Wotif: cheaper but no bargain

PORTFOLIO POINT: Despite its share price fall, Wotif.com is a strong company with a big share of a growing sector.
If, like many stock market participants, you take your cues from price action, a share price fall from $6 to $3.80 (a 37% decline), would lead to the conclusion that the underlying economics of the company have significantly deteriorated. However, if you turn the stockmarket off and focus on the business and its performance, you may in fact find a growing, successful and healthy business.

With recession talk dominating the media, it is hard for many to see through the clouds and find a market that is likely to grow in the foreseeable future. I have identified one market that has been forecast to double over the next four or five years and a company that stands to benefit handsomely from this growth.

I am referring to Wotif.com Holdings Limited (WTF). Its investment fundamentals are attractive with a low requirement for capital, demonstrated profitability or return on equity, a history of increasing earnings each year, strong cash flow, cash on the balance sheet and no net debt. Couple these characteristics with the shift in the way people are using the internet to purchase their travel and accommodation, and you find a company with significant tailwinds.

Wotif.com is an e-commerce business with a strong suite of leading Asia-Pacific online travel and accommodation brands, including wotif.com, and lastminute.com.au.

The success of the Wotif.com business model stems from enabling web surfers too quickly and easily access more than 12,000 hotels in 45 countries, compare room prices, room features and even make on line reservations. Gone are the days of searching for this information by calling hotel after hotel. Through its different brands, Wotif.com provides business and leisure customers with a booking service for all their travel requirements – accommodation, flights, car rental, insurance, travel packages and tours.

In terms of Wotif.com’s potential market, Euromonitor International (EI) has forecast that online sales will reach approximately 27% of total sales by 2012 (currently 13.2%) in Australia. This equates to a compound annual growth rate of approximately 18% pa and a potential market on-line market of $2,760 million.

WTF was a pioneer in this sector and is Australia's leading on line travel and accommodation service provider, commanding a leading market share position of 41%. Brand awareness in recent surveys was recorded at over 50%. Wotif.com is well positioned to benefit from the growth forecasts for the online and sub travel and accommodation markets.

Source: StockVal screenshot of Wotif.com analysis

Profitability

Wotif.com’s historical return on the capital employed in the business from 2005 to 2008 is highlighted at the bottom of the table with a Normalised return on equity well over 100% for each year (red box). This is a remarkably high level of profitability and is highly attractive if it can be sustained.

Wotif.com’s early strategy was focused on short-term “distressed” sales of accommodation or travel, and it had a narrow booking window of 28 days or less. This year it intends to extend its current booking widow (how far forward customers can book) from 90 to 365 days.

Increasing the window is likely to improve the company’s cash flow and increase its cash holding. As at December its cash balance was $71.2 million (red box) largely as a result of the booking pre-payments made by its customers. While the future earnings on cash held is likely to be lower with lower interest rates, the extension of the booking window will assist in mitigating the impact.

I expect a company with these characteristics to have a very high return on equity as its uses its client’s money to fund the company’s ongoing capital requirements.

Strong cash flow

Strong cash flows are a standout feature of Wotif.com business model. Underlying cash generation is excellent with a higher conversion of earnings into cash flow (ie, net profit compared to operating cash flow).

The company’s high cash flow has enabled it to pursue organic and acquisitive growth strategies within Australia. In 2008 the company also raised $20.5 million of new capital to help fund a number of acquisitions including Asia Web Direct (HK) Limited, which expanded its business into Asia.

Potential risks

Although the on line barriers of entry are low, the Wotif.com brands, reputation, supplier relationships, economies of scale and technology platforms are likely to provide a material barrier for a new entrant to compete.

Its competitors can be divided among fragmented online retail, hotel and airline websites. While there are a large number of online retailers exist, only a few compete with a similar product offering. The individual websites of hotel and airline companies do not offer customers the one-stop shop for all things travel-related.

With its commission structure and fees at the low end of the market range, it is difficult for competitors to compete on price. We view the risk of a large international competitor having an unprofitable price war an unlikely scenario at present.

At the end on a long bull equity market in 2008, Wotif.com made material acquisitions. It is uncertain at this stage whether or not it paid too much for the future earnings of these businesses. This to be a significant risk for shareholders.

Summary

While the fundamentals for Wotif.com reflect a robust business that is well positioned in a tough economic environment, unknowns are if management paid too much for acquisitive growth and whether the forecast growth in the online travel and accommodation market will emerge. If you want exposure to this market Wotif.com is well worth considering, and in doing so you will want a view on the value of its shares.

Although we believe it is a highly attractive company, at its current share price of over $3.80 (and price/earnings multiple of 20) it is significantly higher than StockVal’s assessment of its intrinsic value at $1.86. This, however, is a company to watch and if its share price falls it could potentially be considered for investment.

Russell Muldoon works withStockval, an online company valuation service provided by Clime Investment Management Limited.