Australia | Nov 07 2016
This story features FLIGHT CENTRE TRAVEL GROUP LIMITED. For more info SHARE ANALYSIS: FLT
Flight Centre has issued weak guidance, signalling a significant skew to the second half in FY17. Brokers are sceptical growth will be easy to achieve.
-Weakness stemming from several avenues including lower yields from lower airfares
-Brokers suggest problems lie with the company's cost base
-Continues to gain market share, providing confidence in the longer term
By Eva Brocklehurst
Ahead of its AGM, Flight Centre ((FLT)) has indicated earnings are likely to be significantly skewed to the second half in FY17. The guidance provided to the market is below broker forecasts and suggests pre-tax profit will be $320-355m for FY17, versus several forecasts that were above or at the top end of that range.
Morgans was expecting a subdued update but the guidance was worse than anticipated. The particularly weak first half results that are indicated – pre-tax profit is guided to be $105-120m versus $145.9m in the prior corresponding half – mean the market is likely to be sceptical about a return to growth in the second half. The broker estimates earnings will be the most skewed to the second half in years and, while the fundamentals are far from stretched, maintains a Hold rating.
The company has cited weakness in the UK following the Brexit vote and in the US associated with the presidential elections as well as adverse currency impacts and lower yields arising from lower air fares. Credit Suisse notes front-end retail operations appear to be running at lower profitability than has formerly been the case. At the same time retail cost structures are growing because of growth in consultants and online expenditure.
One of the main variables in Credit Suisse's assumptions is the assessment of downside risk to earnings forecasts and valuation stemming from a more permanent change in the company's super over-rider income. The yield factor highlighted in the company's downgrade suggests a growing dependence on super over-rider income, the broker asserts, which was an issue in a number of prior results.
Both UBS and Deutsche Bank highlight the view that Flight Centre has a problem with its cost base, not a revenue problem. The drivers of the downgrade to earnings guidance include ticket depreciation, a $10m FX headwind, cost pressures and weak UK and US markets. UBS reduces its estimates to reflect the downgrade and highlights ongoing uncertainty, as guidance assumes ticket prices stabilise in the second half, which could prove optimistic.
Beyond FY17 the broker expects earnings to grow, industry capacity to remain steady and the company continue to win share. The issues driving the downgrade are cyclical and not structural, UBS believes. These are expected to abate as industry capacity normalises throughout 2017 and the catalyst will be some signs of stabilisation in airfares.
A US corporate travel market opportunity exists and UBS believes there is up to 3% earnings accretion available. The US market is large, fragmented and Flight Centre only has a 1% share. Upside risk to estimates are envisaged should the bookings environment pick up. UBS also believes the market is pricing in a structural decline in Flight Centre's Australian earnings and this is overly pessimistic.
Deutsche Bank agrees some of the headwinds are temporary and argues an easing of airfare deflation will not necessarily result in a corresponding slowing of volumes. The broker highlights the clear relationship between consumer demand and airfares, noting that the company used to state that declining airfares were helpful to its business, as Flight Centre is not only selling airfares.
Strong ticket volumes provide consultants with more opportunities to sell other products, such as rooms and ancillary items, which are generally not declining in price.
Flight Centre has continued to gain market share, which provides some confidence that the business is not structurally broken, but Deutsche Bank believes changes need to be made to peg down costs in an environment where high single-digit transaction value growth is no longer achievable. Following the update the broker reduces estimates by 9-11% over the forecast period.
FNArena's database shows one Buy rating, five Hold and one Sell. The consensus target is $33.94, suggesting 13.4% upside to the last share price. Targets range from $28.31 (Macquarie, yet to update on the downgrade) to $37.90 (Ord Minnett, yet to update on the downgrade).
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