.

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By Tony Featherstone

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at December, 6 2016. This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances. This article does not reflect the views of nabtrade.

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