Flight Centre: Structural Or Cyclical?

Flight Centre (FLT) shares took another whacking yesterday in the wake of its shock profit downgrade on Monday and the spate of broker downgrades which naturally followed the update.

The shares fell another 5%, on top of Monday’s 9% slide and ended at $31.88 yesterday, the lowest since August of last year.

The 14% slump of the past two days took the year’s drop to date to more than 15% and over 27% for the past 12 months.

Rival online travel group, Webjet (WEB), which tickled the market’s fancy late last week with a positive update (made to look even better by Flight Centre’s surprise on Monday) has enjoyed a better 2016.

Even though Webjet shares dipped 0.1% to $6.33 yesterday they are still up more than 11% for the year so far and 80% (yes, 80%) for the past year.

Monday’s Flight Centre warning that underlying profit before tax would fall by 2% to 5% instead of rising by 4% to 8%, drove the sell-off and the spate of broking downgrades which saw cuts of 10% and more in earnings forecasts for the group for the next three years.

Flight Centre pointed to several causes, including political uncertainty related to the federal election campaign in Australia and Britain’s Brexit debate, investment in growth and a weak leisure market in the United States.

On an investor briefing on Monday, Flight Centre CEO Graham Turner’s indicated there was more and he pointed to the fall in international airfares and an increased preference for flying budget carriers that had led the travel agency to miss commission targets with individual airlines.

"As such, it is not delivering sufficient growth to the incumbent suppliers that is required to earn the super-overrides which have underpinned margins in the past. We do not expect this trend to abate and it will likely be compounded by continued cost growth,” Deutsche Bank analyst, Michael Simotas said as it lowered its recommendation on the stock from “buy” to “hold” and cut its 12-month price target by 25 per cent to $36.

Bell Potter analyst John O’Shea dropped his 12-month price target by 12% to $35.70, said the traditional Flight Centre branded stories in Australia were performing worse than expected.

"The problem for Flight Centre is that the core Flight Centre branded store network in Australia is the largest contributor to group earnings with a relatively high fixed cost base and the company has been ‘investing for the future," Mr O’Shea said.

"The downgrade highlights the fact that the company may need to accelerate a cost reduction program for the Australian business given the implied earnings run rate as we enter FY17."

And Macquarie Equities analyst Sam Dobson said he expected Flight Centre’s ongoing transition to offering more online booking products would impact margins in the coming years. Flight Centre has an income margin of 13.5%, but rival Webjet, which is not losing share, has a lower margin of 9% to 10%.

He added Flight Centre’s belated decision to offer bookings on low-cost carriers will introduce lower airfares that might negatively impact margins.

"While some see a marginal [transaction value] benefit arising from entering the low-cost carrier market, we think this will be negated by the cannibalisation of full-service carrier fares," Mr Dobson said.

Macquarie maintained an “underperform" recommendation on Flight Centre but cut its 12-month price target by 18.5% to $28.26.

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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