DESP - Why Despegar Could Lift Off Once Again

2023-06-08 02:05:11 ET

Summary

• Latin American online travel agent Despegar is on the threshold of returning to profitability.
• The company is reporting tremendous year-over-year growth.
• I believe shares could enjoy a major rerating over the next 12 months as the company completes its post-pandemic turnaround.

Despegar.com ( DESP ) is Latin America's leading native online travel agent website and application. Despegar means "to take off" in Spanish, but shares have done quite the opposite since their debut.

Originally hailing from Argentina, Despegar.com began trading near its all-time high price and has been on a pretty steady descent since that point:

While the pandemic didn't help matters, the stock made its biggest drop back in 2018. That was tied to a major decline in the state of the Argentine economy, where Despegar has a major presence. Soft economic conditions in other key Despegar locales such as Brazil didn't help matters.

While shares initially bounced back from the COVID-19 lows in 2021, the stock has given back those gains and recently retested its all-time low price. Just over the past month, however, Despegar has started to pick up some momentum again with DESP stock rebounding from $5.25 to $7.

Upon further examining, there are some decent reasons for the recent optimism. In the interest of full disclosure, I own a tiny position in DESP stock from prior to the pandemic in my buy-and-hold portfolio. So, while I am technically long the stock, I haven't actively bought any more in years. That context aside, here's why I'm starting to get interested in Despegar as a potential investment idea once again.

Return To Profitability, Strong Top-Line Growth

Judging from the stock price, you'd probably assume Despegar was another failed e-commerce company that never reached profitability and is suffering from an outsized cost base. However, that's not at all the case.

Despegar was profitable prior to the onset of the pandemic. It lost quite a bit of money over the past couple of years, which is to be expected given the consequences of the COVID-19 outbreak.

However, travel is now roaring back across South America. And in some LatAm markets like Mexico, traveler numbers are now way above 2019 levels. Overall, it took a while, but the LatAm market is back as far as travel and tourism goes.

This is reflected in Despegar's latest quarterly numbers. The company's gross bookings surged 44% and revenues jumped 41%, comfortably topping expectations. Of interest, total bookings only rose 5%, but average selling price soared 36%, showing the favorable impact on the industry as international travel has become much easier with the lifting of assorted COVID-19 restrictions and requirements.

With this past quarter's results, Despegar's revenues have now topped the pre-pandemic peak on a trailing twelve months basis:

Despegar did report a small operating loss last quarter. However, analysts expect it to return to GAAP profitability next quarter. And looking out into the next couple of years, the analyst outlook is rather encouraging:

The company is at an estimated 62x this year's earnings, which isn't too surprising given that it will only hit profitability in Q2 and most of profits will likely come from the year-end holiday quarter. But moving into 2024, analysts see the company making 36 cents a share putting the stock at 19x next year's earnings. And that drops to 11 times estimated 2025 earnings.

While Despegar's current elevated revenue growth rate isn't going to carry on forever, the outlook is for the company to keep posting double-digit top-line growth for the foreseeable future as well.

Given the general lack of enthusiasm for many South American stocks at the moment, it's not surprising that Despegar shares aren't flying high just yet. However, the numbers are solid enough to make quite a decent bull case.

This is one of the COVID-19 travel recovery stories that took longer to play out given the slow speed of the economic reopening in Argentina and several other LatAm travel markets. But it's happening at a rapid pace now, as Despegar's 41% year-over-year revenue growth rate this past quarter shows. As the company moves into outright GAAP profitability over the next quarter or two, that should attract a larger group of investors to the equity.

Thoughts On Risk & The Business Model

I've done some expert calls about Despegar and some of its rivals in the South American market. The obvious competitive risk most people would probably think of is the international OTAs such as Booking.com ( BKNG ).

However, my understanding is that the multinational firms have not put much money and attention into Spanish-language advertising. Particularly with the downturn in almost all LatAm economies since 2014, there has not been much desire for foreign firms to put a lot of capital to work in South American travel and e-commerce.

Additionally, I'd note that Despegar has done a great job of partnering with local banks and retail stores and thus is much more integrated as a brand into the community. While anyone can translate a website into Spanish and hope to pick up some traffic through Google search, I don't believe the foreign firms have anywhere near the same physical and cultural presence in Latin America as Despegar.

