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CFA Institute Research Challenge
Hosted by
CFA Society Sydney
Griffith University
2016 | CFA Institute Research Challenge
Flight Centre Travel Group Limited
FLT: AU/ FLT.AX Recommendation
Industry: Consumer Discretionary
Current $36.85
At 31/8/2016
è Market Cap è Avg Daily Volume è Free Float Target $31.93
AU$3.6B 820,640M 50.49%
100.93M Shares Potential Downside 13%
Executive Summary
Key Stock Data Sep16
As per our valuation, we issue a sell recommendation for Flight Centre (herein ‘FLT’ or the
52 Week Range 45.37 - 29.38 ‘Company’). Our 12-month target price is $31.93AUD, with a projected downside of 13%. This
Institutional Ownership 62.45% has been calculated using a combination of (1) The Dividend Discount Model, (2) Discounted
Free Cash Flows to the Firm, and (3) several Relative Valuation techniques.
ROE 18.67
Current P/E 12.93
Investment Thesis and Outline
Est. International P/E 10.21 Industry volatility, lowered necessity for travel agency intermediation and little international room
Est. Domestic P/E 14.08 for expansion all collectively suggest that FLT will face future struggle. Declines in financial
performance of the Company in 2016 have resulted in weaker competitive positioning. We
EPS 2.42
believe this is paving the way to eventual stagnation of income, and hence loss of investor returns.
Est. EPS 2.69 A summary of our fundamental top-down analysis is as follows:
Price/Book 2.37 • High International Competition: Many key international players already dominate worldwide
1
Price/Sales 1.21 market share. We forecast eventual online market saturation, leaving little room for global
development unless FLT can steal revenue from its existing competitors.
Dividend
• Lowered Industry Commission Potential: Increased sales demand from price wars between
Div. Yield 4.30% domestic budget airlines cannot offset lowered commission revenues. Further, demand for
DPS 1.52 agency intermediation is decreasing as online platforms are making it easier for consumers to
5 year Dividend bypass the middleman, and compare the competition.
12.59%
Growth
• Shifts in consumer preferences: Consumer preferences have shifted and now favour
localised travel due to the weak AUD/USD primary pairing. This form of travel is simple and
Relative Performance does not usually require agency intermediation. Further, corresponding growth in inbound
S&P/ASX200 travel does not form revenue for FLT.
Ticker: AS51 • Expensive Capital Structure: FLT currently has the most expensive WACC of all peers as
2
1m 3.73 CAPEX is funded entirely through equity. As the Company is focusing on future expansion,
6m -25.46 this will reduce the profitability of such ventures.
12m -19.81
• High Expenses and Low Net Profit Margins: For the previous 3 financial years, operating
expenses have grown at a higher rate than revenues, leaving low and unimproved net profit
S&PASX 200 Consumer Discretionary margins. This has led to a ROA below peer average, and an ROE at a second all time low,
Ticker: S5COND causing concerns for shareholders.
1m 5.76 • Low Potential for International Profits: As FLT have shifted their focus onto claiming
6m -16.68 international market share, expenses incurred do not benefit from FLT’s economies of scale
within Australia. Consequently the bottom line for these segments is not as profitable as it could
12m -13.58
be if revenues were incurred domestically.
• Many investment risks are faced and inherently volatile: Operation within 14 countries
Source: Bloomberg & Team Estimates naturally causes high amounts of foreign exchange and economic risk. Further, FLT’s large
fixed expenses combined with commissions fluctuating due to price wars cause high operating
risk.
Income Statement
2016 2017F 2018F 2019F 2020F
($'000,000)
TTV 19305 20608 21879 23095 24234
Revenue 2640 2878 3058 3222 3372
EBITDA 409 456 459 473 482
EBITDA Margin 15.49% 15.86% 15.01% 14.67% 14.29%
Net Income 245 272 265 265 265
Net profit Margin 9.264% 9.466% 8.683% 8.240% 7.868%
Balance Sheet ($'000,000)
Total Assets 3001 3285 3596 3936 4308
Total Liabilities 1655 1812 1983 2171 2376
Total Equity 1346 1473 1612 1765 1932
Ratios
FCFF/Share 2.80 2.77 2.72 2.65 2.56
EPS 2.42 2.70 2.63 2.63 2.63
DPS 1.52 1.61 1.55 1.54 1.53
ROE 18.70% 19.33% 17.21% 15.72% 14.35%
ROIC 18.18% 18.30% 16.36% 15.03% 13.61%
1
Priceline (PCLN:US) $1,418.59, Expedia (EXPE:US) $113.13, CTrip.com (CTRP:US) $48.96
2
Above, also including Webjet (WEB:AU) $9.64, HelloWorld (HLO:AU) $4.30, Corporate Travel Management (CTD:AU) $18.14
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2016 | CFA Institute Research Challenge
Figure 2: Corporate Structure Business Description
Company Overview
Founded in 1981, FLT is an Australian based travel agency headquartered in Brisbane, Queensland.
The Company had its IPO in 1995, and boasts 2.64B in revenue and 3000 stores in 14 countries as
of FY16. Despite their name, FLT is not limited to revenues from airline ticket sales, and actually
provides a number of services within the travel industry, such as cruise lines, car hires, and hotel
accommodation.
Business Structure
Source: Flight Centre Travel Group Previously known as Flight Centre Limited, FLT changed their name to Flight Centre Travel Group
Annual Report Limited in 2013. Majority of the Company’s revenues are derived from the travel industry, where
they operate within leisure, corporate and wholesale sectors. Of the 40 brands under FLT, leisure
Figure 3: Recent Acquisitions has consistently remained the strongest sector, while the corporate division has grown to 33% of
revenues for FY16 under 6 dedicated brands. The Company are targeting consumers at many
different stages of travel: expanding their products to include tourist activity packages (Cruise About)
and currency exchange services (Travel Money).
Excluding the travel industry, in 2016 only 9.92% of total revenue was attributed to FLT’s other
companies. Evidently, FLT’s business structure is hardly diversified. This is due to the fact that
management are aiming to use such expansion into other areas to support FLT travel segment
growth simultaneously. For example, products from Buffalo Tours are sold within FLT’s travel
package bundles, and courses offered First Class Education Group include travel agency training
for employees.
