value and opportunity

This is part 2 of the Flight Centre analysis after the book review last week.

The “old” business model

The Australian based company is a classic “travel agency”, both, running physical agencies as well as offering airline tickets and tours over web sites.

A traditional travel agency usually works like this: They offer flights from preferred airline partners and hotels or packages also mostly from certain partner companies. Traditionally you would go into a travel agency and ask if they can recommend you a destination, then you would be offered some colorful catalogues where they list the offered hotels (with prices mostly depending on the official “star system”) and then gladly sell you the “Bundle”.

Like 20 years ago, this was almost the  only way to do this, especially if you would go for a destination for the first time. I remember for instance that around 15 years or so ago, a travel agent booked me into a Hotel in Lanzarote which looked nice but I was the only one not wearing a ManU jersey for breakfast. You didn’t see this in the prospectus. Also booking flights back then was difficult to do on your own.

The challenge: “Debundling”

However theses days, things are very different. It is actually quite easy to create one’s own package. Searching for flights is easy  and selecting a hotel via Booking, Tripadvisor or Trivago easy and convenient. Just a few seconds more and you get your rental car. You don’t need an appointment with a travel agent and the information is also much better than in the traditional catalogues.

Key issue: Great retailer but ….

Flight Centre’s corporate culture worked very well in a typical retail environment. They were able to open one kiosk after another and make them profitable quite quickly because employees were well incentivized to sell certain products/packages. The big question is: How does this translate into the new online world ?

I don’t think that “Multi channel” or “omni channel” is the answer for a retailer. Just offering the same products online that you offer offline does not do the trick. It reminds me a little bit about the feeble attempts of traditional insurance companies offering online contact to an insurance sales person. No, I don’t want to chat with an insurance agent online, neither do I what to have a person online trying to sell me a hotel room where he/she gets the most commission. Personally I trust a Booking.com rating much more than an opinion of a sales guy working on commissions.

To be successful online, you need a lot of know how to direct traffic your way without getting clobbered by Google referral costs and you have to be good in converting visitors into actually buying/ booking things. Plus you need to know how to make your services easy and hassle-free to use. This is know how that has little or nothing to do with physical selling travel, so Flight Centre starts at zero in this regard.

It doesn’t help that Graham Turner didn’t belive in the internet for a long time. They seem to step up their efforts to a certain extent right now, but I think it might already be too late, at least in order to achieve significant organic growth in retail growing forward.

On the positive side, Flight Centre is still very poplar in Australia, as this study shows, but it is also interesting that it is more or less the last “traditional” Travel Agent remaining.

International expansion

One of the main growth drivers of Flight Centre has been international expansion. Flight Centre expanded internationally quite early but it is interesting to see in the last 6m report, that around 91% of the profits still come from their home market Australia. The US business doesn’t look good even 10 years after buying Liberty Travel and the large and profitable UK business has seen their profit shrink by -25% in the first 6 months of the 16/17 business year.

They seem to move now more aggressively into Asia, but so far their international expansion over the last 10-15 years doesn’t look like a success story

Corporate Travel

This seems to be the only success story from their most recent expansion program. Almost 1/3 of their business these days seems to be corporate travel, mostly services to SME companies. I think this kind of business fits better to a company like Flight Centre as some personal service makes more sense than for retail travel.

Unfortunately, Flight Centre only reports by geography, so it is not possible to find out how profitable that line of business really is. Interestingly there is a pure play listed Australian company called “Corporate Travel management”, which according to the stock price seems to do much better than Flight Centre in recent years:

The company seems to grow quite quickly, both organically and via M&A and seems also to be quite succesful in the US. However the stock price seems to factor in quite a lot of growth with a P/E of around 44.

Client Cash, “Float” and the EV/EBIT multiple

Travel agencies like Flight Centre usually generate a kind of “float” as they require their clients to pay directly whereas they usually pay the airlines only around the time the flight is actually happening. In Australia there used to be regulations around what one could do as travel agency with the money, but it seems to be that 2 years ago, the market has been deregulated.

If you look at Travel Centre’s balance sheet, the company had around 1 bn of cash at the end of December 2016. If we would deduct this fully from the enterprise value, the stock would be very cheap at a trailing EV/EBITDA of around (3,1-1)/(0,35)=6x EV/EBITDA. 

Flight Centre however nicely distinguishes between its own cash and client cash. Own cash was around 350 mn, client cash around 650 mn. Plus they do have some securities which then according to the half-year report adds up to around 450 mn AUD “own cash” from where 100 mn external debt has to be deducted. In order to calculate EV, I would prudently only deduct the “own net cash” in an amount of 350 mn AUD.

Based on this Net cash figure, EV/EBITDA increases to (3,1-0,35)/0,35= 7.9 times EV/EBITDA. If the negative trend (-20% EBITDA) from the first 6 months persist, we then would end up with a valuation of ~10 times EV/EBITDA which doesn’t look that cheap.

As they operate mostly in countries where there is still positive interest, they can generate some investment income on the “float”. What I found very strange however is that for the first 6 months “interest received” equals interest paid. The interest they pay is called “BOS interest” and is explained by the annual report comment:

D2 BUSINESS OWNERSHIP SCHEME (BOS) OVERVIEW FLT believes it is important that its leaders see the businesses they run as their own and, under the BOS, invites eligible employees (front-line team leaders) to invest in unsecured notes in their businesses as an incentive to improve short and long-term performance.

This is the reason why the net interest result of Flight centre is actually almost always around zero or even negative. But clearly the float gives Flight Centre some extra income on the interest earned on the investments. However, it is much more difficult to use the float “Buffett style” as the underlying liabilities are very short-term and any major disruptive event would reduce them very quickly.

 

Pro’s and Con’s overview

+ CEO/owner (15% but 67 years old)
+ very interesting corporate culture, decentralized, many small businesses
+ Good track record of organic growth & profitability
+ growth opportunity in corporate travel
+ rock solid balance sheet

• “Brick and mortar” Travel agency
• late move to online
• (so far unprofitable) international expansion
• dependency on flight tickets
• New fancy HQ

Summary:

Flight Centre was a difficult case for me. There is a lot to like at this company. Great managment, decentralized structure, conservative financial position etc.

On the other side, the problems are quite obvious. Online travel does the same to traditional travel agents what Amazon does to retailers. For me it is hard to figure out how Flight Centre’s distinct Corporate Culture transforms to an increasingly online dominated market. There are a lot of examples that great “Brick and mortar” sales organisations have troubles succeeding in the “new retail” world.

Clearly, there will be always people who will book there packaged holiday in a flight centre kiosk, but growth needs to come from elsewhere. As international growth in their traditional business doesn’t seem to work, their options look limited.

So for the time being, I will not consider investing in Flight Centre but rather stay on the sidelines.