One way to find interesting Magic Formula stocks is to look for ones that might be able to "fill the gap".
"Filling the gap" is a technical analysis term that refers to when a stock suffers a significant price decline in a short period of time, usually in the period after earnings or adverse news. This is called the gap.
Many times, the market reacts too aggressively to negative news or results. In the short term, the stock becomes oversold, selling below a reasonable fair value even after accounting for the negatives. Over the course of a few weeks or months, the stock will often slowly rise to "fill the gap" that it lost so rapidly.
But we also have to be careful, because there are plenty of instances when negative news really does affect the long-term earnings potential of a company, warranting a sell-off and reducing the likelihood of a gap fill. It is also possible that the stock was overvalued in the first place, and the gap simply brought the valuation back to earth.
One such dramatic decliner in the MFI screens is Travelzoo (NASDAQ:TZOO), down about 25% over the past month. Can it get back to the $24 level in the near term? Let's take a look.
What Does Travelzoo Do?
Travelzoo is a publisher of travel sales and specials. The company's primary assets are its Travelzoo websites, the Top 20 newsletter, the Newsflash e-mail alerts service, a few travel-based search engines (SuperSearch and Fly.com), and more recently, the Groupon (NASDAQ:GRPN)-like services Local Deals and Getaways, which provide discounted products or services from local spas, hotels, and restaurants. Clients such as airlines, rental car companies, hotels, restaurants, and travel agents pay Travelzoo advertising fees to list their offerings on their Internet-based platforms. The company has over 2,000 clients and has over 24 million subscribers and website visitors. Europe accounts for about 27% of revenues with North America making up the rest.
The value proposition is compelling. To its customers, Travelzoo offers airlines, cruise lines, and hotels a way to liquidate unused inventory quickly and at low cost. To consumers, Travelzoo offers significantly cheaper means to travel.
Why Did the Stock Plummet?
For many years, Travelzoo was a high-flying growth stock. From 2004 through 2011, the company averaged 32% revenue growth annually, raising revenues from $34 million to $150 million.
Times have changed. In the past two years, Travelzoo has posted unimpressive revenue increases of 1.9% and 4.7%. In the most recent quarter, they posted a year-over-year decline of 4.7% and are expected to be negative for the full year. Margins are also falling, from almost 24% in 2011 to under 15% this year.
Right now, Travelzoo's business model just looks worn. The real difficulties are in the Search and Local units, where sales are declining rapidly (over 20% year-over-year). Local deals have little long-term potential, in my opinion. There is now an unbelievable amount of competition, not only from Groupon but also from Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN), LivingSocial, and dozens of others. Not only that but consumers are fatigued on the voucher model, and deals that are no longer that enticing.
Can Travelzoo Turn It Around?
Travelzoo has one ongoing initiative that has real potential to make a difference. The company launched the initial phase of its hotel booking platform in late March, now allowing direct booking from its websites (before, they simply provided vouchers, like a coupon site).
This is big for a couple of reasons. One, the voucher fatigue that we described earlier also applies to the travel business - consumers just were not using them like they used to. Second, being able to book hotel rooms through Travelzoo sites allows the company to participate in full-priced business, allowing them to operate successfully in peak season (where unused inventory is low). Third, it opens Travelzoo's sites up to higher-end hotels that disliked operating only in a discount environment.
The company is seeing good early results. During the test period, the company was earning $54 in revenue from customers utilizing the booking platform, vs. an average $13 through the voucher model. Management expects to start seeing revenue contribution as early as next quarter, and a wider rollout is planned for later this year.
Potential Upside Still Looks Limited
Despite the promise of the hotel booking engine, I still want to be careful on assuming a dramatic turnaround. Booking is the "bread-and-butter" business of competitors like Booking.com, Priceline (PCLN), Hotels.com, Kayak, Hotwire, and a bunch of others. Travelzoo is coming in late to a very competitive market, and it will be difficult building a foothold. Additionally, growth from the booking business will be battling against continued declines from Local and Search, and a flattening out travel voucher business.
Ultimately, I expect reasonable success from Travelzoo over the next several years, projecting 10% annual earnings growth. The market has assigned about a market-average multiple to the stock for the past few years, which I expect to continue. Given all of this, I see TZOO as worth about $20/share, upside of about 15%. However, the volatility in valuations for travel stocks does present the potential for much higher stock prices then this should the booking business take off.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.