Is Flight Centre Downgrade Just Short-Term Turbulence?

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

-Top line growth to continue
-Margin sustainability in question
-Further downside from online drift?
 

By Eva Brocklehurst

Broker suspicions were proven correct after Flight Centre ((FLT)) acknowledged profits were likely to fall in FY16, just two weeks after leaving forecasts unchanged but suggesting meeting guidance was not a foregone conclusion.

The company is guiding to a decrease of 2-5% in profit compared with FY15, after previously forecasting growth of 4-8% and, as also expected, the downgrade is predicated on the uncertainties surrounding Australia's federal election and the UK vote on an EU exit, as well as revenue margin contraction.

Morgans suspected a downgrade would be forthcoming but this was worse than forecast. Consequently, the broker has little confidence in the short-term earnings outlook and believes earnings uncertainty will continue into FY17, in a tough consumer economic environment.

Top line growth is expected to continue, with the company signalling FY16 total transaction value (TTV) growth of over 8.0% but airfare competition in several jurisdictions has affected over-riders, which has resulted in margin contraction for Flight Centre.

Morgans downgrades FY16 and FY17 forecasts by 5.6% and 6.0% respectively. The share price weakness over recent weeks is, in quantum, greater than the implications from the downgrade, the broker contends but, given the uncertainties, a Hold rating is retained. Morgans lowers its target to $36.10 from $41.00.

One positive, unearthed by Ord Minnett, is that Australian leisure travel was not a primary driver of the soft outlook. The broker finds this refreshing news, as the segment has had a tough period. The company has also said that Australian leisure and corporate TTV growth was ahead of the Australian Bureau of Statistics outbound growth rate of 4-5%.

Combined with strategic investments, Ord Minnett expects TTV growth to translate into no earnings growth for Australia, but takes some encouragement from the TTV statistics. Otherwise, the broker estimates the organic decline in profit in FY16 implied by the forecasts is in the order of 7-10%, after backing out the uplift from Top Deck, other acquisitions and the FX benefit in the UK and US. The broker reduces profit forecasts by 6.8% and 10.1% for FY16 and FY17, respectively.

Deutsche Bank downgrades to Hold from Buy. The broker notes falling airfares used to be good for Flight Centre, given lower prices stimulated sufficient volume uplift to more than offset the deflationary impact. This time, turnover is still growing, which suggests sentiment is not so bad, but a margin trend is emerging.

Airline competition and capacity increases behind the declines in airfares mean the company's TTV is split across more carriers. This does not deliver the amount of growth to incumbent suppliers which would earn the super over-riders that have underpinned Flight Centre's margins in the past. Deutsche Bank suspects the trend is here to stay and will be compounded by continued cost growth.

Macquarie had anticipated the downgrade and expects the transition to online travel business will continue to impact margins in coming years. Flight Centre enjoys margins around 13.5%, the broker notes, whereas Australian onlinie competitor WebJet ((WEB)) has an income margin of 9-10%. The broker does not agree that the stock offers value at current levels.

Given the high fixed cost nature of the business, the significant operational leverage in the retail business is a concern. Same-store metrics, on a revenue and earnings basis, continue to be negative so, the broker observes, as store growth slows or even stops so too will revenue. Cost growth, on the other hand, is expected to continue to significantly erode earnings margins.

On Macquarie's estimates Flight Centre will deliver negative earnings growth in FY20 and, with further downside to come from online cannibalisation and market share losses, this is not the time to buy the stock. Underperform rating retained.

UBS takes a different view. The broker believes the drivers of the downgrade are cyclical, rather than structural changes such as online travel agents winning share. UBS now forecasts a 3.0% decline in FY16 profit with Australian profit to be flat, US profit below FY15 and the UK down in constant currency terms.

For over ten years the broker observes the market has questioned the sustainability of Flight Centre's “high touch” travel business and the share price is factoring in a long-term structural decline in earnings. The trends include airlines and hotels going direct to consumers, growth in online-only sites and growing consumer competence in booking online. Yet UBS believes these risks have been overplayed and the company is well placed to grow earnings in the medium term.

Flight Centre has just one Buy rating now (UBS) on the FNArena database. There are five Hold ratings and one Sell (Macquarie). The consensus target is $36.91, suggesting 16.3% upside to the last share price. This compares with $41.27 ahead of the news. Targets range from $28.26 (Macquarie) to $41.44 (Credit Suisse, yet to update on the downgrade).

See also, Flight Centre Flags Cautious Outlook on May 9 2016.
 

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