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Flight Centre Now On More Even Keel

Australia | Oct 23 2018

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

FY19 guidance from Flight Centre was shy of expectations but brokers suggest the decline in the share price has put the valuation on a more even keel.

-Business ex Australia expected to dominate growth in FY19
-Soft discretionary spending, labour costs challenging Australian business
-Sustained cash flow, amid upside from possible capital management

 

By Eva Brocklehurst

Brokers are in two minds about Flight Centre ((FLT)), noting substantial challenges in its Australian business while lauding the growth in corporate and international segments.

The company provided FY19 guidance for the first time at its AGM, indicating a pre-tax profit range of $390-420m. Credit Suisse suggests guidance is below expectations because the market has underestimated the impact of labour costs in Australia and the absence of credit card surcharge revenue in the UK.

UK business profitability is being affected by the elimination of credit card surcharges following regulation introduced in the second half of FY18. Additional start-up costs are also weighing on forecasts for Germany.

Citi moderates long-term margin forecasts to 2.05% from 2.20%, removing the upside risk to targets from its base case. The broker considers valuation is no longer demanding but retains a Neutral call because of the lack of transparency around the drivers of margin expansion and the uncertainty in Australia.

Morgans agrees margins are under pressure because of higher costs, particularly from the new enterprise bargaining agreement and staff recruitment in Australia. Nevertheless, the broker notes Flight Centre is confident in delivering its business improvement program out to FY22, although achieving this implies double-digit profit growth over FY20-22.

Flight Centre has been oversold, Morgans adds, relative to the extent of the downgrade to the outlook, and there is further upside from possible capital management. The business may offer a lower growth outlook relative to its peers but there is an impressive track record of sustained cash flow, while the balance sheet is strong.

The company is currently conducting a review of the balance sheet to consider the most appropriate use of excess cash. Morgans upgrades to Add from Hold but cautions investors that patience is required and any re-rating is unlikely to occur until there is evidence the Australian business has improved.

Bell Potter observes transformation strategies are yet to translate into higher earnings and short-term disruptions are weighing on momentum, downgrading forecasts by -5.8% and -6.3% for FY19 and FY20 respectively. The broker, not one of the eight monitored daily on the FNArena database, remains cautious about the outlook for outbound leisure travel in the short to medium term and retains a Hold rating with a $51 target.

UBS considers the guidance conservative and reiterates a Buy rating, estimating Flight Centre is cycling over $50m in one-of costs in the second half of FY19 from re-branding, marketing and the exit of leases. In the longer term, the broker is confident of the earnings outlook, although believes Flight Centre is a polarising stock with many discounting the strength of the brand and its ability to mitigate the structural shifts in

the market.

Australia

The Australian business has been disrupted and is expected to decline once again in FY19. The disruptions have been caused by a large fall in staffing, brand consolidation amid store closures, and a media investigation which unsettled customers and drove elevated discounting.

The company assumes flat airfares in its guidance for FY19, which Citi suspects is conservative and provides room for upside should this translate into inflation in airfares. Still, given the soft consumer environment there is a risk of reduced travel frequency.

While a modest improvement is expected in Australian leisure business, Credit Suisse believes Flight Centre is still ceding market share and profits are weak. Soft discretionary spending is also not helping. Store closures, as well as the growth of online channels, are likely to be a continuing feature of the performance in Australia.

Credit Suisse upgrades to Neutral from Underperform believing the company will settle into a slower rhythm of productivity improvements in FY19, while the re-basing of the Australian business is likely to be the main uncertainty.

Macquarie also upgrades to Neutral from Underperform, perceiving valuation concerns are now largely addressed and, with consensus estimates likely to be reduced following the update, the risk to earnings is more evenly balanced. The broker cites a preference to be a buyer, but before becoming more confident awaits a more compelling valuation and proof the Australian leisure business has stabilised.

Management has indicated many of the factors contributing to a weaker Australian business such as negative media, re-branding in staffing levels are transitory but Macquarie is concerned this could be more enduring as profits in the region are highly leveraged to operations.

Flight Centre had $306m in excess franking credits in FY18 that it may look to distribute, Morgan Stanley asserts, in light of the proposal by the Australian Labor Party to limit imputation credit refunds. Alternatively, the broker estimates a $200m buyback would be 3.6% accretive on its FY20 estimates.

International

Morgan Stanley notes US business continues to rate lowly, despite contributing 19% to FY18 earnings. With the US and Canadian leisure businesses now entering break even and a growing corporate business with significant long-term potential, the broker expects the contribution from the Americas to grow to 24% of earnings by FY22.

Flight Centre now expects profits from overseas business to approach 50% in FY19 and a reduced reliance on the Australian leisure business means earnings streams will be less subject to disruption risks over the longer term. Moreover the company's corporate business is based on relationships which increases the barriers to entry and contracts are typically 3-5 years in duration.

Switching costs are also high, as booking systems are integrated into the customers business systems. Morgan Stanley estimates Flight Centre generates around 50% of earnings from corporate customers. The broker also believes the pullback in the stock provides an attractive entry point, upgrading to Overweight from Equal-weight.

FNArena's database shows four Buy ratings and four Hold. The consensus target is $54.62, suggesting 13.2% upside to the last share price. This compares with 57.61 ahead of the AGM. Targets range from $43.67 (Credit Suisse) to $67.00 (UBS).

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