Though originally a brick and mortar store based company, new technology developments are
forcing FLT to expand online to continue sustainable growth. The Company has shifted its business
structure by investing in online booking platforms, either by developing its own websites and online
brands such as Aunt Betty, or acquiring businesses who already have a foot in the door such as
BYOjet and Student Universe (Figure 3).
Source: Bloomberg &FLT annual
Company Strategy
Report FLT is undertaking a transition from traditional travel agency to a ‘person-to-person’ travel service
provider. This includes less reliance on physical stores and increased presence online. Further, the
Figure 4: FLT Revenue Break- company also wants to further personalise customer experiences, by giving agents the ability to
down work from home and build a selective customer base.
The Company is undertaking large geographical expansion, and does so primarily through
acquisitions. Within the last two financial years FLT have acquired several profitable companies,
such as StudentUniverse.com. It is expected that they will continue to capture market share through
this method.
Revenue and Expenses
FLT’s main source of income is on a commission basis with individual airlines. As these contracts
are largely discretionary, FLT’s revenue streams can fluctuate, particularly if high competition is
shrinking retail prices. These contracts include different commission streams, such as a flat dollar
amount per ticket sold, a percentage, and even overrides if FLT is successful in selling all their
holdings. FLT’s revenues are hence a percentage of their total transaction value (TTV); an unaudited
Figure representing the total price of transactions they have undertaken as an agent.
Source: FLT Annual Report &
FLT suffers from high operating costs, particularly through wage and rent expenses necessary to
Bloomberg
maintain their dominant brick and mortar stores. Management is making efforts to combine several
smaller stores into a few large ones to maximise efficiency. Further, as the Company is planning
Figure 5: Industry Sentiment
further expansion into digital platforms, this may also then cut these expenses.
Survey: Factors Essential to
tourism
Geographical Performance
FLT has operations across 14 countries, among which Australia comprises of 49% revenue. This
should come as no surprise as FLT have built themselves to a bellwether status within the domestic
market; with a total of 20,000 employees within Australia and 79% of the domestic industry revenue.
Following Australia are both the Europe and North America segments, at 15.6% and 11.2%
respectively. In FY16, South Africa hit a record first-half year result, becoming the third most
profitable country by TTV to EBIT margin.
FLT’s success however, is not consistent across the board. The INDUASIA segment contains India,
Singapore & Malaysia, Greater China and United Arab Emirates. FLT have had increasing issues
within this area and closed losses in FY16. However in order to compensate, management have
Source: Austrade made acquisitions within the area to capture increased market share. In particular, the Company
may expand into mainland China to add to their geographical diversity.
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2016 | CFA Institute Research Challenge
Figure 6: Terrorism Incidents Industry Overview and Competitive Positioning
FLT operates under the Travel and Tourism subsector of the ICB; an industry that currently has
an adjusted market value of $7.05B AUD and an adjusted 5-year CAGR of 11.16%. This growth
rate is dependent on macro-economic factors which highly influence the expected travel
expenditure of both corporate and leisure consumers. In particular, business and consumer
confidence levels, exchange rates, and discretionary income Figures all remain key drivers in the
revenue potential of travel intermediaries (Figure 5). Additionally, the industry is also subject to a
large amount of social and environmental challenges, such as Brexit, the Zika Virus and increased
Source: Global Terrorism Database threats of terrorism (Figure 6). These effects are further described in Appendix 2. These issues
pose great threats to consumer confidence levels; a crucial element to success within an industry
Figure 7: YOY International that survives on discretionary spending.
Travel Growth
Decreases in Outbound Travel Reduce Industry Sales
Currently, growth of total Australian overseas departures is below the 10 year YOY growth
average (Figure 7). This slow in outbound growth can be attributed to the weak AUD, as
international travel for Australian residents is obviously becoming more expensive. While this is
matched with a higher amount of incoming foreign travellers who wish to reap the benefits of a
cheaper exchange rate, Australian travel agencies such as FLT will not profit. This is because
bookings will likely be made from a foreigner’s local travel agency, or online platforms. We expect
this situation to continue and hence FLT’s revenue streams to struggle, as NAB economist
predictions favour a further weakening of the AUD (Figure 8).
Emerging Budget Airlines and Increased Aeroplane Capacity Reduce
Agent Commissions
The previous 10 years have seen the emergence of budget airlines revolutionise the travel
Source: bitre.gov.au; industry. This increased demand for cost-effective travel is being driven by shifts in consumer
IBISWorld; Team Estimates preferences (Figure 9), a large driver of Australian tourism. Combined with falling international
airfare prices (Figure 10) demand has increased significantly for FLT products.
Figure 8: Currency Forecast ($)
Yet this is not matched with corresponding profit growth, as commissions are also cut with retail
price. While the decision to offer these bookings is necessary to retain market share, it is expected
FLT’s profit margins will suffer considerably.
Increasing aeroplane capacity also has a similar effect. The enhanced supply of tickets is
expected to act as an incentive for airlines to offer overrides within their contracts. Yet inherently
with such over-supply, prices must be decreased to also increase demand. Combined with the
slow down of international travel, these increased capacities are eroding commission potential. It
is expected that this will adversely affect FLT, and that their profit margins will lower
correspondingly.
The Need for Travel Agency Intermediation is Greatly Lowered Due To 4
Source: NAB & Bloomberg L.P
Key Factors
1. Consumer Preferences Favour Simple Localised Travel: Increased consumer preference
Figure 9: Passenger Count for localised travel within Australia is evident by high passenger growth to domestic destinations
(Budget Vs Full Service) (Figure 11). While increases in discretionary spending would normally plant the perfect seeds for
growth within the travel industry, agencies cannot derive revenue from localised travel due to it’s
inherent simplicity. Consequently, this effect is expected to be disastrous for FLT revenues as
excess consumer income is spent on travel that does not usually require agency intermediation.
2. Online Platforms Create Higher Competition and Increase Direct Online Supplier Sales:
The online industry is highly concentrated by direct suppliers and major online agents, who
collectively hold 72% of revenues (Figure 12). Many of these well established travel companies,
such as airlines, hotels and other direct service providers face little difficulty in expanding online.
