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Has Flight Centre's share price already flown?

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By Andrew Main

It’s hard to avoid aviation clichés when you see what has happened to Flight Centre’s (FLT) share price in the wake of last week’s profit upgrade.

The shares climbed 10% from $40 to $44 in a day despite the fact that management was effectively reiterating a previous guidance that it was looking at an underlying net profit before tax of between $325 million and $330 million for the year to June 30.

That would be a lift of between 2.5 and 4.9% on the 2015-6 year’s result. Most of it was psychology, clearly. As a Citi analyst report noted, it took five downgrades in three years before the Brisbane-based group managed the positive report. Banging your head against a brick wall then stopping, seems an apt analogy.

That’s a bit snarky considering the broker concluded Flight Centre would enjoy double digit earnings upgrades in the 2018 year just begun, and 2019.

Flight Centre had previously talked about earning between $320 million and $355 million for the year just ended before getting an attack of nerves over what it called “challenging” first half conditions, and cutting guidance back to $300-$330 million.

We’ve got a situation now where most of the brokers are finding the stock either a bit fully priced or overpriced. According to FNArena, there’s only one, Ord Minnett, that’s actually stuck a “buy” on it since last week’s news.

But the investors are piling in.

I’ll have a go at explaining why.

As a fundy just told me, there’s a lot of cash around at the moment looking for a home, and any stock that smacks of solid earnings and a bit of growth has got the retail investors lining up.

It does the stock no harm that it’s a household name: Flight Centre has a reported 2800 shops and businesses in Australia. All that bright signage and lively “destination board” arrangements in the shop windows count for a lot of consumer sentiment.

But there are definitely some clues around that cheap airfares have not been making it easy for Flight Centre.

For a start, the British Pound has had the vapours since the upheaval of the Brexit vote. As the company put it, “FLT’s UK operation will deliver another record profit in local currency, although the significant falls in the British currency’s value during the past year will adversely affect translation to Australian dollars. 

Looking at the first half nerves, the company was hit by what it called “unprecedented” airfare discounting in Australia, the US, India and Singapore. That, plus the Pound’s woes, meant that the company suffered a 32% drop in half-year pretax profit from $146.3 million to $113 million.

So you can see it’s been a very strong turnaround story in the second half, with pretax profit almost tripling, which management partially attributes to a cost cutting exercise that  has included some mid level redundancies.

One statistic that gives a really clear picture of how the company operates is the ratio of sales to profits, or Total Transaction Value (TTV) to PBT. It’s no surprise that budget air ticket shops don’t operate on vast margins, but how’s this? If the company hits $330 million for the year, that will be on TTV of just over $20 billion.

In other words, for every $1000 of tickets it sells, it’s earning pre tax $16.50 or 1.65%.

If you make the heroic assumption that they sold around $10 billion of tickets in the “challenging” first half, then the margin shrinks to 1.13%.

The good news is that a sharp focus on costs does wonders for the bottom line of such companies. The Ords analyst, who incidentally is new to that job, has put a $48 target on the stock thanks to a stabilisation in airfares and an improved earnings outlook.

That said, other brokers see the stock as fully priced, particularly as it closed yesterday at $44.80.

Morgans keeps it as a HOLD on that basis, while Macquarie says it will Underperform due to what the broker sees as continued softness in airfares in FY18. It sees margin decline in the medium term coupled with valuation pressure, thus seeing risks skewed to the downside. The theoretical price target is $28.70, which is not what holders want to see.

Citi has also had a close look at the skinny margins at Flight Centre but has concluded that ratio should climb from 1.6 to 1.9% over five years.

That looks like a Himalaya of a mountain to climb, but if you want to split some arithmetical hairs, that’s a rise of more than 18% in that ratio. If they can also lift overall sales, and you can assume that’s front and centre of planning, then there’s a turbo effect, a double whammy on the upside..

Jumping outside the square for the moment, analyst group CapitalCube says the stock is sharply undervalued and has an implied value of $55.77.

“Its current price to book ratio of 3.29 is about median for its peer group,” says a note dated July 10, referring to peers such as HellowWorld and Webjet, the latter being the most expensive in CapitalCube’s estimation.

It sees Flight Centre as having room to grow faster. “Compared with its chosen peers, the company’s annual revenues and earnings change at a slower rate, implying a lack of strategic focus and/or lack of execution success,” it notes.

My conclusion? The stock’s had something of a relief rally thanks to the upgrade and is now sitting at the top of most analysts’ price estimates.

Long term, it’s probably an interesting proposition but at these levels, traders would probably conclude that this bird has flown. 

Source: ASX. Data as at Wednesday 12 July, 2017

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Published: Wednesday, July 12, 2017


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