Structural Problems For Flight Centre

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

-More subdued Oz outlook prevails
-Online competition heats up
-Offshore business still strong
-Healthy balance sheet
 

By Eva Brocklehurst

Flight Centre ((FLT)) is flying lower. Risks have become elevated in the face of a slowing domestic market, more competition and rising costs. The combination of risks suggests to brokers that caution is warranted. The company has also signalled it has begun to lose market share. Flight Centre has downgraded FY15 guidance to $355-365m, around 4.0% below prior guidance at the midpoint.

A reversion back to long-term averages in outbound travel growth rates, plus the competition that is affecting market share, makes Morgans cautious about the near-term investment view. The loss of domestic market share through consumers booking directly with online providers is of most concern, while positive aspects centre on the strength of offshore operations, particularly in the UK and US. Morgans downgrades to Hold from Add but would become a buyer of the stock under $35.50, believing the company is well placed over the medium to longer term as it benefits from a new era in travel – cheap airfares, more choice, greater comfort and less flying time.

Flight Centre's balance sheet is strong and Morgans does not expect capital management any time soon. The company has a noted preference to invest in the network and make strategic acquisitions, which increase vertical integration in a capital-light manner. Morgans believes there is still plenty of market share for Flight Centre to win in highly fragmented markets, particularly in corporate travel. There is also an opportunity for the company to review its cost base.

Credit Suisse downgrades earnings forecasts for FY16 by 7.4%, expecting current rates of growth, albeit soft, will continue. The broker concedes this point in the cycle means it is difficult to predict growth rates but household income remains subdued and the cost of international travel is unlikely to support outbound leisure travel in FY16. A loss of market share and growth in competitor products means constraints for Flight Centre's top line. The broker also observes Flight Centre grew consultant numbers by 5-6% over FY15 and there is a chance it has over-extended growth in that area at the wrong time.

Meanwhile, the US business is encouraging, with Flight Centre gaining more traction in long-haul leisure travel demand and corporate activity. Credit Suisse does not believe it will take long for the company's small base in the US to compound into a meaningful profit contribution while its market share is negligible. Offshore segments are an important source of growth and could offset the decline in Australian profitability, in the broker's view. Credit Suisse accepts some of the factors on the downside may be short term but downgrades to Neutral from Outperform.

Macquarie is of a similar inclination, downgrading to Neutral from Outperform. Flight Centre's downgrade to earnings expectations is principally reflecting sluggish demand but uncertainty around medium-term margins and market share means the broker finds better value in Qantas ((QAN)) in the sector. Capacity growth may be picking up but the impact on Flight Centre is less pronounced, given it has lost share to domestic carriers' direct distribution channels. Macquarie notes the agreement with Air Asia could offset some of this but is doubtful it will be enough. The stock appears fairly valued at current levels.

UBS reduces forecasts to allow for the weaker Australian results. The broker considers Flight Centre has done a good job in growing over the past ten years in the face of challenging structural trends such as hotels and airlines going direct to consumers, growth in online sites and growing consumer competence in booking online travel. Despite these trends, UBS retains a Buy rating as the business is strong and the stock not expensive. Nonetheless, greater clarity on Flight Centre's ability to reverse share loss is required at the FY15 results.

Australian profits have peaked and the various factors outlined above are likely to increase pressure on profitability, in Morgan Stanley's view. Online travel penetration is low in Australia compared with other developed nations so Morgan Stanley expects the share loss will continue. Outbound travel as also weakened as a result of the pullback in the Australian dollar. As Australians choose to travel domestically in response, these destinations do not necessarily require an agent and short-haul flights are now cheaper. The broker expects revenue margins will remain under pressure as capacity growth becomes rational and the airlines negotiate lower fees.

At current levels Deutsche Bank believes the market is pricing in a worse scenario than reality suggests, particularly given the company's growing cash balance. The Australian leisure market remains soft but the corporate market is performing reasonably well, in the broker's opinion. Internationally, all business, with the exception of Canada, are expected to be profitable. Deutsche Bank reduces FY15 estimates by 5.0% and removes its previous forecasts for a recovery in Australian leisure in FY16. The broker's dividend reductions have been larger than the changes to earnings forecasts, to reflect management's reluctance to distribute excess capital.

Flight Centre now attracts three Buy ratings, three Hold and two Sell on FNArena's database. The consensus target is $39.71, suggesting 12.8% upside to the last share price, and compares with $45.03 ahead of the guidance downgrade. The dividend yield on FY15 and FY16 consensus estimates is 4.3% and 4.6% respectively.
 

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