2023-05-13 09:07:05 ET
Summary
- Expedia's shift of strategy and strong industry recovery has propelled its topline growth to a quarterly record.
- The company has strong operating and free cash flow, but its current ratio hasn't been greatly boosted in recent quarters.
- Its accumulated debt burden has arrived at a record high in absolute value, and compared to its equity, EBITDA.
- Adoption of generative AI could give the company a boost, but it is unclear how much of a lead it could have with limited information. On the other hand, a looming economic slowdown is visibly on the horizon.
Investment Thesis
The comeback story of Expedia from the pandemic has been strong and impressive. We dig in further to construct an overall picture of the company's financials and look beyond the balance sheet for its future growth risks/drivers.
Company Overview
Expedia Group (EXPE), started 25 years ago, is an online travel company providing services by allowing travelers to research, plan, and book travel via its platform and supply portfolio. The company's desktop and mobile products feature approximately 3 million lodging properties. It has reportable segment as Retail, B2B, and trivago.
Strength
In its last earnings report, Expedia witnessed its quarterly revenue rising to its highest ever at $2.7 billion, an increase of 18%, compared to the same time in 2022, while its earnings reported a loss of 20 cents per share, missing some analyst's estimates of a loss of 4 cents a share.
Expedia's balance sheet has experienced a dramatic slump and comeback in the past few years due to the pandemic shutting down travel and subsequent recovery to higher prices and record accommodation bookings. The recovery is evident as, on a TTM basis, its revenue and net income have roared back to their pre-pandemic levels while its free cash flow far exceeds these previous levels. Although most recent data pointed to flattening. Since 2021, after witnessing a sharp slump out from external pressure that it has no control over, the company has shifted its growth strategy from a transaction-based relationship that needs continuous customer acquisition to boosting long-term relationships and loyalty with its customers, mostly through its app. It aims at providing experience differentiation for return customers to help increase engagement and repeat rate.
Expedia: Revenue, Free Cash Flow and Net Income (Calculated and Charted by Waterside Insight)
Expedia's earnings also staged a comeback. The company's largest segment Retail (B2C), including Brand Expedia, Hotels.com and Vrbo, Orbitz, Trevelocity, ebookers and Wotif Group, has its portfolio of worldwide connections with different targeted groups of customers. This segment saw the biggest comeback, rising almost 2x compared to its pandemic low for the same period, and has exceeded its pre-pandemic level by Q3 last year. Its B2B segment also has a similarly strong recovery, resulting in its total adjusted EBITDA rising higher than its pre-pandemic level by 22%, since Q1 2020's results were largely unaffected by the pandemic yet.
Expedia: Adj. EBITDA by Segment (Charted by Waterside Insight)
In addition, the company has strong control over its cost of revenue. There has been lots of talk about how traveling has become more expensive. Still, Expedia has been able to quench the cost and expenses from their peak during the pandemic era sharply back to its average level before that.
Expedia: Cost and Expenses (Calculated and Charted by Waterside Insight)
By a similar token, its capital expenditure has observed a normalization as well. These effectively helped Expedia to stay competitive.
Weakness/Risks
One item that has been lower lately is its weak net cash flow, despite the strong operating cash flow. The company has been going on a borrowing spree. Its cash flow from financing activities reached its highest level on a TTM basis at $2.8 billion.
Expedia: Net Cash Flow Breakdown (Calculated and Charted by Waterside Insight)
This is one of the items on its balance sheet that has not reverted back to normal. The company's debt-to-equity ratio is at 3.57x and its debt-to-EBITDA ratio is currently at 8.53x. Not only are these high numbers on their own, but they are also almost tripled compared to before the pandemic. It probably has almost exhausted its near-term borrowing capacity to take on new debt in the market.
Expedia: Debt-To-Equity Ratio (Calculated and Charted by Waterside Insight)
The company has used more long-term debt than short-term, and most of the borrowing came from the era of easy monetary conditions. The earliest senior notes due is in 2025, around $1 billion.
