Diverging Margins In Webjets’ Results

Australia | 11:16 AM

Following interim result releases, brokers remain keen on Webjet Group's potential but are concerned over the decline in Web Travel's margins.

-Web Travels' result not as bad as feared
-Margin decline still causing concern
-Webjet Group to benefit from economic recovery and pick-up in domestic leisure travel demand
-Webjet Group result included margin surprise

By Greg Peel

Web Travel Group ((WEB)), the B2B wholesale hotel bed booking business (WebBeds) demerged from the original Webjet in September, posted a first half FY25 result described by analysts variously as "weak", "better than expected", "a relief" and "messy". The clue to divergence lays in the latter: The result was messy due to the demerger and change in accounting standard.

Total transaction value (TTV) rose 25% year on year, revenue was up 1%, underlying earnings declined -11% and profit was down -6%. The group earnings margin fell to 41.1% versus 45.0% a year ago. Overall, the result beat consensus expectations, Morgans notes, due to a change in the accounting standard, lower corporate costs (timing issue) and lower than expected D&A, net interest and tax.

In line with guidance, cashflow was weak, however Web Travel finished the first half with a strong net cash position of $279.7m, with no term debt but $250m of convertible notes outstanding.

Marginal Worries

In FY23 and FY24, when the two divisions were still part of the one company, the B2B division delivered revenue margins above 8%, which were in line with pre-covid levels. At the company's March strategy day, management offered FY25-26 revenue margin guidance of 7.0-7.5%. At the AGM in August, margin guidance of 7.0% was provided. Last month, first half FY25 guidance was lowered to 6.4%.

Web Travel achieved a revenue margin of 6.6% in the first half, and management is confident the margin will stabilise in FY26 at 6.5%.

Management reiterated the three drivers of lower margins in Europe specifically, which it had outlined in October, with Europe previously the company's highest margin region. Increased competition is an issue, as are volume rebates paid to customers.

Those rebates, known as "overrides", are expected to continue through to FY26. Overrides are payments made to WebBeds' customers once they hit certain volume/TTV thresholds. Override agreements with customers are renegotiated every 6-18 months which leaves a revenue drag of rising financial incentive payments to customers as TTV grows.

The other driver was a tough June-July period in Europe when WebBeds was impacted by tour operator FTI filing for insolvency, the European Football Championships and the Olympics. Lower directly-contracted hotels and more third-party providers also impacted margins. WebBeds' earnings margin was further impacted by increased costs.

In regard to FY26, management believes the revenue margin will stabilise at around 6.5% and its earnings margin will increase to around 50%. If achieved, this would result in very strong earnings growth in FY26, Morgans notes.

However, margin guidance is being questioned. It implies operating costs only increase by 4.9% in FY26 versus 12.3% in FY25. Web Travel nevertheless stressed efficiency measures are in place. Moving forward, the customer overrides will remain, but near term there is potentially upside from the one-off issues in Europe in FY25.

Importantly for Morgans, management has implemented greater pricing controls. Increasing the mix of directly contracted hotels will also increase margins. Management said its new customers are generally smaller and therefore higher margin. However, the offset is geographic mix and higher booking growth from lower margin regions which dilutes the margin, the broker notes.

Are We Confident?

Web Travel's result caught the market a little by surprise, Ord Minnett suggests, in that it appeared odds-on just last week that the "downgrades come in threes" scenario could play out. The market appears to have been somewhat relieved this did not eventuate, the broker notes, notwithstanding the material step down in revenue margins from the 8.1% levels reported just 12 months ago.

With regard the aforementioned reasons for margin decline, Ord Minnett's industry analysis suggests although there is little doubt all these factors had a negative impact, there has not been a sector-wide reduction in revenue margins of this magnitude. This suggests to the broker some of these factors are Web Travel-specific and within the company's control.

In these circumstances, the pendulum could go either way, but Ord Minnett's sense is as these issues are "worked through" over the next 12-18 months, then risks lay to the upside.

Goldman Sachs believes management addressed sufficiently the different factors driving the significant decline in WebBeds' revenue margin to 6.6% from 8.1% and gave clear guidance for FY25-26 to deliver a cautiously optimistic outlook.

Web Travel's revenue margin in the second quarter came in at 6.4%, so the first half average of 6.6% implied some recovery.

This margin recovery provides an initial level of comfort, but showing stable, or better still increased, margins over the next two halves should help restore confidence and drive a potential re-rate, UBS suggests.

The key downside risk are increased overrides, Macquarie believes, with the key upside risk an improved supplier mix. Around 50% of Web Travel's inventory is via direct contracts with hotel chains (15%) and third-party providers (35%). Opex growth will be required to support staff increases, Macquarie notes, as the company grows volumes in less-established regions.

The bedbank market has long been in a structural decline, Shaw and Partners notes, with rising direct bookings and online travel agents (OTA) taking market share. However, the transition towards hoteliers cutting the number of suppliers and viewing WebBeds, Hotelbeds, and Expedia as platforms via scale and technology differentiation is expected to continue to consolidate the industry.

Web Travel delivered 25% TTV growth for 1% revenue growth in the first half, Morgan Stanley notes. Over the same period, Expedia B2B delivered 20% revenue growth off a base more than an order of magnitude larger. Unfortunately, this broker does not get a sense for relative margins.

If part of the attraction of bedbanks for hotels is to diversify distribution, as Web Travel suggests, it strikes Morgan Stanley as strange that one of the largest OTAs should be having so much traction. The broker can't help but think one million-plus directly contracted hotels and exclusive wholesale distribution agreements with some of the world's largest hotel chains could translate to supply and distribution advantages for market leaders.

Morgan Stanley's core concern, namely that margins could come under further pressure, remains, as Web Travel's offer is substitutable and lacks relative scale.

The Value Factor

One positive piece of news was an announced $150m share buyback, due to spare balance sheet capacity, which will be used to offset future dilution from the $250m in convertible notes due in 2026.

Not positive enough for Morgan Stanley nonetheless. On margin concerns, this broker retains an Underweight rating.

For other brokers, there is an element of giving management the benefit of the doubt to some degree due to the -32% fall in share price post the weak September update.

While UBS recognises concerns around potentially shifting competitive dynamics, this broker believes Web Travel shares have been oversold and the balance of risk is to the upside.  UBS retains a Buy rating.

Ord Minnett has increased its revenue margins assumptions from 6.3% to 6.5- 6.6% into perpetuity but sees upside risk to these numbers, also retaining Buy.

Shaw and Partners' Buy rating is supported by a view that FY25 is a rebasing year with around 20% earnings growth to resume from FY26.

While there are question marks over its margins and earnings growth profile, Web Travel deserves to trade on a similar multiple to its domestic peers, Morgans suggests. But given earnings uncertainty remains, this broker maintains a Hold rating.

Longer term, Macquarie expects Web Travel will successfully grow TTV, but remains cautious on its ability to drive operating leverage as it scales. Structurally lower revenue margins make the company more reliant on cost control, the broker notes, and higher capitalisation may reduce earnings quality. Macquarie retains Neutral.

Citi also retains Neutral following a first-glance review.

That leaves three Buy or equivalent ratings among brokers monitored daily by FNArena covering Web Travel, three Hold and one Sell. The consensus target has risen to $5.55 from $5.26 but the range is significant, from $3.70 (Morgan Stanley) to $6.80 (Shaw).

Goldman Sachs retains a Buy rating with a target increase to $7.00 from $6.70.