The challenge of value investing is to buy exceptional companies at bargain prices. Identifying great companies before the rest of the market does takes real skill, as does knowing when the market has over-reacted and created a buying opportunity.
Consider Flight Centre Travel Group. I last wrote about it for The Bull in September 2014 when it traded at $44. “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.”
The stock hit a 52-week low of $31.41 in December as the market fretted about a rare earnings downgrade, and amid broader sharemarket weakness at the time. The sell-off drove this exceptional company into bargain territory.
Chart 1: Flight Centre
Flight Centre rallied to $39.35 after a better-than-expected interim result in February sparked a 12 per cent rally and reminded the market that great companies have a knack of bouncing back quickly from the occasional bout of poor performance.
The company reported total transaction value (TTV) of $8.1 billion for the first half of FY15, slightly above consensus forecasts. The TTV was up 8.8 per cent and has almost doubled in eight years, underpinned by Flight Centre’s rapidly expanding network.
Underlying profit before tax of $138 million was slightly below some broker estimates. But the big kicker was the company confirming earnings guidance for FY15 of $360-$390 million. For a market worried about Flight Centre’s growth trajectory, it was an important result.
The company’s offshore businesses mostly impressed. The Australian operations are key to achieving earnings guidance, for they contribute the bulk of underlying earnings. But strong growth in the offshore businesses is needed to unlock a sharply higher valuation.
Flight Centre opened its 300th shop in the United States in the first half of FY15, its 250th shop in Canada and 100th shop in Asia and the Middle East. It has opened large-format stores in the US, India and Abu Dhabi, with has another hyperstore to open in Hong Kong.
Flight Centre achieved record underlying earnings in the UK, South Africa, Singapore and Greater China, albeit off a low base. It had a stronger result in the US business and combined overseas earnings rose 25 per cent to $25.3 million, partly aided by positive currency moves.
Translating strong international growth into sharply higher underlying earnings is critical. The result showed the core Australia business had disappointing growth in TTV because of subdued sales growth and lower sales commissions. There was some slight improvement in the local business, but the outlook remains challenging and Flight Centre noted “ongoing volatility” for its domestic markets.
At the same time, the Australian business had higher-than-expected costs from investments in staff and marketing/sales. Although some costs are temporary, Flight Centre faces margin pressure from doing business in a high-cost country such as Australia.
Flight Centre expects stronger contributions from its overseas business in FY15, particularly the UK and US operations. It identified “continued growth in overseas operations” during a seasonally stronger second half’ as a clear opportunity for FY15.
I expect the company’s FY15 profit to be at the higher end of its $360-$390 million guidance. A slowly improving Australian domestic leisure and business travel market, and faster earnings growth from the offshore business, are good signs. The guidance also excludes earnings from the recently acquired Top Deck business, which could add few more million to the result.
Long term, Flight Centre should benefit from powerful thematics: an ageing population with rising demand for domestic and international travel; the continued blurring of online and full-service travel advice; and the importance of scale and cost, and barriers to entry that the largest operators build through their brands and service platforms.
Morningstar has a fair value of $45 for Flight Centre and three of six analysts in a consensus forecast it compiles have a strong buy, and three a hold recommendation. Some investment banks have 12-month price targets near or above $50 for the company, implying a handy total return.
Flight Centre was nearing value territory at $44 and badly oversold at $31. It is hard to find many negatives with its long-term outlook and the market is underestimating the potential value of its offshore operations.
Self-Managed Super Funds could do worse than hold a company with a strong travel brand and rapidly expanding global footprint in a travel market that will be buoyed by the ageing population this decade and next.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply 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 February 25, 2015