Priceline (NASDAQ:PCLN) presents an interesting opportunity for the long term investor. The business has been achieving strong rates of growth for an extended period of time, and delivering excellent margins and returns on invested capital, yet all shareholders have seen in recent months has been a shareprice that's been in freefall. Priceline has declined almost 17% since the beginning of the year. The business now trades at share price levels which investors saw in mid 2013. Yet Priceline is a much better business than in 2013, with revenues and operating profits that are 30% higher .
Brand perception and inventory depth drives moat
I like dominant businesses with natural barriers to entry that help ensure long-term profitability. Priceline has the characteristics of a wide moat business. The company benefits from the broadest range of listed properties available for booking, and is a name and destination that is synonymous with travel booking. That makes it top of mind for consumers looking to book travel.
Profitable high margin business with strong cash flow
The thing I love about Priceline is that the business moat keeps progressively expanding. Priceline has always been a high margin business. However these margins have been progressively expanding over the last few years. Incredibly, gross margins have doubled in less than a decade and now stand at 90%. Operating margins have also shown a similar level of expansion and stand at close to 35% today. The combination of margin expansion , plus a rapidly increasing topline have resulted in a business that has grown EPS more 10x in the last decade. Priceline is not just a business with a high level of profitability. The company also manages to produce significant levels of cash. Priceline manages to convert between 25-30% of revenue into free cash flow.
Priceline's dominant economics and strong growth have made this an amazing investment for long term investors. $10,000 invested 10 years ago would be worth close to $500,000. Given such strong economics, the key consideration for long term investors becomes whether suitable long term growth drivers exist.
Continued online shift and emerging markets will drive growth
The overall share of the online travel market is still fairly modest, at only 40% of total bookings. This level of penetration will continue to progressively expand over time, providing Priceline with an inbuilt growth driver.
However emerging markets will grow at a much faster rate than the rest of the world. Increasing rates of digital penetration in these markets coupled with rapidly increasing disposable incomes should create a ripe environment for increasing discretionary travel, much of it booked online. Priceline is very favorably positioned in emerging markets with CTrip (NASDAQ:CTRP) and Hotel Urbano partnerships positioning Priceline well in China and Latin America respectively.
Google, AirBnB don't concern me at this stage
There seems to be some thought that competitive pressures may start to impact Priceline's market position and inhibit longer term growth. Google (NASDAQ:GOOGL) and AirBnB stand out too me as potentially impactful threats, however I'm not particularly concerned about either of them. Google has been doing more in the online travel space and is providing transactional capabilities for flights and hotels. However discoverability is poor, the user interface is clunky and Google currently just serves as an aggregator across other portals such as Priceline and Expedia (NASDAQ:EXPE). Google may do more in this space in the future, but for now, I don't think travel search poses a great threat to Priceline.
AirBnB is potentially a disruptive business model, not only to Priceline and other hotel inventory aggregators, but to the hotels themselves. AirBnB allows individual home and apartment owners to list their own inventory for users to book short term and medium term stays. The thinking here is that this inventory could disrupt the hotel market and reduce the need for booking hotels on portals such as Priceline. In my opinion, AirBnB will have a long way to go before it is able to threaten Priceline.
Regulators are already scrutinizing AirBnB business practices and its encouragement of operators providing hotel like services without applicable oversight and paying relevant taxes. AirBnB also suffers limitations with respect to inventory location. Individual owners/investors are unlikely to have prime inventory locations which vacationers will prefer. Finally, there are the cultural aspects of just staying in someone else's house. While Westerners may be more open to such a practice, it will be interesting to see whether consumers in emerging markets, particularly in Asian economies, embrace such an experience. I think AirBnB may well capture a slice of the online travel market, however its unlikely to disrupt Priceline in any meaningful fashion.
I will be watching developments here with a great deal of interest.
Current valuation has me buying
In my view, it is clear that PCLN is a great business. In fact, it is a great business with a strong set of growth drivers that should propel growth for quite some time.
I'm interested in investing in a business with a robust market position that has strong growth drivers which will allow superior growth. I think Priceline represents that kind of a business. Analysts are forecasting Priceline will grow earnings close to 18% annually over the next five years. Given the historic rates of growth that the business has achieved, I think this looks very achievable.
With a TTM P/E ratio of 21x earnings, this suggests a likely rate of return going forward for investors of at least 15% annually if PCLN achieves the level of growth that analysts expect and can maintain its valuation. I think 21x earnings is very reasonable for a business that should continue to grow in the high teens. Morningstar currently rates the business 5 stars.
While Priceline's stock price may show a high level of volatility in the near term as the shakeout amongst growth and technology stocks continues, those who are willing to hold for an extended period of time should see good investor returns.
Disclosure: I am/we are long PCLN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.