2023-03-09 06:41:37 ET
Summary
- Expedia Group, Inc. is an online travel company that operates internationally through its Retail, B2B, and trivago segments.
- Expedia's financial performance has been very good, already returning to pre-COVID profitability. Management is confident they can see a significant improvement in EBITDA margins in the coming year.
- The company is facing economic headwinds as demand declines, although this has yet to seriously bite.
- Our view is that travel in China will begin to increase soon, with Expedia also having a full year of travel available for other locations such as Japan.
- Based on the company's current valuation, we see an upside of 14-27%.
Company description
Expedia Group, Inc. ( EXPE ) is an online travel company that operates internationally through its Retail, B2B, and trivago segments. It offers a wide range of travel-related services through various brands including, Expedia, Hotels.com, Vrbo, and CarRentals.com, among many others. Additionally, Expedia owns Trivago, a hotel metasearch website that sends referrals to online travel companies and travel service providers.
The company's largest competitors are Booking.com ( BKNG ) and Trip.com ( TCOM ). Outside of these 3 businesses, the industry is relatively fragmented, with many large regional players and some segment specialists such as Airbnb ( ABNB ).
Share price
Expedia's share price performance in the last decade is a story of two halves. Firstly, the company has its pre-COVID performance, which has been extremely good, with consistent gains into 2020. This was driven by a shift in consumer habits towards online travel agencies. Since then, the company has seen its share price rise incredibly, before crashing back down. This period can best be described by strangely robust demand and its subsequent decline of it.
Investment thesis
With the company's share price returning to its pre-COVID levels, now feels like a great time to assess the business. Travel outside of a few pockets has fully opened with no restrictions and we are back to worrying about normal issues like the economy.
Based on market share, Expedia is the smallest of the big 3 OTAs. When factoring in that Trip.com earns the vast majority of its revenue from China, Expedia is likely part of an international duopoly. This gives the company significant barriers to entry. With this in mind, the key to long-term success with Expedia is whether travel trends will work in the company's favor and how attractive the financials of the business are. We intend to assess just this.
Financials
Expedia Financials (Tikr Terminal)
Expedia's financial performance across the last decade has been incredibly impressive, with the company achieving growth across the board.
Revenue has grown at a CAGR of 11%, driven by a structural shift in consumer trends in the industry. Historically, consumers need to utilize travel agencies or book directly, which was both time-consuming and inflexible. Further, the industry was highly fragmented and serviced almost solely by local operators. OTA's changed the game, they offer consumers the ability to browse travel/holiday options easily, aggregating a significant amount of inflation. With the rise of smartphones, the last decade has only seen an acceleration of this. Our view going forward is that these sites will only become more useful, as consumers increasingly avoid booking direct, due to the perception that it will be more expensive. In many cases, this is not just a perception, as the following example shows.
LHR > DBX (£599) (Expedia)
LHR > DBX (£701) (British Airways)
The cost of revenue is primarily comprised of customer services and fees incurred to secure the customers booking. These expenses have increased at a lower rate than revenue which is unexpected given the increase in wages we have seen in recent years but are reflective of economies of scale as volume increases.
S&A expenses on the other hand have ticked up from 51-56% of revenue to 57-60% of revenue. This has been driven by greater marketing and costs incurred to drive traffic from search engines. This is a key expense for the business as although they have a substantial market share, the number of websites in the industry is high and so it is critical to be in front of potential customers at all times. Management has been focusing their efforts in this area, with investment to drive greater cost efficiencies and better target customers. This has been beneficial for the business, with margins improving Q/Q. Q4 Adjusted EBITDA margin hit 20%, far above current levels. Management has been very bullish in commentary, believing we will see impressive margins as early as 2023.
Expedia has a lot of non-operating noise within its accounts, the largest of which in FY20 relates to restructuring charges and the impairment of goodwill.
From a profitability perspective, the company is in a better position than its pre-COVID state, with slightly a higher EBITDA margin and far a superior FCF margin. Reduced capex spending has contributed to this. Our view would be that this comes down slightly, but the EBITDA margin is more likely to be sustainable.
Moving onto the balance sheet, the company has engaged in deleveraging, which is important given the level of debt it has accrued since Dec19. This has reduced the company's net debt / EBITDA ratio by more than half to 2.34x. Our view is that this is a comfortable level now and allows the business some level of flexibility if it needs to raise debt in the future, such as to engage in M&A. Fitch's most recent credit rating for the business is a BBB- , however, we can see this coming up once they reflect their view of the recent repayment.
Investors looking for distributions will likely find value in Expedia, with the company having a history of both dividend growth and share buybacks. COVID has clearly disrupted this but with things finally back to normal and the company deleveraged, both can continue to grow once again.