Nonetheless, the amount of outstanding debt is worse than about 89% of the companies in the travel and leisure and the consumer cyclical sector. The company has recently been taking debt reduction measures, including the redemption of over $1.5 billion in senior notes in 2022. But the effort will need to go further. According to the company's own assessment, "a 50 basis point increase or decrease in interest rates would decrease or increase the fair value of our debt by approximately $115 million." The company essentially needs to churn out a high topline growth rate in the medium term, due to the longer-term structure of the debt, in order to maintain a satisfactory momentum for its profit and margin.
On the other hand, the company's current ratio has been greatly boosted during the pandemic era, and it has been declining since, similarly reverting back to its own normal rate. Interestingly, it had an even lower current ratio before '08-the current level of 0.83x is already at its higher end. But given its higher debt load this time around, higher than before '08, and more economic uncertainty ahead, it will be beneficial for the company not to drift much lower than this ratio.
Expedia: Current Ratio (Calculated and Charted by Waterside Insight)
The company has just announced a partnership with Afterpay, which will allow travelers to use "Buy now, pay later" services through the app. We think at this time, with consumer credit deteriorating as a whole, it may not be the best time to assume such exposure, especially when the company is not in a cash-rich position to support the experimenting phases of the services' pros and cons to its bottom line. So we will need to see how it develops.
Big Picture: Macro Trends And Beyond
Travel is hot in 2023. As the data suggested, the CPI of urban consumer airline fares is elevated. But what's catching up to it is the producer price index of air transportation. The growth rate of the PPI has, in fact, caught up and exceeded the CPI on the index level. Although the overall activities are still strong, the margin will start to erode. Lodging, which takes up about 75% of its total revenue, is directly impacted by air traveling. In its Q1 results, its lodging revenue still logged a 26% increase compared to the same period last year, the biggest increase in all service types. However, one of its competitors in lodging, AirbnB (ABNB), started seeing fewer bookings. It will be interesting to see how Expedia holding up in the next few quarters.
Expedia's chairman Barry Diller has recently claimed that the company is at the forefront of using OpenAI's ChatGPT to develop generative AI assistants to travel and booking. We think this is an interesting direction to take as it could work to the benefit of drawing customer loyalty to the brand. However, AI algorithm has been used in the travel and booking industry for years, so adopting generative AI may not be that far-fetched for most of the largest players in the industry. How far ahead and if Expedia can keep a lead in this is not quite clear at the moment. Supposedly most other major players push out their own version of airline or lodging booking assistants not too much later than Expedia; if it does work out a lead in this regard with a big if, at the moment, the playing field could be leveled out sooner or later. Not saying with certainty, but it is a possibility. This attracts our attention going forward but we are not actively pricing it in yet.
Financial Overview
Expedia: Financial Overview (Calculated and Charted by Waterside Insight)
Valuation
Combining all our analysis above, we use our proprietary models to assess the fair value of Adobe's stock with a ten-year projection forward. In our bullish case, Expedia sees moderation in its cash flow growth from '23 to '25, with strong rebound accompanied with volatility later on; it is priced at $102.31. In our bearish case, the company sees a visible slowdown in growth in '23-'25, not only due to its debt payments but also the macro environment; it is priced at $75.37. In our base case, the slower growth coexists with higher volatility in later years; it is valued at $80.75. The current price reflects the market's moderated yet still relatively bullish sentiment toward the company.
Expedia: Fair Valuation (Calculated and Charted by Waterside Insight)
Conclusion
Expedia's dramatic comeback from the pandemic lows has proved the resilience of the company's revamped business model in building long-term relationships with customers. The rapid recovery of the traveling and lodging activities also helped propel the company's revenue and operating cash flow to exceed pre-pandemic levels. However, the company also has accumulated its largest debt burden in recent years. With a weakening macro economy, even though travel could be expected to heat up this summer, investors who have a long-term horizon should expect some normalization in the company's margin and earnings. We recommend a hold at the moment.
For further details see:
Expedia Group: Taking Stock After A Roaring Comeback