Flight Centre Cruising At Altitude

This story features FLIGHT CENTRE TRAVEL GROUP LIMITED. For more info SHARE ANALYSIS: FLT

-Valuation compelling for Morgan Stanley
-Aust dollar correlation doesn't fit
-Capitalising on shop and online
-No signs of lower base rate commissions
 

By Eva Brocklehurst

Travel services operator Flight Centre ((FLT)) has established a position in the top 100 Australian stocks, yet it is one of the most shorted stocks in the market, Macquarie notes (Number five on ASX top shorted list; see FNArena's Short Report). The company continues to demonstrate earnings resilience, despite fears that shop front travel agency business is dying. Flight Centre is still making inroads into offshore businesses and has a network of around 2,300 shops and 36 brands.

Morgan Stanley has expressed a view that the share price will rise relative to the country index over the next 60 days. This is because the stock has weakened recently, making the short term valuation that much more compelling. Along with a strong FY13 result the broker expects a positive outlook and for the stock to outperform during August's earnings season. Other brokers reassessed the stock earlier in July when Flight Centre made the second upgrade in as many months to profit guidance for FY13. Australian consumer growth is seen offsetting slowing corporate growth, while the company confirmed the market share gains being made in the UK. Flight Centre USA continues to improve and corporates now represent 40% of the business. All countries in which the company operates are expected to make positive earnings contributions.

Macquarie does expect a more sluggish FY14 because of the slowdown in Australian demand but with net cash and substantial franking credits, investors are seen buying into the strong longer-term travel demand without taking on airline pricing risk or capital intensity. There is also the potential for either an increased dividend or accelerated growth though bolt-on acquisitions.

One thing Macquarie has observed is that the stock is NOT negatively correlated to the Australian dollar. There is little statistical correlation between the share price and strength of the local currency, other than during the GFC. Travel patterns are driven more by airline capacity and falling real costs of travel. Even with a falling Australian dollar the cost of an international holiday can still be cheaper than domestic travel in terms of food and accommodation. Moreover, Flight Centre is not just about leisure. A third of the total transaction value (TTV) stems from a corporate client base and that has grown around 23% over the past three years, a much faster rate than the leisure offering. Still, there is a risk that a continually falling Australia dollar could lead to a shift in Australian passenger travel patterns back towards domestic rather than international travel and this, on balance, could be a negative for Flight Centre.

Another interesting figure in the Australian dollar story is the fact that Flight Centre's ticketing for international travel is over 70% and this proportion did not materially changed despite the strengthening of the Australian dollar against the US dollar from FY09 to FY12. Macquarie's reasoning is that the company's wholesale strength meant it continued to provide attractive domestic holidays for those looking to stay close to home. What would likely be of greater concern to the broker, with the falling value of the Australian dollar on the trade weighted index, is if airlines started to restrict international capacity (reversing what they did when the Australian dollar was strengthening). This would slow international growth and make for higher airfares. There is no sign this is happening, as yet.

Macquarie observes Flight Centre is holding up well against online travel agents and since selling of product actively commenced online in 2011 the company's model is now a blend that capitalises on the strengths of each channel. Physical infrastructure provides a major point of differentiation with pure online offerings. Travel agents are still an integral distribution channel for the airlines and Flight Centre has a market share in Australia at around 38% of travel agency spending.

Airlines and hotels are bypassing intermediaries such as Flight Centre and transacting directly with consumers and Macquarie suspects that over time this could rise, improving airline bargaining power and ability to negotiate down existing base commissions. In Flight Centre's favour is its size and scale in the Australian market and, as yet, there are no signs of lower base rate commissions and lower margins, or TTV per store decreasing in either the UK or Australia.

Any other concerns? Citi has observed that total returns are running at just 2% and, while further positive earnings surprises may be in store in FY14, this is factored into the share price. The broker prefers a Neutral rating. All the good news is now factored into the share price for Deutsche Bank as well and UBS has a similar Neutral theme. Macquarie acknowledges that, as with any company in the travel industry, fluctuations in demand can be caused by natural disasters, disease outbreaks such as SARS, terrorism and the economic cycle. Demand risks can have a materially negative effect on earnings, as evidenced in FY09 when earnings fell to $88 million from $200m the prior year. Hence, Flight Centre maintains a fairly sizeable cash balance as a precaution against such risk which could have a negative near-term impact on bookings.

Macquarie has chosen to upgrade the stock to Outperform from Neutral and joins CIMB, JP Morgan and BA-Merrill Lynch with similar ratings on the FNArena database. All up, there are five Buy ratings and three Hold. The price targets range from $38.70, jointly held by UBS and Citi to Macquarie's $53.16. The consensus target price of $43.62 suggests 1.1% downside to the current share price. The stock is tightly held. Five investors have 48% of the share registry with CEO and founder Graham Turner holding 15% and fellow founder Bill James 13%. The business ownership scheme is also quite unusual. Shop managers invest in unsecured notes which pay floating returns depending on the profitability of their businesses.
 

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