Ctrip: Q2 Earnings Review

Summary

Ctrip reported mixed 2Q14 results: revenue beat both consensus and guidance, while EPS fell sharply year-over-year.

The 2Q revenue beat was primarily driven by strong growth in the company's two largest business segments: accommodation reservation and transportation ticketing.

The decrease in net income was largely due to non-GAAP operating margin declining 13 percentage points to 12% in 2Q14 from 25% in 2Q13.

I believe investors should wait on the sidelines for Ctrip's stock.

Ctrip.com International (NASDAQ:CTRP), the leading Chinese travel booking service provider, reported mixed 2Q14 results on July 30: Total net revenue of $277.6 million was 3.0% higher than the Wall Street consensus of $269.5 million and 3.3% higher than the midpoint of management's guidance of $263.7-273.8 million. EPS of $0.14 was three cents above the consensus of $0.11, but fell 41.7% year-over-year from $0.24 in 2Q13.

The 2Q revenue beat was primarily driven by strong growth in the company's two largest business segments: accommodation reservation and transportation ticketing. In the accommodation reservation segment, total revenue rose 47% year-over-year to $121 million, mainly driven by a 64% year-over-year increase in the reservation volume. Management attributed the surge of reservation volume partly to its decision to aggressively develop Ctrip's group buy hotel business two quarters ago. I note that the reported revenue and volume growth numbers implied a 10.4% year-over-year decrease in the average revenue per reservation (1-(1+47%)/(1+64%)). I attribute this decline in average revenue to the fact that over the past 12 months Ctrip has expanded into many lower-tier cities and added a large number of lower-priced hotels to its network. Overall, the rapid growth of reservation volume in 2Q14 has more than offset the decline in average revenue per reservation, leading to strong revenue growth for the accommodation reservation segment.

For the transportation ticketing segment, total revenue rose 39% year-over-year to $117 million, mainly driven by an 83% year-over-year increase in the ticketing volume. During the earnings conference call, management noted that air ticket volume growth was between 35%-40%. This implies that the bulk of the 83% ticketing volume growth came from the company's new train and bus ticketing businesses. I note that the reported revenue and volume growth numbers implied a 24% year-over-year decrease in the average revenue per ticket (1-(1+39%)/(1+83%)). I attribute this decline in average revenue to the company's expanding train and bus ticketing businesses, where Ctrip receives lower commissions than it does from air ticketing. Overall, the rapid growth of ticketing volume in 2Q14 has more than offset the decline in average revenue per ticket, leading to strong revenue growth for the transportation ticketing segment.

Despite impressive year-over-year growth in total revenues, Ctrip's non-GAAP net income dropped 23% year-over-year to $40 million in 2Q14. The decrease in net income was largely due to non-GAAP operating margin declining 13 percentage points to 12% in 2Q14 from 25% in 2Q13. Commenting on the declining profitability, management reiterated that 2014 is a year of strategic investment for Ctrip, and the company's current priority is to gain market share at a faster pace. This strategy was clearly reflected in the company's operating expenses: Sales and marketing expenses in 2Q14 rose 77% year-over-year to $77 million, and accounted for 27% of total net revenues for the quarter, up six percentage points from 21% of net revenues in 2Q13. The surge in sales and marketing expenses were partly due to a branding campaign in the quarter which aired Ctrip's newest TV commercials during several of China's top TV shows. Product development expenses rose 55% year-over-year to $77 million, and accounted for 25% of total net revenues, up three percentage points from 22% in 2Q13. Management attributed the increase in product development costs to the increased spending on the development of Ctrip's popular mobile app, and the expenses associated with the company's Baby Tigers program, which was aimed at internally developing new products within the company.

Looking ahead at 3Q14, Ctrip management guided 30%-35% year-over-year revenue growth, which translates into $327.3-339.9 million in revenue for the quarter. For the accommodation reservation segment, management guided 35%-40% year-over-year revenue growth and 50%-60% volume growth. For the transportation ticketing segment, management guided revenue to grow 30%-35% year-over-year and the volume to grow 60%-70% year-over-year. For the packaged tours segment, management guided 10%-20% year-over-year revenue growth and 40%-50% volume growth. For the corporate travel segment, management guided revenue to grow 30%-35% year-over-year. I attribute the guided revenue growth primarily to the ongoing shift of travel booking from offline to online in China. As for profit margins, Ctrip management guided non-GAAP operating margin in the second half of 2014 to be similar to the 12% recorded in the first half of 2014, and expected margin expansion going into 2015 and beyond, driven by the operating leverage resulting from recent investments. Management also noted that non-GAAP operating margin of 20% to 30% would be "very much achievable over the long term".

I believe investors should wait on the sidelines for Ctrip's stock. The revenue growth was indeed impressive for the company's major business lines. However, the big declines in operating margin and net income, combined with management's comments during the earnings call, indicated that Ctrip is now in a spending mode where earnings growth is depressed by aggressive spending on product development and marketing. Considering Ctrip management's expectation for margin expansion going into 2015, I believe investors should wait on the sidelines at least until this recovery of profitability takes place.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.