Whether Priceline Has Outpriced Itself

Sep.28.11 | About: Priceline Group (PCLN)

Stop me if you've heard this story before: A high growth, always beating, going to the moon, will be worth a trillion dollars someday, company falls flat on its face. Months and years of success are ruined in a matter of hours.

Have you heard that story before? Take a look at the history of Netflix (NASDAQ:NFLX), Sodastream (NASDAQ:SODA), First Solar (NASDAQ:FSLR), and Crocs (NASDAQ:CROX). Notice a pattern? All of these companies were priced for perfection, going up, up, and away; they were never going to fall ... until that one day. That one day when all of a sudden, the 80% growth wasn't there, those shoes weren't sold, those soda machines were stuck on store shelves. Every high growth company will experience a fall at some point, but that's not necessarily a bad thing. Crocs needed to rework its product lines, and the company has come back. Netflix is currently trying to redo its business model.

The problem with being priced for perfection is that you have to be just that. Perfect. And not every company can be all of the time. So watch out for that one quarter, because it is coming. It's not if, but when. Just when you think things are fine, you wake up with a stock down 10%, 20%, or even 50% in a matter of days. My fear is that Priceline (NASDAQ:PCLN) could soon be the next one to trip up.

On August 4th, Priceline released its second quarter earnings statement. The news was good, and the stock jumped 9%. A lot of analysts love the stock right now, and that's not necessarily bad. But when everyone starts drinking from the same fountain, it is sometimes wise to step back and walk away.

In guidance for this quarter, the company forecasted revenue growth of 37% to 42%, and analysts are currently expecting 41.7%. That's near the high end of the range. No big deal, the company has beat estimates before. So then they expect gross profit to increase 54% to 59% year over year. Okay, that's good, so that means their cost of sales is really coming down. Adjusted EBITDA is supposed to increase by 64% to 70%. Seems like a nice number. And lastly, EPS is expected to increase by 75%.

So why am I so cautious? Well for starters, achieving twice as much EPS growth as revenue growth means you really need to hit your marks. Take a look at the following tables.

Revenue Growth 1Q 2Q 3Q 4Q
2009 17.50% 30.10% 33.40%
2010 26.50% 27.10% 37.10% 35.00%
2011 38.50% 43.70% X Y
Click to enlarge

X is currently 41.7% (analysts), 37% to 42% (company guidance last report); Y is currently 36.2% (analysts).

Gross Profit Growth 1Q 2Q 3Q 4Q
2009 20.30% 37.30% 52.70%
2010 53.20% 45.90% 53.50% 52.80%
2011 58.50% 68.30% Z
Click to enlarge

Z is company's estimate of 54% to 59%.

So either the company is being ultraconservative, or they are slowing down. The revenue numbers don't concern me that much. Even if they come in at 41%, it will still show improvement in the year over year numbers, but be down from last quarter's growth. That gross profit growth number is what worries me. They are forecasting it to be lower than the past two quarters, and if it is near the bottom of the range, won't show too much improvement as they've done in the first two quarters if you look down the chart. Being that this is their biggest quarter of the year, they need to hit on those margins.

Priceline currently trades at a 36 trailing P/E, which is double that of its main competitor, Expedia (NASDAQ:EXPE). You may find that justified being that Priceline's growth this year and next is double that of Expedia's, but you still are paying a lofty price for the company. Priceline currently trades at 4.68 times 2012 sales estimates, while Expedia trades at 1.77.

Priceline has a history of beating estimates, and I won't ignore that fact. But, their guidance was $9.10 to $9.30, and current estimates are for $9.31. I wouldn't be surprised if we come up a few more pennies before their report, which is currently scheduled for November 7th. If you look at their last 4 quarters, they have beaten EPS estimates by 7 to 12%. But those are on lower EPS nominal values. A 7% beat on current estimates implies $10 or more of EPS, which means 87% year over year growth. That's a lot. And like I said, it's likely that analysts might up their estimates some more in the next month.

Now we all know that Priceline has created a great concept. Tell us what you're willing to pay and we'll make it happen. This is a great company, and I don't see it going away anytime soon. But like many examples before, this company is priced for perfection, and it has to deliver. It's up 50% in the last year. While I do expect this company to beat on the bottom line, just remember that we could be heading for another recession and gas prices were up about 30% over a summer ago. There is such a thing as "not enough of a blowout," so be careful when entering this name at such a high valuation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.