Webjet: Growth at a compelling valuation

Online travel agent Webjet (WEB) has been a phenomenal performer with the share price up over 300% in the last three years, compared to the ASX Small Ords Accumulation Index which is up 60% (obviously not a return to be baulked at either!).

In the last year, the WEB share price is up over 45%, however the trading has been quite volatile in that period. Reasons include an acquisition, an equity raising, a disagreement with their auditor, and a rapidly changing business mix. On top of this, there has been plenty of short interest in the stock.

Valuation still appealing given the growth

A key takeaway from today's result is that despite the move up in WEB's share price, valuation is still appealing. As one of the larger technology-oriented growth stocks on the ASX, WEB is trading on a FY19 PE multiple of ~25x (and ~21x on an ex-cash basis) a vastly lower multiple than other peers offering high growth rates.

For example, FY19 consensus PE multiples for many high growth stocks remain elevated, indeed expensive: ALU (53x), WTC (+100x), PME (50x), XRO (+270x), NXT (+150x) etc.

Without exception these stocks have been fantastic performers for investors; we've clearly been in an environment over the last couple of years in particular where growth stocks have generally outperformed handsomely.

As a growth-focused manager, our view on investment opportunities for some time has been tempered by valuation and risk considerations, to ensure that we're minimising our downside in an investment in the case of a de-rating. There has been nothing in today's WEB result to diminish our conviction in the stock as a genuine growth investment opportunity which is still well priced.

A result above guidance and consensus

Today's FY18 result has shown a business where nearly all divisions are firing (the only exception being their Online Republic business where earnings were down 11%). Very strong growth was reported in their core Webjet consumer brand, as well as their B2B WebBeds business which was non-existent only a few years ago. Importantly these strongly growing businesses make up the lion’s share of WEB’s earnings, leading to a Group result which was ahead of guidance as well as consensus estimates.

For a bit of background, the company operates several brands across two divisions:

1. B2C Travel (which contains the core Webjet brand as well as Online Republic) – these are consumer brands, where flights, hotels, car hire bookings etc are sold. For quite some time now, this division has been benefiting from the shift to online bookings, away from bricks and mortar stores. Critically, this transition has been accelerating, and makes for a powerful move when coupled with Webjet's ever-improving brand name. In fact, Webjet's flight bookings grew at more than 3x the overall market in the last 12 months. The company now dominates the online travel agent market in Australia with a 50% market share currently (and increasing).
2. B2B WebBeds (now consolidated, but brands historically included Lots of Hotels, Sun Hotels, Fit Ruums and JacTravel) – this is a global hotel aggregation business, where hotel rooms are sourced from multiple suppliers, and then on-sold to other travel agents. Importantly, the leverage for WEB is substantial, as they acquire hotel room inventory at agreed rates, while charging their customers a margin – recent trading conditions have been exceptional, with key destinations that WebBeds has exposure to in strong demand, allowing WEB to charge higher rates. WebBeds currently commands the #2 position globally and is winning share in key markets.

The strong growth reported today reaffirms our view that the Group should continue to deliver +25-30% p.a. earnings per share growth over the next few years.

Cash generation strong

Another takeaway from the result was the strong cash generation from the business over the last 12 months. Detractors of the business have cited the potential for weaker cashflow in the FY18 result.

It's true that the working capital dynamics of the rapidly growing B2B WebBeds business is less attractive than the B2C business (where customers pay WEB upfront in advance of their travel). However, pleasingly, the overall Group cashflow conversion was 97%. It's our expectation that the company continues to deliver cashflow conversion in the 90-100% range over the foreseeable future.

Potential kicker in FY20

Finally, to leave you with a thought that we believe the market might be overlooking. Back in August 2016, WEB announced a significant strategic partnership with Thomas Cook, one of Europe's leading holiday companies. As part of the agreement, WEB's B2B business took over responsibility for the management of Thomas Cook's hotel inventory over a transition period.

From mid-2019, the contract becomes a volume-based fee, which we believe will impact WEB's FY20 earnings in a very positive and significant way. This dynamic is something to think about; the company mentioned today that they will look to provide an update at the half-year results in February 2019.