Due to the cost-effective nature of such a platform, these businesses are rapidly increasing their
direct online sales by directly marketing to consumers, cutting out the middleman (Appendix 4).
Source: QAN Annual Report Consequently there is a lowered necessity for travel agency intermediation.
Figure 10: CPI Adjusted Best Such a conclusion is supported by a study conducted by the European Journal of Tourism
Discount Rate Airfare ($AUD) Research in 2015 (Appendix 4). Particularly for frequent traveller, consumers prefer booking
directly online. This is due to the quick and easy nature of the platform, user desire to save
intermediation costs and the ability to effortlessly compare competitors at the click of a button:
increasing the risk of stolen market share.
Further, the study also concludes that online travel research has transformed into an
entertainment platform for consumers, who can come home after a long day at the office and plan
their dream holiday. While these persons are typically low-frequency travellers, and the study
suggests that they are more likely to require intermediation, they are inherently less profitable
than those who travel regularly. Hence the increased presence of direct online booking systems
pose a great threat to travel agency revenues.
Source: bitre.gov.au
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2016 | CFA Institute Research Challenge
Figure 11: Passenger Growth
(%) To Leisure Destinations As this technological expansion favours the easiest methods for consumers, it is likely that agency
presence online could become redundant. Companies such as Google, Facebook and travel
information websites like Tripadvisor are seeing exponential growth in their travel advertising
revenues. This is due to an increase in suppliers expanding their direct online marketing strategies
(Appendix 5). As a result it is likely that these large web conglomerates may look at directing online
traffic more efficiently, causing further disintermediation.
3. Airlines Directly Winning Corporate Contracts Cut Out the Middle Man: Another factor
responsible for agency disintermediation is an increased amount of exclusive contracts won by
airlines directly. Loss of large contracts with these corporate clients is resulting in further agency
struggles. Further, those clients that have been maintained are no longer as profitable, and likely
not to be renewed. This is because enhanced connection speeds have increased teleconferencing
capabilities, hence reducing demand for business travel (Figure 13).
4. Increased Technological Competition Challenge Agency Revenue At All Stages of Travel:
The rises of peer-to-peer travel services is causing further competition and further potential
intermediary redundancy. Agencies strive to target consumers at all stages of their travel, such as
Source: bitre.gov.au
hotel and vehicle hire, where corresponding commissions and packages can be made. However
low-cost alternatives like Uber and Airbnb are now also threatening these revenue streams
Figure 12: Australian Online (Appendix 3). Consequently FLT’s entire service revenue chain is being threatened due to micro-
Travel Agents (OTA) entrepreneurs.
All of these factors are expected to cause future revenue struggles for FLT as a travel intermediary.
Consumer preferences clearly favour online direct bookings without agency involvement. As agency
online sales are expected to continue stagnating, FLT cannot expect any further growth within the
industry from their online platform. Additionally, struggles to maintain corporate contracts, a segment
that accounts for 33% of FLT’s total revenues, are expected to be detrimental to sales.
FLT’s Online Expansion Lags Behind the Industry
Revenue streams within the industry saw massive growth within the 2012-2013 financial year due
to the weak AUD and resulting increased demand for international travel. These excess profits saw
many companies within the industry focus on a cost-effective online expansion. FLT however, was
not one of them. As a result the Company is expected to face struggles within this platform,
Source: IBISWorld
particularly as they face enhanced international competition and are falling behind competitors. This
is further elaborated in the Porter’s Five Forces model in Appendix 1.
Figure 13: Enhanced
Teleconferencing Ability on
Currently, Australia maintains a dominant online presence, with an Internet retention rate of 93.1%
Industry Corporate Travel
(United Nations, ITU, 2015). Naturally then, consumer preferences highly favour online platforms
due to their ease and efficiency, and so these have seen large success within the industry since
introduction. Consequently, there is little market share left to be won by those who did not originally
expand into the platform, such as FLT. While management aims to grow online TTV to $1B in 2017,
this is not feasible with the industry supply chain rapidly transforming. Further, FLT now face
competitors who solely exist online and hence have lower costs and higher profit margins. As half
of the world's population will have access to the Internet by 2020 (United Nations ITU, 2015), and
FLT is lagging behind in an industry expansion that will soon see their current brick and mortar stores
become obsolete, it is expected that they will struggle immensely.
Fierce International Competition Limits Organic Revenue Growth
FLT has attempted a global expansion over the previous decade, however competition is undeniably
Source: Bloomberg; United Nations high with Expedia.US and Priceline.US dominating the online market as a duopoly. The low
likelihood of FLT stealing market share from these dominant players coupled with the eventual
industry approach to market saturation both pose large barriers for FLT to gain online revenues.
Figure 14: Market Share of Total Admittedly, the Company has taken a dynamic approach to obtain market share by undertaking a
Rides (US) large amount of acquisitions and divestitures, particularly within demographic specific service
companies. An example is their acquirement of StudentUniverse (a total overview of all acquisition
activities can be found in Appendix 20. However the Company is struggling to transfer its domestic
success and economies of scale onto an international platform. Global competitors already hold a
large market share that FLT is struggling to steal (Figure 20). As a result the company’s continued
acquisitions are expected to be stagnant to revenues and are in fact distracting management from
further domestic profits. This is magnified as FLTs decreasing market share in Australia is corroding
their economies of scale advantage (Figure 17).
Online Expansion Will Cannibalise Sales and Increase Competition
Switching to a multi-channel agency also poses threats for FLT as this will cannibalize their revenue
streams. Majority of the Company’s traditional customer base originate from brick and mortar stores.
Source: Certify Report By moving online, this opens up an easy platform to compare competitor pricing. Consequently FLT
are providing their loyal, store-based customers a method to reconsider their agency options. As a
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2016 | CFA Institute Research Challenge
result, it is expected that FLT will struggle to retain their in-store customer base through this
Figure 15: Airbnb Number of transition, and so sales will suffer accordingly.
Nights Booked
The Industry Life Cycle Favours High Growth for Competitors
FLT currently resides within the mature stage of the industry life cycle. This is resultant from
management's strategy to protect its currently dominating market share and secure stable revenues.
