From afr today... Market fears Flight Centre's golden era may be drawing to an end
For more than a decade, Flight Centre Travel Group has confounded the short-sellers who thought bricks and mortar travel agencies were a dying business that would face similar business pressures to print newspapers as consumers switched to booking online.
But at a time when Flight Centre managing director Graham Turner is promoting the concept of a "golden era of travel" occurring as cashed-up retired Baby Boomers head overseas on holidays, some investors fear the company's own golden era of near-uninterrupted growth in earnings and its share price has reached its end.
Flight Centre has had online rivals for a long time, but until this week it had never told the market it was losing share to those players. On Tuesday it revealed the value of its leisure transactions in Australia had grown by 2.7 per cent this financial year, behind the overall market growth of 3 per cent.
There is little doubt in the market that if Flight Centre had blamed the share loss on a resurgent bricks and mortar rival like Helloworld rather than on Booking.com and Airbnb, its shares would not have lost 21 per cent of their value in the three days following last Tuesday's profit downgrade.
The cyclical environment is tough, with the company battling headwinds from weak consumer confidence and muted outbound departure growth. But the disclosure that online players were finally taking market share from Flight Centre – even if it was just in domestic accommodation – left the market wondering if the structural shift the short-sellers had predicted for so long was finally occurring.
There was additional concern the weak cyclical environment could be exacerbating the shift, as consumers looked for cheaper direct deals on the likes of Airbnb.
Turner may have deemed the sell phase overdone, but he also admitted that domestic leisure transactions account for around 40 per cent of Flight Centre's Australian leisure transaction value. Based on its 2014 figures, that equates to around $2.5 billion, or 16 per cent of the company's global transaction values at risk. That figure would rise further if you include inroads online players are making in short-haul routes like Perth-Bali. Not all lost to competition
Clearly, Flight Centre won't lose all of that revenue to the competition. But it shows the extent of the risk facing the business. It wouldn't be unreasonable to think within a few years, 5 per cent of its revenue could be lost to online players – although offsetting that, it is increasing revenue overseas as its smaller foreign operations continue to grow.
The other risk to earnings is that in order to keep its domestic leisure revenues steady, Flight Centre will need to invest far more heavily in marketing, a move that would crimp margins. Flight Centre spends an estimated 1.5 per cent of its transaction values on marketing – or about $140 million a year in Australia – which compares with the 6 to 7 per cent spend ratio by global online players Priceline and Expedia (the figure in the local market may be higher given they have run major television campaigns in the last few years).
Flight Centre, due to sheer size, still probably spends more in real terms than each rival, but when combined, the Priceline and Expedia spend could be similar to the more established Flight Centre brand. Expedia and Priceline, the owner of Booking.com, pressured Wotif.com in part by building their brand recognition and using superior technology until the Austraian company had no choice but to sell itself to Expedia at a cut-rate price last year.
Flight Centre, as the largest player in the Australian travel market, is the next obvious target for the global giants - not as a takeover play, but for easy revenue gains. Dynamic packaging of a choice of flights and hotels for uncomplicated domestic and short-haul international breaks has been a major target of Expedia and Webjet over the last year, and Turner admits some of that business will inevitably go to online travel agents.
No mobile booking app
In the meantime, as online travel agents increase their focus on the huge growth in mobile booking, Flight Centre does not have a mobile app for its leisure business nor plans to introduce one. Whether or not the app would offer online booking capabilities, many leisure travellers would probably appreciate having their booking data to hand and being informed instantly of flight delays as Flight Centre does in its corporate business. Plus Flight Centre could "push" news of hot travel deals to mobile screens to encourage more bookings.
A travel industry insider said there was "no question" that Flight Centre should have an app, but added he wasn't surprised, given he believed the business presented itself publicly as a omni-channel retailer that in reality was paying only lip service to online as it looked to protect its core business. Apps are also notoriously expensive to develop, and doing so could further crimp margins at a time when Flight Centre has already done that by raising employee wages and letting them offer discounts in an attempt to secure business.
Travel transactions have been migrating to online for years, with data from market research firm Phocuswright showing online penetration of domestic and international bookings in Australia rose from 28 per cent in 2008 to 42 per cent in 2014, including direct bookings with airlines and major hotel chains. The process in the UK is even more advanced, with 56 per cent of bookings now online, up from 40 per cent in 2008. But until now, at least, Flight Centre hadn't shown any signs of losing market share.
In the near future, Flight Centre is unlikely to face significant challenges in its core business of booking complicated international holidays – most customers like to do that person to person, especially older ones. But there are enough anecdotal studies about 20 and 30-somethings booking European trips online direct with airlines and accommodation through Airbnb that Flight Centre might have something to worry about in the decades to come once the core Baby Boomer demographic dies out. Proven game-changers
Travel review sites like TripAdvisor have proven a game-changer, and some younger customers believe they are less biased than travel agents who receive commissions for bookings. Plus it is easier than ever to book day tours and other ground activities through websites like Viator.
The corporate division is at less risk than the leisure division of losing business to online rivals. But that said, Expedia's Egencia platform has gained some major customers, with The Australian Financial Review's publisher, Fairfax Media, having last year moved its multi-million dollar travel account from Flight Centre's FCm to Egencia.
Turner said the Egencia option is unquestionably cheap on a per transaction basis and might work for a simple domestic-focused business, but companies needing to fly on complex international routes would benefit significantly from Flight Centre's wholesale prices and its higher service levels. Still, the competition from groups like Egencia, even if it does not attract business away from many incumbents like FCm and Corporate Travel Management, could place pressure on their corporate margins when contracts come up for renewal.
Much of the investor focus on Flight Centre is naturally on its Australian business, which accounted for 57 per cent of transaction values and 76 per cent of earnings before interest and tax in the 2014 financial year. A scenario involving ongoing margin compression in Australia would obviously have a major impact on its earnings, although it is notable Flight Centre said margin compression was less severe in the second half than the first and margins were now near last year's levels on a month to month basis.
To bolster margins and earnings, Flight Centre has been looking to vertically integrate by buying smaller tour operations like Top Deck Travel and Back-Roads Touring. It is developing unique products in the Australian market that online rivals cannot offer to customers, like The Captain's International Airfare Packages and a new Beach Escape range. It is also seeing strong demand in the US and UK businesses, which rank number two and three in sales terms and will deliver both top and bottom line growth. The depreciation of the Australian dollar will also help boost its overseas earnings.
Some analysts believe the recent share price falls could be the trigger needed for Flight Centre to reinstill confidence by buying back shares and returning cash from its record $500 million-plus year end balance to shareholders. But there is little doubt Turner will face plenty of questions at the company's full-year results on August 27 trying to probe whether Flight Centre's golden era of growth will continue or if it is drawing to an end.
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