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Morningstar | Flight Centre Special Dividend Pill Swallowed in Readiness for ANZ Turbulence

We reduce our fair value estimate on Flight Centre by 4% to AUD 36.50 per share. The adjustment reflects the cash leaving the business with the stock trading ex-entitlement to the AUD 1.49 fully franked special DPS from March 22, 2019--a capital management initiative declared on Feb. 21, 2019 which will be paid to shareholders on April 12, 2019.

There is no change to our operating earnings forecasts or our fundamental intrinsic assessment of Flight Centre. Shares in the no-moat-rated group remain overvalued, trading at an 18% premium to our adjusted fair value estimate. The overvaluation is stark when compared with domestic leisure peers such as Corporate Travel Management and Webjet, as well as U.S. leisure peers such as Expedia and Booking.

In fact, we estimate Flight Centre to have the lowest earnings growth outlook over the next three years, with three-year EBITDA and EPS CAGR forecast at just 2.6% and 2.1%, respectively, compared with peer averages of 15.3% and 21.0%, respectively. Yet, on a price/earnings-to-three-year EPS CAGR, or PEG, ratio, Flight Centre's 7.3 is multiples higher than the domestic leisure sector peer average of 1.2 and the U.S. average of 1.4. Even if we take consensus' more bullish three-year EPS CAGR outlook of 8.1% for Flight Centre, its PEG would still be 2.6, leaving no margin of safety.

The near-term earnings outlook certainly does not warrant such a lofty premium to peers. The Australia and New Zealand EBIT (still 55% of group total) has now declined dramatically for two consecutive halves, down 11% in the second half of fiscal 2018 and 32% in the most recent first half of fiscal 2019. We expect the trend to continue in the second half of fiscal 2019, forecasting a fall of another 23%. And the domestic economic backdrop is far from conducive, given the potential impact on consumer discretionary spending of the weak housing market which was down a further 6.9% in the recent March quarter on a national basis (per RP Data).

We are, of course, fully cognisant of stellar earnings growth being generated from overseas operations. Fiscal 2019 EBIT from Americas are projected to jump 65% to AUD 115 million, 10% to AUD 82 million from Europe, Middle East and Africa, and doubling to AUD 15 million from Asia. The 24% aggregate EBIT CAGR from these international businesses (from fiscal 2015 to forecast fiscal 2019) demonstrates the success management has achieved in diversifying away from Australia and New Zealand in recent years. This has been particularly fuelled by inroads into the corporate travel sector which now accounts for 37% of group total transaction value, up from 30% in fiscal 2015.

However, the sustainability of this earnings growth is where we have reservations. Aggregate EBIT margin from overseas operations has jumped from 10.5% in fiscal 2015 to forecast 17.0% in fiscal 2019. Competitive and structural considerations drive our forecast EBIT margin of 13.6% in fiscal 2023 but we suspect consensus is assuming a more bullish margin scenario longer term.

More importantly, we are concerned about the earnings trajectory for Australia and New Zealand, where EBIT has declined from AUD 272 million in fiscal 2015 to a forecast AUD 182 million in fiscal 2019. Granted, we anticipate the current business transformation and productivity improvement program to elevate this division's EBIT to AUD 222 million by fiscal 2021. But we expect earnings to drift back below AUD 200 million by fiscal 2023. We see pressures on Flight Centre's predominantly physical store-based model in the region intensifying, as consumers become more comfortable dealing directly with suppliers and online agencies, and technology continues to erode the information imbalance between Flight Centre and the leisure traveller.

Finally, in the leisure peer trading multiples cited above, the domestic sample consists of Corporate Travel Management, Ardent Leisure, Event Hospitality and Entertainment, Village Roadshow, Webjet, Helloworld Travel, and Sealink Travel. The U.S. sample consists of Expedia, Booking, TripAdvisor and Travelport Worldwide.