The company’s competitors however, are all estimated to have a strong growth outlook, and hence
in a position to retain market share and greater benefit from industry success. Online competitors
Webjet and Helloworld have strong forecasted growth for FY17, largely due to strategic M&A
Activity. Although the online market is reaching saturation, these competitors are all stealing
proportions of FLTs market share, and so are within the shakeout stage of the industry life cycle
(Figure 18).
Source: Cowen &Company; Team
Estimates.
Investment Summary
Figure 16: Porters 5 Forces We issue a sell recommendation for FLT with a 12-month target price of $31.93AUD, representing
a 13% downside potential from it’s current stock price of $36.85 on August 31st, 2016. The three
valuation techniques used to derive our target price were the Dividend Discount Model (DDM), the
Discounted Cash Flow Model (DCF) and Relative Valuation techniques (RV). This downside is
driven by:
• Lowered agent commissions due to decreases in outbound travel and price wars;
• The high costs and little profit potential of international expansion both in store and online due
to existing competitors and forecasted online market saturation;
• Reduced necessity for agency intermediation within the industry;
• FLT’s below average capital structure; and
• The Company’s high and inefficient operating expenses and resulting inability to improve low
Source: Team Estimates margins.
Figure 17: Industry Market Share Investment Drivers
(Australia) Decreased Domestic Agency Commissions: High competition within the industry is resulting in
exceedingly low airfares, reducing commission margins for FLT. Despite increased demand due to
over-supply; revenues are still expected to decrease accordingly. Further, the weak AUD is resulting
in lower outbound travel rates, and so discretionary income is being spent on localised travel, which
has comparatively lower profits. While Australia’s cheap currency is increasing foreign travellers,
these consumers are likely to use their own respective travel agencies and so such an influx does
not lead to profits.
Low Potential for Profitable International Expansion: The online travel industry is highly
competitive as it combines direct suppliers and other agency competitors onto one easily
comparable platform. Many existing competitors, particularly the dominating international duopoly
of Expedia.US and Priceline.US, broke into online platforms earlier than FLT, hence securing a
competitive advantage (Figure 20). Consequently, the Company will need to steal existing market
share in order to break through within these markets. This is supported by our prediction that the
Source: Bloomberg market will reach saturation. The result is an increased price competition placing further downwards
pressure on revenue forecasts.
Figure 18: Stages in the Industry
Life Cycle FLT’s management is currently undertaking expansions through the costly acquisitions of
businesses within niche markets. However, this strategy is not permanently sustainable, and does
not improve the Company’s organic growth nor steal market share from other existing competitors.
Profit margins of international segments are also significantly lower than those within Australia, as
overseas expense structures do not benefit from FLT’s domestic economies of scale (Figure 23;
Figure 24). Consequently, management’s focus on international expansion will not result in
corresponding shareholder gains.
Lowered Necessity for Travel Agency Intermediation: Four key industry factors are adversely
affecting demand for FLT services. Firstly, consumer preferences have shifted to favour local travel:
Source: Team Estimates
an inherently simpler task generally not requiring intermediation. The industry’s expansion online,
Figure 19: FLT SWOT- Analysis secondly, has resulted in higher competition and increased sales between suppliers and consumers
directly. FLT is consequently cut out. Airlines are now also targeting large corporate clients,
contracts that FLT used to win. These corporate sales account for 33% of FLT revenues. Finally,
sales are being challenged at all platforms due to the rise of peer-to-peer travel services. This
include companies such as AirBnB and Uber, who are capturing market share from FLT’s car hiring
and hotel packages (Appendix 3).
Expensive and Below Average Capital Structure: FLT has the lowest amount of debt financing
among key industry players. While this might give reason for upside potential, FLT have confirmed
they will not take on any debt capital. Consequently they will continue undertaking much more
expensive investments than necessary, falling further behind competitors.
Source: Team Estimates
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2016 | CFA Institute Research Challenge
Figure 20: Revenue Comparison High Operating Expenses Drive Down Profits and Shareholder Returns: While FLT’s TTV
(US$ Million) (International) grew consistently over the last five years, this does not translate to their bottom line. This is
because expenses are growing at a higher rate than revenue streams, jeopardising profits.
Correspondingly, net profit margins have remained consistently low. Majority of the Company’s
high operating expenses are derived from rent and salaries, as they heavily rely on their bricks
and mortar stores for revenue. Consequently, these low profits are forecasted to continue, and
as revenue streams will be declining while expenses maintain steady growth, profit margins will
be squeezed (Figure 27).
Dividend Policy
FLT's payout ratios over the last five years have been in line with their dividend policy of returning
50-60% of NPAT to shareholders, with the only exception being FY14 when a fully franked
Source: Bloomberg dividend of $1.52 led to a payout ratio of 74%. This particular outlier was due to the directors
desire to share their strong cash reserves despite a low NPAT for the year. FLT’s current payout
Figure 21: Dividends & Payout ratio of 61% also sits slightly higher than usual, with the ten-year average being 55%. Our
(%) forecasts expect the Company to pay flat dividends of $1.61 per annum until FY20, as we believe
they will maintain a payout ratio of 60% while NPAT stagnates (Figure 21).
Investment Risks
The key risks that pertain to FLT include foreign exchange risk, economic risk, operational risk
and credit risk. The former risk includes translation and exchange risk due to their multicurrency
debt facility. Economic risk includes the high sensitivity global shocks may have on travel
behaviours and discretionary spending. The Company faces operational risk through decreasing
airfare prices, which lower commission streams, as well as the increasing threat of online
competitors.
Source: Bloomberg & Team Estimates
Figure 22: P/E Ratio forecast for
FLT, domestic and international
peers
Financial Analysis
Expensive Capital Structure with No Plans of Changing
Comparative to the chosen peer group, FLT now remains the only major company within the travel
Source: Team Estimates industry that is not taking advantage of debt financing. (Figure 26). While this may immediately
seem like a good reason for upside potential, FLT have never once taken on long-term debt nor
Figure 23: International have any plans to. Although in FY16 both ROE and ROIC (18.7% and 18.17% respectively)
Segments remain higher than 5 year historical WACC (12%), ROE sits at a second all time low for the
company, suggesting future shareholder returns are limited (Figure 25).
