By Michael McCarthy

Since 2012 Flight Centre (FLT) has defied the critics, and some would say gravity. Through soft consumer activity, reduced discretionary spending, web-based competition, a higher AUD, a lower AUD...FLT has managed to deliver. 

Growing earnings usually means a growing share price. So when FLT announced that they were downgrading profit expectations, the market reaction was severe. The shares plunged by almost 9%, driving them to point more than 25% below the March 2016 peak. The quantum of the downgrade is not huge. The problem is that the estimates went from a profit growth of 4-8% to a profit contraction of 2-5%. The shift from growth to shrinkage is crucial, especially as the company affirmed it expected sales volumes to remain steady.


Is Flight Centre cheap?

It’s not hard to argue that FLT is cheap on two popular measures – dividend yield and P/E ratio. If we assume a 5% fall in dividends (in line with earnings) the dividend yield is 4.7%. With franking, it becomes 6.6%. Not compelling, but still reasonably attractive.

The P/E ratio is a better case. At its peak in 2014, the ratio stood at around 20x. Now, it’s closer to 12.5x, levels not seen since 2013. So there is a valuation argument after this week’s tumble. 

However earnings momentum has clearly turned – and the P/E and dividend yield calculation assumes a steady, or slightly reduced state at these levels. The company cited the UK Brexit debate, the Zika virus, the Australian election and airfare price wars as reasons for the decline in profit. This grab bag of external factors may concern investors. 

An external factor not mentioned in the past is the AUD. Around 70% of Flight Centre profit comes from the Australian operations (although international operations are significant revenue contributors). While there are offsets on both sides of the currency argument for FLT, the impact on the bottom appears to correlate with the AUD, ie, a lower currency means lower profits, at least this time around.

Significantly, the company made no mention of competitors. And if you live in Australia, you probably have noticed a number of online travel groups spending significant amounts on marketing. While FLT has done very well in anticipating there is a significant market segment that will pay for the comfort and convenience of dealing in person, younger travellers, in particular, are more likely to respond to the savings an online travel service can offer over a traditional bricks and mortar travel agency.

In addition, groups like Corporate Travel (CTD) are making incursions. While CTD is a much smaller play, with around one twentieth of FLT’s annual profitability, it does have earnings momentum. There’s evidence it’s receiving some support out of the current situation, with the share price rising as FLT’s falls. 

There’s no doubting the strong track record of FLT management. However, the negative earnings trend, combined with a grab bag of external scapegoats, does not look good. The chart shows FLT received strong support when it last touched $30. If management demonstrate a grip on the drivers of the negative trend, this may occur again, and may prove an interesting level for those who simply must own FLT.

But, as the old saying goes, as a trader I wouldn’t buy it with your money.