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Morningstar | Sabre Competitive Position Intact, but External Headwinds Challenge Near-Term Share Performance

Narrow-moat Sabre is executing well with the factors under its control, as its air booking share grew 140 basis points to 38.3% (the fifth straight quarter of share gains), and it continues to migrate slow and expensive mainframe functionality to a faster, cheaper, and more reliable open-source platform. That said, the company is facing new headwinds out of its control, as its customers are impacted by financial hardship (Jet Airways in India) and involvement with tragic 737 flights (Lion and Ethiopian). We plan to reduce our 2019 sales, EBITDA, and free cash flow projections by roughly 1%, 4%, and 7%, respectively, solely to account for these external events, as we leave our estimates for the underlying business unchanged. With some time value of money offset, we expect our $29.50 Sabre valuation to drop by around $1 per share. We view the high-single-digit decline in shares off this news as an overreaction and continue to expect an earnings acceleration for Sabre starting in 2020, as prudent platform investments and current customer headwinds wane.

In late April, reservation customer Jet Airways announced it was suspending flights due to financial hardship from a competitive landscape. We estimate that Jet Airways accounted for about 3% of Sabre's total 2018 passenger boardings within its Air IT segment, which was 28% of its total sales last year. We plan to remove this customer from our 10-year forecast. In addition, this business is also seeing a modest headwind from reservation customers Lion and Ethiopian after the tragedy of their 737 flights. As result, we expect our 2019 Air Solutions revenue forecast to move to a 4% decline from 2% growth prior.

As previously disclosed, 2019 operating profit will be greatly reduced with the accelerated migration to open systems. However, this transition is offset by lower capital expenditure, leading to no change in free cash flow. Also, we see investment waning after 2019, allowing for a return to earnings growth.

Sabre is maintaining its 2019 outlook for its underlying business. But it is reducing revenue, EBITDA, and free cash flow guidance by roughly 1%, 3%, and 7%, respectively, to account for the external issues of three of its reservation platform clients. The reservation platform business is higher margin, leading to a larger negative impact to EBITDA and free cash flow than sales. We plan to reduce our forecast roughly in line with the company's updated targets.

Sabre continues to successfully migrate to an updated cloud platform, which will improve reliability and speed of service, supporting its intact network, switching costs, and efficient scale advantages. We are encouraged that over 90% of Sabre's processing power is now on open systems (less than 10% on outdated mainframe) and that over 50% of its compute footprint is in the cloud (up 14 percentage points from the end of 2018). While the transition remains a multi-year event, we believe that 2019 represents the heavy lifting year and that earnings growth will resume in 2020.