Analysis

This online travel agency shows how the market has been on vacation with its analysis of the firm’s credit

October 28, 2020

Online travel companies have been hit particularly hard by the pandemic. Global travel is expected to take years to return to previous highs, and companies without solid liquidity may not survive the downturn.

Today’s company is one of the two largest players in the space, with a wide array of brands.

Below, we show how Uniform Accounting restates financials for a clear credit profile. We also provide the equity tearsheet showing Uniform Accounting-based Performance and Valuation analysis of the company.

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Travel has been one of the hardest hit industries during the pandemic. Countries across the world closed their borders and limited domestic flights.

These closures have had wide ranging impacts. Far fewer people are vacationing or traveling for work and the airline and hotel industries are expecting multi-year low financial performance.

While lodging, air travel, and even cruises are commonly discussed, there’s another industry heading towards its worst performance in at least a decade – the online travel agency (OTA) industry. OTA firms act as middlemen between hotels and airlines (vendors) and their customers. The industry is essentially a duopoly, with Booking Holdings (BKNG) and Expedia (EXPE) owning the vast majority of business.

OTAs provide one-stop shopping for customers’ vacation needs. A traveler can book everything from airline tickets to lodging, all the way down to rental cars.

Expedia and Booking Holdings together own almost all of the travel sites on the internet, providing customers with an “illusion of choice”. While consumers may feel they are getting a good deal on one particular site, in reality the business all ends up with the same two firms.

In March, we highlighted the market’s concerns about Expedia’s credit as the lockdowns were just beginning across the country. In particular, investors and credit agencies like Moody’s were concerned about Expedia because its business model is riskier than Booking Holdings’.

Booking Holdings acts like a true platform by connecting travel vendors with customers and collecting a commission.

On the other hand, more than 50% of Expedia’s revenue comes from direct merchant sales. The company buys airline tickets and hotel rooms from vendors, then sells that inventory to customers.

While riskier, Expedia benefits because it receives booking payments directly from customers. However, during the pandemic, Expedia’s merchant business has struggled.

Moody’s was also concerned with the emergence of search engine Google (GOOGL) as a third player in the OTA industry. Historically, Google and Expedia worked together to reach a broader audience of travelers. However, Google has recently turned its focus on entering the OTA industry directly and providing an alternative for customers.

We highlighted how Expedia’s strong cash balance and other factors indicate the firm has no real credit risk. Despite its minimal credit risk, credit default swaps (CDS) for Expedia had risen to over 350bps in late March.

Since then, the company has fortified its cash position with a “PIPE” (private investment in public equity) deal from Apollo. This provided Expedia with a fresh cash infusion to improve its liquidity position.

By looking at the firm’s Credit Cash Flow Prime (CCFP), we can see the safety of the firm’s credit.

While projected cash flows have weakened since March, Expedia’s capital raises have created a safety buffer. Cash on hand should be enough to meet all obligations until 2026, where the firm has a $740 million debt headwall.

With the improvement in Expedia’s cash position, the firm’s CDS still stands at 208bps which is still too high. As such, Valens rates Expedia’s credit risk at a much safer 149bps.

Ultimately, Expedia is being treated as a higher credit risk by the markets due to concerns about the travel industry and weakening cash flows.

When looking at Expedia’s CCFP from a Uniform Accounting perspective, it is clear the market is overstating the company’s credit risk.

Expedia should have sufficient cash on hand to service obligations until 2026. While the market has been on vacation with its analysis of Expedia’s credit, the firm has built a strong liquidity position to weather the downturn.

EXPE’s Debt Repayment Capabilities Continue to be Understated by Credit Markets

Cash bond markets are materially overstating credit risk, with a cash bond YTW of 3.365%, relative to an Intrinsic YTW of 1.815%, while CDS markets are slightly overstating credit risk with a CDS of 208bps, relative to an Intrinsic CDS of 149bps.

Meanwhile, Moody’s is accurately stating the firm’s fundamental credit risk, with its Baa3 rating the same as Valens’ XO (Baa3) rating.

Fundamental analysis highlights that EXPE’s cash flows would exceed operating obligations in each year after 2021. Moreover, following a series of debt issuances, the combination of the firm’s cash flows and cash on hand would be sufficient to cover near-term shortfalls and all obligations including debt maturities in each year until 2026, including material debt headwalls of $2.4 billion and $2.7 billion in 2023 and 2025, respectively.

Moreover, the firm’s robust 128% recovery rate on unsecured debt and sizable market capitalization should allow it easy access to credit markets to refinance, if necessary.

Incentives Dictate Behavior™ analysis highlights mostly negative signals for creditors. Management’s compensation framework should drive them to focus predominantly on growth and margins.

The compensation framework may incentivize overspending on capex and increased leverage, which may lead to ROA compression and weaker cash flows for servicing debt, even as the management team successfully executes on delivering growth.

Moreover, although most management members have low change-in-control compensation, CEO Kern’s sizable change-in-control compensation indicates he may push others to seek a sale or accept a buyout of the company, increasing event risk for creditors.

That said, although most management members do not own substantial EXPE equity relative to their annual compensation, Chairman Diller and CEO Kern’s significant holdings may lead them to influence other NEOs to align with shareholders for long-term value creation.

Earnings Call Forensics™ of the firm’s Q2 2020 earnings call (7/30) highlights that management is confident in VRBO growth. However, management may lack confidence in their competitive advantages and their ability to maintain cost savings, and they may be exaggerating their focus on the long-term health of the business.

Additionally, they may be concerned about the level of cancellations, the strength of their balance sheet, and the sustainability of overhead cost savings. Finally, management may be concerned about their ability to separate brands under the Expedia umbrella.

EXPE’s healthy liquidity and robust recovery rate indicate that credit markets are overstating credit risk. As such, a tightening of credit spreads is likely going forward.

SUMMARY and Expedia Group, Inc. Tearsheet

As the Uniform Accounting tearsheet for Expedia (EXPE:USA) highlights, the company trades at a -17.6x Uniform P/E, which is below global corporate and historical average valuation levels.

Negative P/Es imply negative EPS growth. In the case of Expedia, the company has recently shown a 21% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Expedia’s Wall Street analyst-driven forecast projects a 398% EPS contraction in 2020, followed by a 94% shrinkage in 2021.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Expedia’s $102.72 stock price. These are often referred to as market embedded expectations.

The company needs Uniform earnings to grow by 6% each year over the next three years to justify current prices. What Wall Street analysts expect for Expedia’s earnings growth is far below what the current stock market valuation requires in 2020 and 2021.

Furthermore, the company’s earning power is 2x the corporate average, but intrinsic credit risk is 170bps above the risk-free rate. Together, this signals a moderate credit risk.

To conclude, Expedia’s Uniform earnings growth is far below peer averages, and the company is also trading far below its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research