Overall, our view on the company's financials is positive. The company has clearly taken a beating in the last few years, but it has not been materially damaged by this. The company has been able to return to its pre-lockdown margins, almost to its pre-lockdown revenues, and has a balance sheet that is very much intact. Going forward, we see the possibility of sustained buybacks and improved margins.
Economic consideration
We are currently experiencing heightened inflation, caused by supply-side issues and robust demand. This has contributed to slowing demand for discretionary industries, as consumers experience a substantial rise in living expenses. This is clearly an issue for the travel and tourism industry as this is very much discretionary spending that most consumers can avoid. Looking at air travel numbers, we have yet to return to FY20 levels, with it still inconclusive if we are beyond FY19.
Interest rates have only compounded this issue for consumers, with inflation encouraging greater borrowing and consumers facing higher rates.
Looking ahead, our view is that FY23 will be more of what we are seeing now, as inflation is showing its stubbornness in coming down. We are seeing similar things across other western nations, which are also key geographies for Expedia. We believe rates will increase again before everything is said and done, which will only compound problems further. Consumer finances can only take so much before demand capitulates. This will likely mean a tough year for Expedia if the current resilience of the industry wanes. This is yet to be seen but would only represent a short-term headwind and we do not see the business experiencing a decline in sales.
Online travel
The online travel industry is forecast to grow by 14.9% in the coming 5 years, driven by further maturing of developing nations. As individuals are lifted out of poverty, lifted into the middle class, and generally experience greater economic prosperity, they are far more likely to engage with the tourism industry. This usually begins with domestic travel and develops from there. This is an area of opportunity for Expedia, as the business is focused on western economies. OTA's are forecast to grow faster than traditional travel agencies due to the genuine benefit it offers consumers, with little in the way of downsides. There is no reason to suggest consumers are turning away from travel, the opposite is true, the richer people get the more they travel. For this reason, we see Expedia as a great bet on the faster-growing segment of a growing industry.
China
China is one of the last countries to still be fighting COVID, with the country's leadership remaining stubborn with their implementation of a zero-COVID policy. This was relaxed several months ago and cases skyrocketed. We have seen this come down with leadership declaring the war against COVID is now over . Currently, travel into, out of, and within the country is strongly restricted. With COVID stepping aside in the coming months, consumers will once again be able to travel. There is even the chance we see the ravenous post-lockdown demand we saw in the west. This will naturally bring a bump to travel numbers, driving revenue for the business. Not only this but many parts of Asia had not fully opened in FY22, such as Japan, again providing a full-year bump in FY23. It is difficult to quantify what impact this will have but could be as high as a few percent.
Financial outlook
Expedia Analyst forecast (Tikr Terminal)
Presented above is analysts' forecast financial performance for Expedia. As we have established, the company is facing both short-term headwinds and tailwinds, alongside healthy long-term growth.
Analysts are of the belief that FY23 will be a year of growth, with the net benefits of COVID recovery outweighing the economic impact. Our view would be less bullish here, given that economic conditions keep getting worse. This said a decline should be mitigated.
Analysts seem to have brought into management's belief that they can sustain improved margins, with forecasts for EBITDA to increase to 21% in FY23. Once again, we are less immediately bullish and would like to see another quarter or two of this before committing to this conclusion.
Peer group comparison
Peer group (Tikr Terminal)
Presented above is a cohort of online travel companies. There is a clear divide between the growing businesses and the mature ones, but currently, the growth businesses are not showing margins that are as attractive as BKNG/Expedia (Excl. Airbnb). Our view would be that Expedia is attractive if it is priced at a marginal discount to BKNG.
Valuation
Expedia valuation (Tikr Terminal)
The valuations of this cohort are a mess, which shouldn't be surprising given the recency of COVID. Markets are still attempting to accurately price these businesses. In order to derive a valuation for Expedia, we have taken the company's historic EBITDA multiple, alongside Booking.com's, and applied a premium to reflect its current superior performance. We have not priced in what could be impressive EBITDA margin expansion, which analysts seemingly have, giving readers an upside range. Assuming EBITDA margins cannot improve, Expedia's upside looks to be around 14%, if they can by FY23/FY24, the upside is closer to 27%.
Final thoughts
Expedia is a have a wide moat the fastest-growing segment of a growing industry. The company owns a host of big brands and is maintaining these through effective marketing. The company is facing natural tailwinds, as China opens up and the company invests further in operational gains. The company is facing economic headwinds but we have yet to see a material impact from this and so forecasting future issues is difficult.
Analysts are highly bullish on the business and we concur. At its current valuation, investors can enjoy great margins and sustainable buybacks. Any significant improvements in the business will only increase what is a 14% upside at the current share price.
Please note that we are also very bullish on Booking.com, a company we have an investment in. You can find our write-up here .
For further details see:
Expedia: Financially Attractive With Tailwinds Ahead