Sunday, October 21, 2018

Expedia Lacks A Compelling Investment Story

Overview: 

Expedia Group, Inc. is an online travel company, engaged in the provision of travel products and services to leisure and corporate travelers.

It operates through the following segments: Core OTA, trivago, HomeAway, and Egencia. The Core OTA segment offers full range of travel and advertising services to worldwide customers through a variety of brands including: Expedia.com and Hotels.com. The trivago segment involves in sending referrals to online travel companies and travel service providers from its hotel metasearch websites. The HomeAway segment operates an online marketplace for the vacation rental industry. The Egencia segment manages travel services to corporate customers worldwide.

Founded: 1994
Number of Employees: 22,615
Headquarters: Bellevue US
CEO: Mark D. Okerstrom, MBA
Expedia as an investment
Alas, we don't see the case for an upward trajectory.

Analysis Methodology

This will be a general analysis reviewing the following areas of EXPE: earnings quality, growth, value and dividends.   We're also going to look at R&D investment as an indicator of potential competitive advantage for the group.

It will also be a peer based analysis as there are advantages to performing a peer-based analysis over a single stock one including the ability to compare, benchmark as well as find other opportunities.

Peer Group:

Stock Name (Symbol)Last Price Oct 19th, 2018Market Cap
Despegar.com, Corp.(DESP:XNYS)$15.621.0793B
Booking Holdings Inc.(BKNG:XNAS) (formerly Priceline Group (PCLN:XNAS)$1805.7486.2500B
TripAdvisor, Inc.(TRIP:XNAS)$46.606.4085B
Ctrip.com International, Ltd. (ADR)(CTRP:XNAS)$32.6317.7905B
Rakuten, Inc.(RKUNF:OOTC)$7.219.7328B
Expedia, Inc.(EXPE:XNAS)$118.3217.6982B


Quality of Earnings

It is a fact that earnings can be manipulated and can be changed by accounting-driven decisions.  We want earnings that are persistent, can be expected to repeat and aren't the result of one-off events or management tinkering.  I use an nine part quality of earnings framework based off the work of two academics, Lev & Thiagarajan.  You can read their original paper here.  You can read my adaptation here.

The framework looks at nine areas in the financial statements: inventories, receivables, capital expenditures, research & development, gross income, selling-general-administrative expenses, sales per employees, tax rate and audit opinion.  The first two, the fourth, fifth and six are compared to sales levels, capex and/or r&d are compared to industry averages (I use a peer group average as a proxy), the tax rate measures seeks to remove the effect of an earnings bump from a reduction in the tax rate and the a last one looks for a clean audit opinion.  When any of these measures give a favourable signal, it gets a score of one.  All the scores are summed to get a total out of nine, the higher the better.

However none of the companies in this group have inventories, therefore the score is out of eight. 

Here are the results:
DESP - 4
BKNG - 4
TRIP -2
CTRP - 6
RKUNF - 5
EXPE -5

A score of 8 out 8 is excellent, 7/8 very good, 6/8 good, 5/8 tolerable, 4/8 meh, 3/8 bad, 2/8 very bad and 1 or zero out of 8 terrible.  EXPE is tolerable.

Growth

This measure looks at the number of years the companies have been able to achieve year over year growth.  I'm looking at a six year time period so the maximum occurrence is five.

BKNG achieved the maximum score of 5.  If this analysis was focused on them I would look at the possibility of a growth story here, paying attention to the correlation between earnings and price growth. 

However, our focus is on EXPE and with a score of 3/5, it doesn't look like a growth story.  The following graph lends credence to that.  It shows the percentage price change over 52 weeks for each stock.

EXPE has lost 21% over the past year.  They've all lost except TRIP which is up 15%.

Value

We'll look at a couple of valuation measures - Ohlson Clean Surplus (OCS) and enterprise value divided by earnings before interest, taxes, depreciation and amortization (EV/EBITDA).

OCS

The OCS is an interesting valuation model that calculates a theoretical stock value.  While I don't hold it out to be an exact value, it can give a decent ball park or at least an indication whether the stock is over, under or fairly valued.  For a detailed explanation of the model, please review this article.   Academic testing demonstrates that the model has predictive results two to three years out.  Let's see what it looks like for this group:

According to the model EXPE is overvalued, as is the rest of them except RKUNF.  I did play with model inputs for EXPE (I increased the ROE and decreased the dividend payout ratio) and it was still overvalued.

EV/EBITDA

Similar to a PE ratio, this valuation model looks at what one dollar of earnings costs the investor, but using enterprise value and EBITDA instead of price and earnings strips out the effects of different capital structures and lease versus purchase decisions.

EXPE is showing a below average multiple compared to the group and it also has the second lowest value of the group at 14x, however it's still on the high side.  Note, three years ago this number was 13x, so it has increased.

In my opinion there is no value play here.

Income

EXPE and RKUNF are the only companies offering a dividend and EXPE's rate is $1.16/share for a yield of almost 1%.



Competitive Advantage

Regardless of the fact that people are price shopping on online travel agencies (OTAs), this is not a commodity industry and I think it would be a mistake for a company to get caught in that trap.  From unique trips to an excellent interface to superb customer service there many different ways to differentiate and gain competitive advantage. 
Although the R&D spend doesn't tell the full story of competitive advantage, it may hint at the company's priorities. 

R&D as a Percentage of Sales

The travel industry was one of the first to be disrupted with the advent of the internet.  There is still ample room for innovation and in fact, without constant fresh thinking, the OTAs could find someone has disrupted them.  R&D spending is therefore important.   Of the group, EXPE appears to budget a constant ~9% of sales.  This however puts them second from the bottom in terms of percentage spend.

It's a HOLD

In my opinion this company is a hold if you own it and a wait for a better price if you are considering buying, although I don't see a compelling reason to buy it.

It's middle of the road in almost all of the factors - it's market cap is almost right in the middle, it's quality of earnings is acceptable - neither cause of concern or celebration.  It doesn't look like a growth or a value play.   It's got a dividend that has been growing, but it's a surprise to see they have one at all - it seems like they should be reinvest excess earnings in the company.  To think the industry has matured and it is time to start returning cash back to investors seems a bit premature.

Disclaimer

Part of intelligent investing involves taking on risk levels appropriate to one's circumstances.  We don't know what your's are and this analysis should not be construed as investment advice.  INVRS, its parent company, its officers, directors and employees cannot be held responsible for any investment decisions you make.

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