Counterintuitively, the biggest rival to Despegar may be physical travel agents. The industry has been much slower to adopt the internet than in other markets. It's still quite common to buy travel bookings from physical kiosks or storefronts in shopping malls, hypermarkets and the like. Keeping in mind that a significant proportion of the population does not have access to full-service banking in many LatAm countries, Despegar and other OTAs start at a bit of a disadvantage in trying to reach certain types of customers.

Over time, customers will naturally move online. Already, younger LatAm consumers that are comfortable with concepts such as digital wallets are happy to book through apps like Despegar. But the total addressable market for online-booking is likely to remain significantly less than 100% of the overall tourism market for quite a bit longer. Though, to make the bullish argument for Despegar, it is also active in offline channels, such as through its partnership with Falabella , which is one of LatAm's leading department store chains.

There are some other apps aiming at Despegar. There are several smaller sites or apps that focus on one or two countries, such as rival services in Brazil which compete against Despegar (in Brazil, Despegar operates as Decolar).

Also, we're seeing some apps that service other markets try to nudge into Despegar's space. For example, Rappi , a SoftBank-backed food delivery company, is now offering travel services through its platform. I'm skeptical that Rappi will be able to grab many customers this way. I'm not sure there's much natural synergy between selling pizza deliveries and plane tickets, but I could be mistaken. So far, there's little sign of a single so-called superapp that would eat up all the commerce verticals in Latin America, but it's something to watch out for.

Despegar Stock's Bottom Line

I've been watching Despegar stock for years. There was little reason to buy it early on into the pandemic when it was unclear when the company would return to profitability. Instead, I loaded up on the LatAm airport stocks. Due to their high EBITDA margins and low costs, the airport operators quickly returned to profitability and their share prices have soared.

However, with the airports now returning toward roughly normal historical valuations (with one exception), I'm on the lookout for the next part of the travel recovery story to buy into. Despegar is intriguing as it's right on the threshold of returning to meaningful profitability on a GAAP basis. Throw in the prospect of double-digit revenue growth for at least the next few years and there's the framework for a solid bullish case here.

The global economy could go into recession, which would hamper things. Argentina's economy is currently a total mess with 100% inflation and massive problems with the government's budget and international trade balance. I'm optimistic for Argentina since this economic failure should lead to conservatives winning presidential elections this fall. However, results could be rough out of Argentina given the current economic mess. I'm also somewhat skeptical of the new government in Brazil, and Colombia's travel market is a mess between its volatile political situation and the failure of two of its discount airlines earlier this year.

All this to say I'm not pounding the table for Despegar here because I could easily see some bumps in the road that put off a meaningful return to profitability until 2024.

That said, it's hard to argue against the longer-term bull case. The company is already back to positive operating cash flow, it has a large cash position on its balance sheet, and the business is roaring back to life. The company will almost certainly be posting much better numbers in 2024 and 2025 than today.

Meanwhile, DESP stock is selling at just 0.44x Enterprise Value to EBITDA. This is near the lowest valuation Despegar shares have ever sold for. It's also a massive discount to its closest comparable, Expedia ( EXPE ):

I'd note Despegar IPOed at a higher multiple than Expedia in 2017, and shares were right around the same valuation at the onset of the pandemic. Now, though, Despegar shares are going for just a third of Expedia on an EV-to-sales basis. I understand discounting Despegar to some degree due to the shaky political and economic situations in several key Despegar markets at the moment. But 0.44x EV/EBITDA is probably a fair bit too low of a price.

As the firm moves into strongly profitable territory on a GAAP basis next year, I'd expect the potential pool of investors for Despegar to grow significantly. This could push a rerating of the stock into the double digits in the same way that Argentina's airport company, Corporacion America Airports ( CAAP ), rallied from the $7s to the double-digits immediately after it started reporting strong profitability .

Argentina's economy is in poor shape. The global economy could go into recession. And the recovery in global travel from the pandemic could be just about played out. There are clear risks here. However, I see the odds as favoring the bulls.

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