High Operating Expenses Limit Equity Returns
FLT has continuously boasted a high and consistent ROE, largely as a result of their strong
revenue streams. The lack of debt capital creates a small book value size of the company, thus
creating an outstanding total asset turnover (Appendix 9). Such efficiency, however, is limited to
the books. FLT have an outstanding amount of fixed operating expenses, resulting in a
consistently low net profit margin (Figure 27). This has then resulted in an average return on
assets comparative to peers. (Figure 28) This translates into their ROE.
Erratic Capital Expenditure and High Lease Commitments Further
Decrease Profit Margins
Source: FLT Annual Report The Company’s major downfall lies in its large underlying expenses. Capital expenditure has been
volatile and hence not accurately predictable, leading to fluctuating profit margins (Figure 29).
Figure 24: Segment Summaries FLT currently utilize straight-line depreciation, which is incremental at 10% of yearly capital
expenditure; this expense alone grew 22.2% in FY16. For the previous 2 financial years expenses
have grown at a faster rate than revenues (2015: 10.6% to 7.0%, 2016: 13.4% to 11.2%). Further,
FLT operate their stores entirely through lease commitments, and so considerable cash flows
also go toward paying these rental expenses. FLT have a total of $654M of lease commitments
over the next 7 years, with an estimated present value of $529M (Appendix 8). Consequently the
Source: FLT Annual Report lack of any clear management strategy between capital expenditure and free cash flow, combined
with large amounts of short-term lease commitments, will greatly decrease shareholder value as
dividend payouts are hence derived from NPAT.
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2016 | CFA Institute Research Challenge
Figure 25: ROE and ROA International Expansion Will Jeopardize Net Income Due To Higher
Expenses and No Economies of Scale
FLT are quick to boast their international income diversity, with Australia comprising 55.4% of total
FY16 revenues (Figure 23). However differences in geographical expenses result in drastically
different statutory EBIT values, as Australia rose to 74% due to the clear presence of economies of
scale within domestic expense structure. Further, the segment’s profit margin stood at an astounding
21.15%, with the Rest of the World and US regions causing concern at 8.32% and
2.7% respectively (Figure 24). As discussed above, management is targeting strong international
expansion. In doing so however, the larger expenses faced in non-domestic regions will result in
lower profits than if such revenues were made locally. Also, the required capital expenditure to then
set up such income streams in these new segments will then further decrease profitability and
Source: Bloomberg & Team Estimates
efficiency, drastically affecting shareholder value.
Figure 26: WACC Peer Revenues Internationally Are Not Justifying Costs
Comparison The company is adamant regarding their strong TTV growth as a major driver of their success,
however increased sales volume does not result in corresponding revenue growth. (Appendix 8).
When the margin between TTV and revenue is broken down per segment, they severely differentiate,
likely due to differentiating commission laws and standards.
Though overall revenue grew 11.2% in FY16, expenses grew 14.61% (13.4% excluding the one off
impairment charge), resulting in a 5.8% decrease in EBIT. When broken down into segments, all
regions had decreased profit margins in comparison to FY15 (Appendix 6).
As discussed above, FLT is losing market share due to its main competitors deriving online revenue.
While this area is one that FLT are looking to explore further, these trends will continue as younger
Source: Bloomberg & Team Estimates generations favor a technological approach. Despite the Company addressing this, they are still
undertaking large investments into physical assets and employees. This alone increased their wages,
Figure 27: Profitability Analysis rental and depreciation expenses by 11.91% in FY16.
The current management plan clearly favours long-term growth however financially this will not result
in increased shareholder value in the forecasted period. Instead it is expected that expense growth
will continue to surpass sales growth within the next four years, and so any eventual benefits to net
income will not fall within the forecasting period. Consequently, as the dividend policy sits at 50-60%
of NPAT, these growing expenses will be detrimental to shareholder profit.
Valuation
We have used a combination of three valuation approaches: the Dividend Discount Model (DDM),
Source: Bloomberg & Team Estimates the Discounted Cash Flow Model (DCF) and Relative Valuation techniques (RV). These have led us
to our weighted average target price of $31.93AUD indicating 13% downside potential. Each of
Figure 28: Peer ROA these methods have weightings of 20%, 40% and 40% respectively. These were chosen to reflect
Comparison that free cash flows are a better indicator of FLT’s future cash flows opposed to dividends, and also
to reflect our opinion that multiples are the key driver behind making a stock converge to it’s intrinsic
value.
DDM
Dividend Discount Model (20%)
$27.33
FLT has maintained relatively stable dividend payments over the
past 10 years, hence making the DDM an ideal valuation Weighted
Value
technique. The Company has maintained their policy of returning $31.93
50% to 60% of NPAT. Therefore, future dividends are predicted RV (40%)
DCF
(40%)
based on this policy being maintained with forecasted earnings. $33.10
$33.07
Source: Bloomberg
CAPM: The capital asset pricing model was used to determine
FLT's required rate of return at 8.51%.(Figure 31)
Figure 29: Operating Margin
Dividend Forecasts: We have assumed the Company will maintain a consistent 60% payout ratio
Analysis
of NPAT, and hence calculated future dividend payments based on our bearish net income forecasts.
Terminal Growth Rate: The Company’s terminal growth rate was estimated at 3% (Figure 35).
Notably, nearly half of FLT’s total revenues are generated from international markets. Therefore we
have incorporated the GDP growth rate of domestic and international markets to reach a suitable
terminal growth rate. We assigned a weighting of 75% to the average GDP growth rate of the three
most dominant markets (Australia, UK and US), consistent with revenue breakdown per segment.
The remainder is attributed to an average of Asia and South Africa (Appendix 11).
Two Stage Model: Currently our projected dividends indicate a decreasing trend due to our
Source: Bloomberg prediction that net income growth stagnate. However in times of struggling profits, FLT have
historically raised the payout ratio to avoid negative dividend signals. As the last three years’ d
ividends were paid at flat level, we assume that FLT will undertake a similar strategy on the basis of
our forecasted 2017 dividend ($1.61AUD) until 2020. After this, we assume the dividend growth rate
will be constant.
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2016 | CFA Institute Research Challenge
Figure 30:
Based on the above information and Appendix 12, we have reached an intrinsic value of $27.33AUD.
Additional sensitivity analysis has been conducted with two pairs of variables: payout ratio versus
cost of equity and terminal growth rate versus cost of equity.
