Sometimes, the simplest investment strategies work best. Such as buying the highest-quality companies, or adding to positions, during sharemarket corrections or pullbacks. I have advocated this strategy for several years with Seek, REA Group and Carsales.com.
Flight Centre Travel Group also deserves consideration. After soaring from $20 in mid-2012 to $55 earlier this year, the travel operator has fallen to $43.58 after disappointing the market with lower-than-expected earnings guidance, and amid the broader sharemarket sell-off this month.
Chartists will watch Flight Centre closely. It is right on previous price support around $43 and could have a fair way to fall if it breaks through that level. I’m backing it to bounce higher, although further price weakness in the next few months would not surprise. Patient investors might watch and wait for better value in Flight Centre if this latest selloff continues.
Chart 1: Flight Centre over one year
It is a remarkable company. Return on Equity has been consistently near or above 20 per cent in the past decade – a great achievement given myriad problems that have plagued the global travel industry during this time. Cashflow is strong, debt is low relative to Flight Centre’s equity, there is plenty of cash, and capital requirements are reasonably low. These are traits of exceptional companies.
Chart two: Flight Centre over five years
Flight Centre has good long-term prospects on four fronts. An ageing population is, as the company’s management notes, creating a golden age of travel. Ever notice how many afternoon TV ads there for European river cruises and other trips aimed at travel-hungry retirees?
Lower airfares are also encouraging more Australians to holiday overseas. A bigger drop in the Australian dollar, should it happen, might slow that trend, but the ageing population and lower airfare trends still have a long way to run, which is good news for Flight Centre.
The second reason is scale. As more travel is inevitably booked online, profit margins for travel advisers will fall. Travel deals are highly price sensitive and customers can easily compare deals and switch between providers via the internet. Flight Centre’s scale gives it greater capacity to compete with smaller rivals that cannot secure the same deals or prices.
The third reason is Flight Centre’s expanding global footprint. It is not widely appreciated that it is one of the largest travel groups of its kind in the world and the dominant local player in corporate travel. Rapid expansion overseas, after a few years of losses in markets such as the US, will be another earnings tailwind in coming years.
Finally, I like Flight Centre’s emerging strategy to blend shopfronts and online travel. Expect more travellers in coming years to visit travel agencies for upfront advice and book the remainder of their trip online. A hybrid service model, which some travel operators have already embraced, will combine the best of full-service travel advisory with the self-serve online bookings.
Flight Centre’s strategy is well matched to an ageing population that wants to travel. Price-sensitive retirees should be attracted to the market’s best-known travel brand, and favour low-price operators. The ability to move seamlessly between full-service and online travel, all through the Flight Centre brand, is another attraction.
The key to the company’s long-term fortunes is how it captures the customer. Being the middleman between travel suppliers and consumers will be an increasingly precarious position as online travel bookings continue to eat into full-service travel advisory. Greater ownership of the customer will give Flight Centre a stronger sustainable competitive advantage, higher switching costs and greater to ability to raise prices.
The bad news was a weaker-than-expected FY14 result, flagged to the market in late July, thanks to cost rises associated with store rollouts and marketing. This will flow into FY15, with management guiding for 5-8 per cent underlying profit growth, against market expectations of 10 per cent. After such strong price gains, it did not take much to pummel Flight Centre.
Investors who can look to FY15 might find an opportunity to buy Flight Centre for the long term and benefit as continued store openings, cross-promotion of travel services and greater economies of scale create the next leg of earnings growth in the medium term.
My main hesitation is a slowing local economy, a weaker Australian dollar, and slightly higher unemployment in the next 12 months, denting some demand for offshore travel as consumers remain cautious. That negativity could lead to further price falls – and better value in Flight Centre in FY15.
Some brokers have 12-month price targets above $50 for Flight Centre. Macquarie Equities Research, for example, has a $55.85 target, which would imply a total shareholder return (including dividends) over one year of about 30 per cent from the current price.
I am less bullish. Flight Centre looks like it is trading right on fair value, or slightly below it. Further share-price falls from here would put it on the radar of value investors who know that high-quality companies have a habit of bouncing back strongly from sell-offs in the long run.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at September 24, 2014.