This Market Leader Is Now A Bargain

Tim Begany's picture

Friday, February 6, 2015 - 1:30pm

by Tim Begany

 

When gauging market sentiment about a company, don't bother spending hours on reading and research. Just look at its stock chart.

 

Right now, the market has been shunning shares of the world's largest online travel agency, Priceline Group, Inc. (Nasdaq: PCLN). It has slumped 25% since peaking in March 2014, signifying a move into its own bear market.

 

Clearly, after many years of exceptional growth, Priceline has fallen out of favor.

 

Several factors explain the current bearishness, including currency headwinds. Priceline generates 87% of its revenue outside the United States, with 60% coming from Europe alone. The company's detractors figure the strong dollar is sure to create a big drag on profits, especially with central bank stimulus in Europe positioning the dollar for even greater gains against the euro.

 

Priceline bears are also concerned that global economic weakness will hinder travel-related spending by foreign consumers. And they point to Priceline's sales and marketing outlays, arguing that these costs have risen much too quickly for the firm to maintain strong margins.

 

These are valid concerns.

 

However, I believe the market has overreacted to them and the stock is now an unusually good value. It's as if the market sees the headwinds Priceline faces as permanent, and assumes management has absolutely no clue about them -- which simply isn't the case.

 

On Priceline's third-quarter conference call, management acknowledged currency risks and adjusted fourth-quarter guidance accordingly, forecasting a noticeable slowdown in dollar-denominated growth from prior quarters. Yet that still translates into solid double-digit growth.

 

Also, Priceline's management historically provides very conservative guidance and typically manages to subsequently deliver upside at earnings time, as has been the case for the past four quarters.

 

Priceline Group Inc. Earnings, Past Four Quarters
  13-Dec 14-Mar 14-Jun 14-Sep
Estimated Earnings $8.29 $6.92 $12.04 $21.11
Actual Earnings $8.85 $7.81 $12.51 $22.16
Difference $0.56 $0.89 $0.47 $1.05
Surprise % 6.8% 12.9% 3.9% 5.0%
Source: Yahoo! Finance

 

At this point, fears about higher promotional costs compromising margins seem completely unfounded, based on recent sales, general and administrative (SG&A) budgets, which include sales and marketing outlays. Although Priceline's annual SG&A has soared more than fivefold since 2009 to nearly $4 billion, the gross, operating and net margins are all at multi-year highs.

 

Priceline Group Inc. Margins
  2009 2010 2011 2012 2013 Past 12 Months
Gross  53.9% 61.9% 70.7% 77.6% 84.1% 88.9%
Operating 20.1% 25.5% 32.1% 34.8% 35.5% 36.8%
Net 20.9% 17.1% 24.3% 27.0% 27.9% 28.8%
Source: Morningstar

 

While Priceline's global focus may seem like a liability due to recent currency risks and economic uncertainty, it should be hugely beneficial in the long run. To be sure, the firm wouldn't mind the hefty boost that domestically-focused rival Expedia, Inc. (Nasdaq: EXPE) is currently getting from the strong dollar, but Expedia will face its own growth headwinds when the dollar falls off its perch -- something currency analysts believe could occur as early as this year.

 

Moreover, the U.S. travel market that Expedia squarely targets is largely mature. Meanwhile, Priceline continues to expand its wide lead in global markets, where penetration is often low. To circumvent general economic malaise, management is wisely tapping into developing regions with ballooning middle classes like China, which is expected to account for nearly 30% of total travel industry bookings during the next decade, according to Morningstar.

 

Last August, for example, Priceline announced a $500-million buyout of Ctrip.com International Ltd., China's largest travel website. The deal should substantially increase hotel bookings by Chinese residents traveling abroad and within China's borders, management says. And it'll enable Priceline customers in Europe and the United States to book accommodations in China.

 

In July, Priceline completed a $2.6-billion buyout of OpenTable, Inc., an online reservation service with access to 31,000 upscale restaurants serving approximately 15 million diners each month. Although OpenTable derived about 80% of sales in the United States at the time of the buyout, Priceline's management sees ample room for expansion in non-U.S. markets and on mobile devices.

 

Booking.com, a European hotel reservation website that Priceline bought a decade ago for $135 million has evolved into a top-five travel application in 28 global markets, Morningstar analysts point out.

 

Priceline isn't unstoppable, though. Because of various headwinds and increasing competition, investors shouldn't expect bottom-line growth at anywhere near the 45% pace of the past five years. But current expansion initiatives should help Priceline to generate solid double-digit annual profit gains, perhaps approaching 20%.

 

Risks To Consider: The travel industry depends heavily on discretionary spending, which typically declines in times of economic uncertainty. If a full-blown global recession emerges from recent turmoil, then this risk could soon hit Priceline hard.

 

Action To Take --> Simply put, Priceline doesn't need to grow as quickly as it has in the past to justify share price gains, as shares now trade at more than a 20% discount to their historic price-to-earnings multiple of 30.

 

From here, I look for shares to climb roughly 45%, to nearly $1,500, over  the next couple of years. So if you've got room in your portfolio, I strongly suggest you consider taking advantage of this uncommonly good value opportunity before the market realizes this stock is oversold.

 

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Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.