Discount Cash Flow Model
We have also used free cash flows to firm (FCFF) as alternative future cash flow to estimate FLT’s
intrinsic value.
Source: Bloomberg. & Team Estimates WACC: We have considered two major uncertainties to estimate the cost of capital:
1. Historically low interest rates could entice FLT to take on more debt; and
Figure 31: 2. High volatilities in stock price and pressures upon future earnings create higher risk.
Consequently, we used a combination of current WACC (8.3%) and the 10-year historical average
WACC (12%) to reach our long-term estimated cost of capital at 10.15% (Appendix 11).
FCFF: We have computed FCFF from Cash Flows from Operations (CFO), which has been
projected by directly forecasting its components. Two essential components are receipts from
customers and payments to suppliers and employees.
1. We have set the growth rate of receipts at 6.3%, equal to forecasted compounded revenue
Source: Bloomberg. & Team Estimates growth from 2017-2020. Historically, these two factors have shown high correlation with minimal
spread.
Figure 32: 2. Similarly, we set the growth rate of payments equal to the compounded operating cost growth
rate for the forecasted period, at 6.7%.
CapEx Growth Rate: FLT has undertaken aggressive expansion in the past five years, and so we
assume they will continue to invest in fixed assets in accordance with the historic five-year average
CapEx growth rate of 11.5% (Appendix 11).
By applying the same LGR as above, we reached an intrinsic of $33.10AUD. The three key
variables used in sensitivity analysis are WACC, CapEx growth rate and LGR (Appendix 13 & 15).
Relative Valuation
Source: Bloomberg & Team Through our relative valuation model, we derived a target price of $33.07AUD using three key
Estimates multipliers: Price/Earnings (P/E), Enterprise Value/Earnings before Interest Tax, Depreciation and
Figure 33: Amortisation (EV/EBITDA), and Price/Sales (P/S).
This model is then further split into domestic and international to provide insight into differentiating
Company expectations within different playing fields. (Appendix:14).
Within the domestic comparable pool we have included HLO:AU, CTD:AU, WEB:AU and also the
S&P/ASX Consumer Discretionary Index. International peers consist CTRIP:US, PCLN:US,
Source: Bloomberg & Team EXPE:US and the MSCI World Consumer Discretionary Index. All chosen comparables are subject
Estimates to similar risks and growth potential. To derive our final intrinsic value, we have combined both
Figure 34: target prices, weighting domestic and international target prices based on their forecasted
proportions of total revenue as illustrated in Figure 34.
P/E and EV/EBITDA: These multiplies provide an insight into FLT financial health by taking into
account both the Company’s capital structure and earnings. Historically, both international and
domestic multiples have sat above FLT by the same margin.
Price/Sales: This multiple however, serves as an alternative and is useful for identifying how much
revenue the company generates in isolation, with less chance of accounting manipulation. However
as the multiple shows a limited picture by only capturing sales, we have assigned a weighting of
20%. P/S has also traded as a discount, with the international pool sitting significantly higher than
domestic (Appendix 14).
FLT has maintained a dominant presence in the Australian travel industry, hence explaining the
higher target prices in comparison to international for P/E and P/Sales. This further illustrates the
risk FLT will face as they expand internationally and compete with the international comparable.
Additional Sensitivity Analysis
Both the DDM and DCF methods highly depend on terminal value, in order to neutralise this
drawback, we conduct the following analyses to gain further confidence in our recommendation.
Residual Income: One of the key advantages to RI model is the reduced reliance on terminal value
Source: Bloomberg & Team Estimates
for the determination of intrinsic value. Applying the same variables as the DDM, and taking current
book value into consideration, we obtained an intrinsic value of $32.25AUD. This is consistent with
the DCF results. Consequently while residual income was not taken into the final weighting
arrangement, the RI results confirm the results of our DCF model (Appendix 16).
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2016 | CFA Institute Research Challenge
Figure 35: Terminal Growth Monte Carlo: In addition to the sensitivity analyses conducted for each method, we have also
completed a Monte Carlo simulation on the basis of the DCF. In the simulation, we defined
assumptions for five major variables (receipts, payments, CapEx growth, WACC and LGR) and
applied reasonable standard deviations. After running 20,000 trials, the simulation results suggest
that more than 60% of total possibilities estimate a target price below FLT’s current market price
(Appendix 17).
Source: IMF & Team Estimates Scenario: To gain further robustness, a scenario analysis was also conducted based on all three-
valuation models, and has been explained with Monte Carlo distribution. The following table
Figure 36: Scenario Prices illustrates our forecasts for the decisive variables within the three valuation models for each case:
bearish, base, and bullish.
Bearish Assumptions: We assume that FLT’s revenue growth will be below the Australian
outbound travel growth rate of 5.5% (Appendix 19). This is then expected to lead to even worse net
income growth, and a lowered dividend payout ratio. In this situation, the Company will strive for
survival by maintaining a relatively high CapEx growth rate. Further, cost of equity and hence WACC
could rise due to higher risk.
Bullish Assumption: Here, we have assumed FLT’s revenue growth rate will outperform their 5Y
Source: Bloomberg & Team Estimates
average, and stay in line with their historical 10Y long-term growth average by increasing
investments. Net profit margin will be improved, which will boost investor confidence and hence
decrease WACC.
Figure 37: Monte Carlo
Scenario Analysis
Key Variables Bearish Base Bullish
Receipts 5.00% 6.30% 9.00%
Payment 6.00% 6.70% 9.00%
CapEx 11.15% 11.50% 15.00%
Source: Team Estimates
WACC 10.89% 10.15% 9.40%
Cost of Equity 9.13% 8.51% 7.89%
Payout Ratio 50.00% 60.00% 60.00%
Figure 38: Risk Matrix Net profit 1.50% 2.00% 12.50%
Target Price $23.45 $31.61 $40.71
Up/Downside Potential -36.36% -14.21% 10.46%
Probability 0.2455 0.4551 0.2994
Probability Weighted Target Price $32.33
Potential Downside -12.26%
Investment Risk
Source: Team Estimates
By regressing FLTs monthly returns against the S&P/ASX200 and observing the coefficient of
determination, it is evident that FLT’s risk profile is relatively independent from the market.
