Margin Recovery Central To Flight Centre

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

Flight Centre has cut pre-tax profit guidance for FY19 for the third time and broker opinions diverge regarding the longevity of the contributing factors.

-Is the company's Australasian leisure business losing market share?
-More confidence in a margin turnaround required
-Key to achieving targets is demonstrating Australasian issues are not structural
 

By Eva Brocklehurst

The pace of the decline in the Australasian business has accelerated, and earnings visibility remains low for Flight Centre ((FLT)) after the company cut its pre-tax profit expectations for FY19 for the third time. FY19 pre-tax profit guidance has been reduced to $335-360m, an 11% downgrade at the mid point, versus $390-420m previously.

The downgrade is attributed to subdued trading and internal issues, such as the new sales staff wages model, brand consolidation and the review of the company's shop network. It appears Flight Centre has not benefited from the April holiday season and brokers suspect the upcoming federal election will also not be supportive of leisure travel over the coming weeks.

The Australasian leisure business has contributed most of the weakness to the group, but this has been going on for 18 months and Morgan Stanley now questions whether the pressures are not more structural. The broker would like to believe the disruption from store closures, rebranding and new wage deals is transitory, but increasingly suspects this is not the case.

On the other hand, UBS assesses over two thirds of the downgrade is specific to Flight Centre and less than one third is related to cyclical/structural factors.

Macquarie suspects the company's leisure business is continuing to lose market share and underperforming the industry. The broker agrees the weakness could be more enduring, despite management pointing to transitory factors. While value is starting to appear on the stock, Macquarie finds it difficult to perceive a bottom for Australasian leisure and maintains a Neutral rating.

Credit Suisse is more positive, believing Flight Centre is moving towards a more sustainable Australasian leisure business. Leisure is also becoming less material to the overall picture for the longer term. Business outside Australia is expected to generate more than half of group profit in earnings globally.

Trading conditions for travel agents have been tough since late 2018, with customers reluctant to commit to holidays despite enquiry levels remaining high. Deutsche Bank expects this could improve after the federal election, but then the wealth effect from the housing downturn is also likely to being having a negative impact.

The broker is mostly concerned about the brand consolidation going on in the company's businesses and suspects the sales transfer of higher margin cruise and package sales has been lower than expected. Potential solutions involve risking confusion for the customer about what Flight Centre brands stand for.

The stock may be starting to look cheap in an expensive market but Deutsche Bank wants some signs of stabilisation in leisure before becoming comfortable about buying it. 

Expenses such as higher net interest post the buyback and technology costs are likely to be enduring and offset the record profit that is expected from international business. Still, Morgan Stanley considers the implied value of the stock is too cheap and maintains an Overweight rating.

Citi observes sentiment around medium-term earnings potential has deteriorated. The broker concedes there is value below the $40 mark for the stock but intends to remain on the sidelines until signs of stability emerge. Morgans agrees patience is required, and any material re-rating will not occur until there are signs the Australasian business is recovering.

Offshore

Corporate transaction value trends are strong and there are healthy profit indicators for the Americas and UK. Both are on track to achieve record profits and the Americas is set to become the company's second largest market after Australia.

Macquarie expects the corporate & global markets will be the growth drivers over the medium term, highlighting the corporate business, in particular, as high quality and a structurally attractive industry where further market share gains are likely.

Still, as override payments are negotiated at a group level the lower transaction value in Australasian leisure would likely reduce the override payments the corporate operations generate, Morgan Stanley asserts.

Margin

Citi pushes out the required timeline for achieving management's 2% pre-tax profit margin target, to FY25 from FY22. Margins have deteriorated since the target was set, and there would need to be a material rebound in earnings in Australia for the original timeline to prevail.

The broker's second half margin forecasts have been reduced to 1.3%. Morgans assesses the pre-tax profit margin is likely to fall to 1.4%, a level not seen since the GFC. The broker takes the company's margin target with a pinch of salt, considering it aspirational.

UBS points out that, with the exception of Australasian leisure, the rest of the business is performing well and margins are likely to be at trough levels, along with sentiment. The broker forecasts an  FY22 pre-tax profit margin of 1.67%.

Efficiency measures, a cycling of one-offs and corporate growth should then mean margins grow in FY20. If a rebound in margins occurs, the broker believes the stock will re-rate and, coupled with the upside risk for the international business, this underpins a Buy rating.

FNArena's database shows three Buy ratings and five Hold. The consensus target is $44.92 suggesting 17.2% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 6.8% and 4.5% respectively.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms