Headwinds Prevail For Flight Centre

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

While corporate travel and online growth underpin Flight Centre, the leisure business is mired in several uncertainties and profit is expected to decline in the first half.

-Corporate earnings growth stable, online leisure sales double
-Is the potential in Europe underappreciated?
-Scaling up of corporate, home-based and online offering in Australia to provide most upside
 

By Eva Brocklehurst

The earnings trough has deepened for Flight Centre ((FLT)), amid increased volatility in offshore markets and lower interest earnings. There have also been increased costs from the implementation of the enterprise bargaining agreement. On the bright side, corporate travel has continued to deliver stable earnings growth and online leisure sales have doubled during the September quarter, despite relatively challenging trading.

Flight Centre has provided a trading update, indicating first half pre-tax profit will decline. UBS, having already factored in a decline, trims forecasts further to allow for a -5% reduction. Management expects a strong rebound in the second half, given the usual skew. UBS now forecasts 8% FY20 pre-tax profit growth and a three-year compound growth rate for FY20-23 of around 10%.

Citi continues to envisage a return to growth in the second half as several one-off factors disappear. Pre-tax profit is forecast to decline by -6% in the first half which is the fourth consecutive half of declines. Flight Centre has not yet shared in the boost from tax stimulus and interest-rate reductions but brokers acknowledge the visibility into the second quarter earnings is quite limited at this stage.

Citi downgrades FY20 and FY21 pre-tax profit expectations by -8% and -7%, respectively, to factor in a slower recovery in Australian leisure and a moderation of growth in the offshore business. Costs associated with the collapse of Thomas Cook are also factored in. Citi does not expect Flight Centre to reach its 2% pre-tax profit margin until FY25, given a slower-than-expected recovery in Australian leisure.

Morgan Stanley also anticipates the second half will be assisted by easier comparisons and, beyond this, the company will benefit as overseas markets improve and from any upside associated with recent rate reductions and tax refunds domestically. The broker points out the critical booking period, which commences late January, will be important for shedding further light on the full year outlook.

Offshore

Offshore business, which has been a major source of growth previously, is likely to moderate in FY20 in the absence of acquisitions, Credit Suisse assesses. The year is also likely to be affected by Brexit, the unrest in Hong Kong and uncertainty in the US (safety concerns in the Dominican Republic have affected travel to a key destination for the US leisure business).

Corporate upside is partially supported by the acquisition of 3 Mundi in France and its inclusion contributes nearly half of the pre-tax profit improvement the broker assumes for the corporate channel. The remainder of assumed growth is achieved in the Americas.

Credit Suisse also believes the company's position in Europe is not widely appreciated. To date very little corporate travel has been originated by Flight Centre in Europe but the experience in North America is considered a helpful indicator of the potential.

Australia

Trading conditions deteriorated significantly in Australia in the first four months and Credit Suisse suspects debate around the sustainability of the company's shop network is likely to intensify. Home-based consulting and strong online growth are believed by many to be impacting on the shop network. Yet Credit Suisse disagrees, and asserts that while there will be a need to accelerate the transition in channels, the shop cost base can be reduced with a manageable impact on profit.

Upside stems from the fact Flight Centre operates one of the largest online travel booking businesses in Australia, surprising Credit Suisse with the speed of growth, and the home-based and corporate channels are also growing rapidly. Moreover, the broker points out the latter two channels have a significantly higher pre-tax margin versus the leisure business.

Credit Suisse upgrades to Outperform from Neutral, estimating a wide potential guidance range for pre-tax profit of $332-382m in FY20 and assuming no transaction growth from the shops but a benefit from the stabilisation of the net revenue margin.

Nevertheless, online sales represent a relatively small percentage of the company's leisure travel transactions, Shaw and Partners notes. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, goes the other way and downgrades to Hold from Buy, ahead of the expected FY20 guidance at the AGM on November 7.

The business is diversified and strong, UBS concludes. Moreover, the market is not paying for the penetration and scaling up of the online offer in Australia. The broker does not consider the update overly negative in the context of strong top-line online growth and the undemanding multiple implied for Australasian leisure.

There are six Buy ratings and two Hold on FNArena's database. The consensus target is $49.07, signalling 20.2% upside to the last share price. Targets range from $43.50 (Morgans, yet to comment on the trading update) to $54.10 (UBS). The dividend yield on FY20 and FY21 forecasts is 4.0% and 4.6% respectively.

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