Figure 39: Trade & Other Consequently, approximately 71% of total risk faced by FLT is unsystematic (See Appendix 19 for
Payables ($'000) time-varying volatility modelling) This can be attributed to the outlined risks below.
Foreign Exchange Risk
FLT plans to expand their international operations (Figure 42), increasing their exposure to foreign
exchange rate risk. As illustrated in Figure 39, FLT dramatically increased its foreign trade payables
by 118% between 2014 and 2016 (Appendix 22).
FX1 - Translation Risk: For functional and presentation purposes, FLT’s financial statements are
recorded in AUD. Transactions occurring overseas are transformed to Australian currency at the
time of the transaction. Conversely, Asset and liability translations occur on the date of the statement
using the closing rate. Any spreads arising from the translations are then reclassified to profit and
loss, which have a history of being highly volatile (Figure 40).
Source: FLT Annual Report
FX2 - Cash Flow: While forecasted cash flows are highly probable, they can be subject to
Figure 40: Net exchange forecasting error as the contracts are re-priced every 12 months. Over the previous 5 years,
differences on translation of variations in gains and losses from cash flow hedges have remained relatively low (Figure 41).
foreign operations ($'000) Mitigation: FLT is risk adverse in their hedging strategy. The Company aims to minimize exposure
and achieve a 1:1 hedging ratio. FLT treasury only enter into forward foreign exchange when
exchange forecasts become highly probable. Thus, speculation is not FLT’s hedging strategy.
Economic Risks
ER1– Consumer Confidence and travel patterns: Global shocks such as terrorism, political unrest,
natural disasters and social pandemics can have an adverse effect on consumer travel confidence,
potentially decreasing TTV. Furthermore, changes in discretionary income and exchanges rates can
alter consumer travel patterns.
Source: FLT Annual Report Mitigation: FLT’s strategy involves increasing their brand and geographic diversification to avoid
relying on a single segment.
92016 | CFA Institute Research Challenge
Figure 41: Changes in Fair Value Operational Risk
of Cash Flow Hedge ($'000) OR1 - Budget Airlines and Price Wars: While lowered airfares result in increased demand, benefits
are likely offset as cuts in retail prices also erode commissions and overrides. Individual agreements
between each individual airline carrier outline guaranteed payments and volume incentives. Hence
if budget airfares continue to trend downwards, commission incentives and margins offered by
carriers may decrease to compensate.
Mitigation: FLT consultants have lowered their commissions in a bid to increase demand.
OR2 - Technology Disruptions: Rapid and continuous technology expansion of online booking
platforms is likely to constrain industry growth and impact FLT market share. Online industry players
Source: FLT Annual Report such as Webjet are able to enter the market with little capital and provide heightened price
competition. Consumers will then be able to bypass travel agencies and book directly with the travel
Figure: 42: FLT Australian provider.
Revenue Proportion Mitigation: FLT has acquired a number of brands such as StudentUniverse and BYOjet.com to
ensure they maintain significant market share.
Credit Risk
CR1 – Credit ratings: FLT is exposed to credit risk through their forward foreign exchange contracts,
their cash equivalent and available for sale assets.
Mitigation: All FFX contracts and 87% of liquid assets are equivalent to S&P rating AA to A-
(Appendix 21).
Figure 43: Board of Directors Corporate Social Responsibility
Board of Remuneration Ordinary
Directors FY16 ($) shares Governance
Graham 675,000 15,244,487 As an ASX listed company, FLT utilizes the corresponding corporate governance principles. While
Turner
Managing
most principles are implemented, the company does not separate the remuneration and nomination
Director/CEO committees as per Principle 2: ‘structure the board to add value’. Consequently, FLT has a rating of
Gary Smith 201,218 15,000 4.49 out of 5 based on our estimations, so is bested by some competitors such as Corporate Travel
N.E. Director Management, who have implemented all principles (Appendix 27). FLT meets all six OECD
Chairman
John Eales 150,848 3,000 Corporate Governance Principles. Further, the Company shows growth in their environmental and
N.E. Director social scores yet a decline in corporate governance as provided by the Thomson Reuters Asset4
Robert Baker 150,503 2,500 database (Figure 45; Appendix 25).
N.E. Director
Board of Directors
Source: FLT Annual Report FLT’s independent directors only hold small amounts of shares, which could lead to a moral hazard,
as they may not act in the shareholder’s best interest but rather in their own (Figure 43). Further,
Figure 44: Board Members FLT has the smallest board of directors’ comparative to all peers worldwide, with only four members
opposed to the international average of eight (Figure 44). Consequently, the Company does not
have a separate audit and remuneration committee. Also, FLT does not have a female director. This
has been historically proven as suboptimal, as females improve company performance, risk
management and the quality of the decision making process. The absence of such diversification
and gender equality can lead to one-sided decisions (Appendix 26).
Corporate Social and Environmental Responsibility
The Company founded the Flight Centre Foundation in 2008, supporting organisations engaged in
movements for the environment, children, education and cancer support (Appendix 23). FLT
provides employees the opportunity to volunteer their time to charities and community organisations
while still being paid, and matches their donations dollar for dollar. The Company was recently
Source: Bloomberg appointed to the top ten ASX listed charity givers (Australian Charities Fund, 2016). The
Foundation's charity partners are non-political and receive limited or no support from any
Figure 45. FLT ESG-Scores government entity. Overall, donations to communities since its foundation amounted to $7.7 million
Asset4 at the end of the 2016 financial year.
Source: Thomson Reuters Database
10tg2016 | CFA Institute Research Challenge
Appendix: 1
Force 1: Threat of New Entrants
1) Strict Regulatory and financial monitoring pressures on new
agents Supplier Power
2) Existence of Economies of Scale and incumbent exclusive
partnerships makes entry difficult and/or unprofitable
3) Rise of technology based travel advice allows low cost and Threat of Threat of New
innovative myriad micro-entrepreneurs to quickly gain market Substitution Entry
share. However online market heavily dominated.
4) Higher comparable Profit Margins for Online Travel Booking
services
5) Large Network effect of current market leader (FLT) provides Buyer Power
Competitive
more tailored and cost effective service to clients. Rivalry
Force 2: Threat of Substitute Products
1) Holds largest market share, however there are highly
substitutable branch and online travel booking services.
