SABR - Sabre: I Want To Be Bullish But There's Simply Too Much Debt

2023-05-29 04:04:07 ET

Summary

• Sabre is one of the three main players in the global distribution system market.
• As airlines and other travel markets have come back, Sabre should have recovered as well.
• Instead, the company remains unprofitable, revenues are short of pre-pandemic levels, and the former CEO is out.
• There's theoretically a high-margin business here if new management can right the ship.
• At this valuation, a buy is tempting, but the balance sheet is a huge concern.

Sabre ( SABR ) is one of the world's three major global distribution systems ((GDS)). These should be attractive high-margin businesses, and quality-focused investors have often praised the industry. Indeed, noted quality company investor Terry Smith's Fundsmith LLP has become the third-largest holder of the company with a 7% stake in Sabre.

The three major players are Spain's Amadeus IT Group ( OTCPK:AMADY ), Travelport (which is owned by private equity) and Sabre. Notably, China has a separate player, TravelSky ( OTCPK:TSYHY ) which serves that market, but there is limited interplay between China's GDS and the markets Sabre primarily serves.

While Amadeus has recovered its losses and is now flat over the past five years, Sabre, by contrast, is down more than 80% and is trading below the March 2020 lows:

It's additionally worth considering that Sabre shares have plunged once again in 2023 even as Amadeus has enjoyed a solid rally year-to-date.

I bought call options on Sabre in 2020 as a potential recovery play in the travel industry. Fortunately, that was a position with a fixed expiry date and a pre-defined amount of risk. Because, there's no nice way to put it, Sabre stock has been a disaster over the past 24 months.

It's an especially surprising turn of events since the global travel industry has picked back up so strongly over that time span. If travel volumes are up so much with the airlines, cruise lines, and other such clients that use global distribution systems to sell tickets, why has Sabre stock been such a dog? And does it have any chance of turning things around?

Balance Sheet Strains

The overwhelming issue with Sabre is its excessive debtload. The company has $4.8 billion of long-term debt as of March 31. This is a simply gargantuan amount, especially in comparison to the company's $1.1 billion market cap. The firm has a book value that is close to negative $3 per share, which speaks to the perilous situation here. If you strip out goodwill, book value would show an even larger deficit.

The good news is that Sabre doesn't seem to face any near-term liquidity risks. It had $817 million of cash on hand as of last quarter. More broadly, it has $1.4 billion of current assets against $864 million of current liabilities, suggesting that Sabre has plenty of funds available to handle is present obligations.

Sabre is back to roughly breakeven on an operating income basis but is still producing negative free cash flow. Sabre projects itself returning to positive free cash flow generation in Q3 of this year. However, it remains to be seen if the company can generate the sorts of robust cash flows which will be necessary to start making a dent in the company's truly massive debtload.

The company announced a $665 million funding facility to refinance some of its existing debt last week. Notably, shares declined sharply after this was announced, perhaps reflecting the market's skepticism that this will be enough. As all of Sabre's current notes come due by 2027, there will be a lot more refinancing that will have to occur to keep the company going beyond that point.

Longer-Term Competitive Risks

Historically, Sabre has been perceived to be stronger in the corporate channel versus peers that were stronger selling to consumers and leisure travel. There is inherently some risk to Sabre, and other GDS companies, as the industry has shifted toward online bookings and now -- in the post-pandemic period -- toward tourism rather than corporate business travel.

Specifically, I'd argue that this one chart highlights the risk inherent to Sabre's business. It is gross margins, and it was in sharp and steady decline throughout the 2010s. I've cut the chart off at the beginning of 2020 to note that the firm was already having major profit margin issues long before anyone had heard of COVID-19:

And, also of note, key rival Amadeus' profit margins are both much higher than Sabre's and were not in decline prior to 2020. It would appear that Sabre's reliance on the corporate channel caused it unique problems as mix shift went heavily toward less profitable online transactions.

Prior to the pandemic, part of the bullish view on Sabre was that it was being held down due to antiquated information technology systems. The company was investing heavily in upgraded IT, which in theory should have improved the margin profile and helped shore up its competitive position versus Amadeus and Travelport.

However, those heavy investments ended up having star-crossed timing. Now, Sabre is having to make good on the debt associated with these investments before the related cash flows have really started to roll in.

SABR Stock Verdict

I spent the majority of this article focusing on the negatives, since I want to be clear this is a high-risk investment that could easily go to zero. I personally own no SABR stock as I own plenty of the airport holding companies and view them as far higher quality and more attractive ways to get exposure to the growing commercial aviation sector.

That said, respected investors such as Terry Smith find considerable value in Sabre today. And analyst estimates (though take these with a mountain of salt on a company such as this one) project the firm hitting a low single-digits P/E ratio in 2025:

There is a path to not just profitability but strong profitability here if management can hit 2025 guidance. This, in turn, relies on the long-awaiting tech upgrades paying off as expected. These would drive both lower computing costs and hopefully higher market share, both improving revenues while reducing the cost of goods sold.

There's also a bullish argument around the fact that the GDS is only 70% or so of revenues. The other Sabre businesses, namely Air IT and hospitality, appear to be higher-quality and less at risk from the technological disruption that has hit Sabre's GDS business.

Finally, from a trading perspective, SABR stock is near its all-time lows, and more than 15% of the float is currently sold short. It's not hard to imagine any sort of spark causing a significant reversal in sentiment and the share price.

This is a massively levered business with a large and increasing revenue base that is dramatically out-of-favor at the moment. Yet the industry it primarily serves, aviation, is still seeing robust travel growth as it recovers from the pandemic. Sabre's heavy investments in IT, in theory, should finally start to pay off. And perhaps the new CEO will bring innovative ideas to shore up operations as well.

Sabre is a highly speculative company and there's stuff I'd personally much rather own in the aviation space. That said, for people that like levered turnaround stories with a real shot at panning out, there's enough here to have this on your radar.

The company's debtload, however, is simply gargantuan. There's no two ways around it. As much as I'd like to rate this a speculative buy, I must stick with a hold rating until the company can generate some cash and show that there is light at the end of the tunnel in terms of addressing the balance sheet.

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