This Travel One-Stop Shop Looks Undervalued

Online travel agent Ctrip CTRP reported 18.8% revenue growth in the second quarter, in line with its guidance midpoint of 18.5% but lower than Meituan’s 43% growth in the in-store, hotel, and travel segment and Tongcheng-Elong’s 21% growth. For the third quarter, the company expects revenue growth of 10%-15%, lower than the second quarter’s growth due to weak macroeconomics. An approximate effect of 400-500 basis points comes from the slowdown in Hong Kong and Taiwan and flight price reductions resulting from reduced demand; this is incorporated into the third-quarter outlook.

We have increased our own 2019 operating profit forecast by more than 2 times on the basis of Ctrip’s year-to-date performance. Our growth assumptions for margins and revenue are unchanged, except for the sales and marketing expenses/sales ratio, during the years ahead. Our margin assumption was previously conservative due to a big miss on margin expectations last year (only 3.5% non-GAAP operating margin in the fourth quarter) due to investments in customer service, and we were worried the same situation could happen this year. A large decline in the sales and marketing expenses/sales ratio in the first half was another reason for the revision in operating profit for 2019. We’ve increased our fair value estimate for narrow-moat Ctrip to $50 per share from $47, and we think the stock is undervalued.

Management reaffirmed its non-GAAP operating margin target of over 20% during the next one to two years, underpinned by operational efficiency in domestic and outbound businesses. We now assume that a non-GAAP operating margin of 20% is achievable by 2021.

The operating income margin in the second quarter was 15.3% versus 9.9% in the year-ago period, predominantly helped by a mid-single-digit reduction in the sales and marketing expenses/sales ratio. We slowed the pace of the sales and marketing expenses/sales ratio’s decline over the next two years as the ratio is now very low and marketing expenses may increase as the macroeconomic environment improves.

We expect continuous investment in product development and marketing in the overseas market targeting local customers of overseas countries for Trip.com, which is still at the early stage in expanding internationally. For example, countries such as Korea and Japan have not yet reached break-even points. The expansion of the international travel business excluding Chinese outbound business would offset the improvement in operating margin coming from the expansion of higher-margin Chinese outbound business.

Higher-margin international businesses accounted for more than 35% of revenue, and management expects this to increase to 40%-50% over the next three to four years. Hotel and flight ticket revenue for cross-border travel more than doubled the growth of China’s outbound trips in the second quarter. Hong Kong and Taiwan accounted for one third of Chinese outbound traffic. However, as a result of protests in Hong Kong and travel restrictions to Taiwan imposed by the government, there will be a reduction in travel to these two destinations, dragging down Ctrip’s growth in the near term.

Ctrip did not report the year-over-year growth of gross merchandise value of offline stores this quarter after reporting triple-digit growth in the first quarter. Ctrip-branded low-star hotel room nights were up over 50% versus the same quarter last year, compared with up approximately 60% in the first quarter.

According to iResearch, Ctrip had a leading market share of 63.8% in transaction value and 47.5% in terms of room nights in the online accommodation reservation market in the first half of 2019. Ctrip’s average price of room nights was the highest among peers, according to iResearch. We agree with Ctrip’s strategic shift from competing on coverage network and prices to competing in customer service and experiences. The introduction of third-party overseas ride-hailing services in more than 785 cities across 47 countries, with translation services and 24/7 customer service, enhances Ctrip’s status as a one-stop-shop travel platform and user experience.