2) Other Flight Planning Services, particularly low-cost online travel booking services. However, buyers are still
dependent on a quality face-to-face tailored servicing.
3) Brandjacking: illegal use of popular brands by brandjackers to drive traffic to their sites without the permission of
brand owners. Potentially drawing away revenue and reputation of FLT.
4) Disintermediation: Especially on a domestic level, as Australian’s typically avoid travel agents when travelling
domestically. Additionally airlines are now directly approaching customers reducing potential commissions for FLT.
Force 3: Bargaining Power of Buyers
1) Easily substitutable for other agents, and thus can negotiate price wars between agents.
2) Information Asymmetry: Lack of pricing information, especially on grounded services (hotels) between customers
and suppliers creates dependency of buyers. This due to the complexities of travel.
Force 4: Bargaining Power of Suppliers/Sellers
1) High Threat of backward integration from Airline suppliers due to online pricing
2) Grounded travel Services (hotels) have little influence of FLT, as their revenues are highly dependent on the agency
relationship.
3) High Competition between suppliers, creates higher commission potential, and low bargaining power.
4) Enhanced Capacity and supply of available airline seats has enhanced the negotiating power for agents to receive
more commissions in order to fill the excess supply.
Force 5: Competition in the Industry
1) The Innovative Deployment of online travel agency models are showing higher levels of profitability than store-
based agents.
2) Enhanced online competition has forced FLT to enhance their online presence to keep market share. But, this has
cannibalised their store sales.
3) Still the market leader with economies of scale advantage.
4) Competition is fierce for offering low-cost travel services, hence marketing, brand awareness and online strategy
will give the competitive advantage.
Appendix 2: Current Issues affecting Travel
Spread of the Zika Virus
Most Popular Travel Destinations for
Australian Travellers (ABS Data)
New Zealand
Indonesia
USA
UK
Thailand
China
Singapore
Fiji
Japan
India
11tg2016 | CFA Institute Research Challenge
Zika Virus
The top 10 international destinations for Australian Travellers are shown in the above table. The transmission of the
deadly Zika virus has been reported in 50% of the most popular travel destinations. Thus, it is expected that international
travel demand will decrease through fear of contraction when travelling. Although it could be argued that the Zika virus
would simply cause travellers to change their travel destination, this is not so easy. A key reason for these travel locations
is their low-cost, and short distance from Australian Airports. The majority of south-east Asia has been infected by the
Zika Virus, and thus the closest alternative is the European region or the northern parts of Asia. However, these are
generally more expensive alternatives and thus may not be of adequate substitution for Australian Travellers. There is
also the alternative for the Middle East, but travel to these countries has decreased by the effect of terrorist associations
which are discussed next.
Terrorism
Since 2000, there has been a nine-fold increase in the
number of deaths from terrorism. More recently the events in Global Terrorism Threat
France, Bangladesh, turkey, United States as well as
Australia highlight the increased threat at high-target areas. 50,000
The Australian Government has listed mass gathering places Number of
such as hotels, markets, public transport, airports and tourist 40,000 Incidents
sites are a common target for terrorism activities. Australian’s Deaths
are viewed by the levant (ISIL) as a key target for terrorist 30,000
attacks. Even in cases where Australian’s weren’t Injuries
necessarily the target, Australian citizens are still harmed by 20,000
indiscriminate attacks. The immense fear from Australian
Travellers particularly after events in 2016 has created a 10,000
culture that hesitates to travel. A common trait is to cancel
flights and travel after a major terrorism event, even if it is in 0
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
another country. A survey in 2015 compiled by YouGov has
shown that 10% of American travellers have cancelled their
trip in response to terror, and 18% have delayed their travels.
The world is now on red alert (figure 3), and we expect this Source: Global Terrorism Database
adjustment to consumer preferences will cost the travel
industry, and thus the travel agent industry.
Brexit
The effect on the UK leaving the European Union caused an immediate downturn on the world travel market. However
the effects on airline share price, exchange rates and consumer confidence have already started to adjust from June.
However the long-term effects are not fully realised yet. We expect the travel industry in Australia to have limited effect
from the Brexit other than a decrease of UK tourists in Australia, which would be offset by an increase of Australian
passengers to the UK. Although, once the Brexit is fully undertaken there may be a change in visa protocol which overrides
the current no-visa policy for Australians holidaying in the UK and EU.
Ultimately the Brexit has the biggest effect on the UK and European travel market. Thus with FLT deriving 13% of their
profits and revenues from this continent, they are at risk of long-term revenue slowdowns. The International Air Transport
Association has predicted
by 2020 UK air passengers could be 3-5% lower due to a downturn in economic activity and fall in sterling.
The Insurance Industry
The insurance industry has faced rising costs in the form of reinsurance expenses over the past five years. An unusually
high incidence of natural disasters and terrorist encounters around the world has led to a rise in the volume and value of
insurance claims, forcing reinsurers to increase premiums (Wu, 2016). Ultimately, indirect costs of travel are increasing
and this correlates with a decreased consumer confidence in travel due to the current aforementioned global risks. What
was once seen as a safe and reliable place to travel, is now sacrificed due to the increasing threat of terrorism. Which
has forced insurance companies to raise their risk-adjusted premiums. This problem also relates to FLT’s Travel insurance
revenue stream. Thus enhanced insurance premiums are reducing the total Passenger outflow as well as the profit
margins of Flight Centres Insurance Products.
Source: Wu. T. (2016). IBISWorld Industry Report OD4216. Travel Insurance in Australia. Retrieved from http://www.ibisworld.com.au
Appendix 3: The Sharing Economy
The Travel industry like most industries are rapidly expanding into peer-to-peer services. The low-cost options as well as
direct exposure to locals is providing a more authentic and cost-saving experience compared to traditional Travel
operations. Micro-entrepreneurs are offering alternatives in an array of travel sectors such as hotels (Airbnb),
transportation (Uber, Lyft), dining (Eatwith, Feastly) and tours (Viator, Vayable). This growth is not just left for leisure
travel, business travellers are increasingly adapting their Travel & Expenses (T&E) budget for more cost-effective sharing
economy services.
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