Ctrip.com - Significant Downside Likely

Summary

Q4 likely represents a peak in operating margins.

Large operating losses at Qunar and Long increase the probability of earnings disappointments.

The staggering debt load increases operating risks.

After a good Q4 2015 for Ctrip.com (NASDAQ:CTRP), now comes the integration of operations with huge losses -- a daunting task. The company's long-term positioning is favorable, but the short-term risks are high. We are maintaining our price target of $27.50 and maintain our sell rating.

52-Week Range

$21.54 - 57.36

Total Debt (billions)

$4.8

Shares Outstanding

302 million

Total Debt/Equity

48.8%

Insider/Institutional

7.4% / 87%

ROE (ttm)

6.5%

Public Float

207 million

Tangible Book Val/Share

$2.37

Market Capitalization

$12.3 billion

Daily Volume

4,936,300

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FYE Dec.

2015A

2016E

2017E

EPS($)

Actual

Current

Previous

Current

Previous

Q1 Mar

$0.06A

$(0.07)E

$0.07E

$0.09E

Q3 Jun

0.07A

0.04E

0.14E

0.22E

Q3 Sep

0.14A

0.14E

0.22E

0.39E

Q4 Dec

0.03A

0.02E

0.04E

0.20E

Year*

$0.07A

$0.14E

$0.47E

$0.89E

P/E Ratio

99x

208x

48x

Change

14%

(305)%

536%

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FYE DEC

2015A

2016E

2017E

Revenue ($ mil.)

Actual

Current

Previous

Current

Previous

Q1 Mar

$373.4A

$675.9E

$548.9E

$912.4E

Q3 Jun

407.6A

745.9E

591.0E

999.5E

Q3 Sep

500.5A

916.1E

720.9E

1,236.7E

Q4 Dec

443.7A

776.4E

557.7E

993.8E

Year*

$1,682.3E

$3,114.3E

$2,418.5E

$4,142.5E

Change

49.7%

85.1%

33%

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*Numbers may not add up due to rounding.

*EPS is pro forma, GAAP and pro forma data in our forecast.

Q4 2015 Update

  • Ctrip.com reported a strong Q4, with expanding margins. It expects contracting margins in 2016 with the recent investment in Qunar (NASDAQ:QUNR) and eLong (NASDAQ:LONG).
  • We believe there are huge holes in the bullish case for CTRP in 2016 driven by irrational pricing competition in online bookings, huge losses at QUNR and LONG, significant investment requirements in the coming years, slowing core growth, short-term concerns over Chinese economic growth, and high debt loads.
  • The integration issues along with continuing competitive pressures create a difficult operating environment for CTRP, and yet the stock is priced for perfection. The stock price is susceptible to any misstep in 2016.
  • Despite a rosier long term outlook, management only guided for Q1 2016. Consensus estimates have declined as expected, and we perceive further risk to estimates. The wide range in EPS estimates attests to this.
  • Our revenue forecast increases but margins decline in 2016. We update our forecast and maintain our price target of $27.50.

Risks

  • Growth in Chinese consumer spending may not slow down despite slower economic growth.
  • Operating performance at subsidiaries may improve at a faster pace in 2016 than we anticipate.

Quarterly Summary

Ctrip.com reported revenues slightly better than our expectations along with improving margins that drove pro forma EPS. Accommodation Reservations and Packaged Tour revenues were below our expectations, while Transportation Ticketing and Corporate Travel channels beat our expectations. Sequentially, revenues declined 11.4% from Q3 2015, gross margins remained healthy at 73.4%, but operating expenses increased 2.4%.

For FY 2015, net revenues increased 49.1%, gross margin improved to 72.1%, and GAAP operating profit margin was 3.5%. CTRP reports pro forma operating margin of 9.4% after adjusting for stock compensation. FY 2015 was a strong year, but we still question the company's high valuation in light of the significant challenges CTRP faces in 2016.

CTRP provides stock based compensation adjustments to operating expenses from which it calculates a pro forma EPS. We use the stock compensation data, but also include other non-operating income due to how the company describes this line item. CTRP notes in its 6K filings that this line item includes financial subsidies, investment income foreign exchange gains/losses and re-measurement gains. In Q3 2015, CTRP reported $376 million in non-operating income, the majority of which was $350 million from the gain on deconsolidation of a subsidiary. We calculate pro forma net income by adjusting for stock compensation as provided by CTRP, and adjust for the after tax impact of the other non-operating Income. We believe this provides a clearer view of operating income and earnings.

Note: CTRP reports in RMB and $US, while consensus forecasts are typically in RMB. Our forecast is in $US for ease of understanding to $US-based investors. Any reference to consensus or guidance given in RMB has been translated to $US using the conversion rate of 6.4778 RMB to the $US. This is the conversion rate used in latest CTRP report.

Our Short Thesis Remains Intact - High Risk in 2016

  • Management guidance was sketchy, but one thing is for certain -- margins will decline in 2016. After factoring in the additional revenues from increased ownership of Qunar and eLong, management is guiding for Q1 2016 revenue growth of 75%-80%. Management could not provide a core growth rate separate from the additional QUNR and LONG revenues, which raises questions about internal tracking capabilities. CTRP clearly has its hands full. We estimate that core growth in Q1 2016 is in the 40% range, after adjusting for the additional revenues from QUNR and LONG. This is down from the 49.7% revenue growth in FY 2015. Management is guiding for 30% CAGR growth through 2020. The trend in lower core revenue growth is evident. Gross margins will decline significantly in 2016 driven by the losses at Qunar and eLong. We expect GAAP operating margin to be negative in Q1 2016. Management is not providing any guidance beyond Q1 2016, which is only a few weeks from completion. Our takeaway is that there is a lot of internal uncertainty for where margins will be in 2016 and 2017.
  • Competitive pressures remain high. Despite the bullish investment thesis that consolidation of online transportation ticket and hotel purchases will lead to higher prices and expanding margins for CTRP, the company faces competition from several sources. A primary revenue growth driver for the bullish thesis is airline ticket sales, but airline companies are direct competitors in attracting the end customer. On the quarterly conference call, management stated that recent investments "enable us to reduce irrational pricing competition and should, over time, put the industry back on a healthy and sustainable growth trajectory." We note the cautionary guidance on competitive pricing and a reiteration in answering questions that do not spell an immediate improvement, and identify management uncertainty when the improvement will occur.
  • Lofty operating goals; high degree of execution risk. CTRP noted it needs to invest on several fronts including mobile applications, and penetrating tier 2 and tier 3 cities. Management stated its goal of 20% to 30% pro-forma operating margins in the "mid- to long term." The current consensus forecast of $0.77 for FY 2017 describes a pro forma operating margin of 11.6%, which makes sense. Our above consensus 2017 estimate correlates to a 12.9% pro forma operating margin. We do not anticipate a 20% pro forma operating margin until 2019 at the earliest. We perceive management's portrayal of lofty long term operating goals as very challenging to meet in four to five years.
  • Consensus estimates lowered; wide range in estimates points to high short term risks. There are 15 estimates for FY 2016 ranging from $(1.49) to $0.24, and the range for FY 2017 is $0.23 to $1.42. Estimates have lowered significantly since the Q4 2015 report on March 16. Such a wide variance in estimates among industry analysts identifies a wide range of justifiable outcomes. Our takeaway -- there is a high likelihood that CTRP will miss current estimates. The uncertainties of integrating the recent investments in Qunar and eLong, slower economic growth in China, higher debt, high amount of intangibles on the balance sheet, and the higher share count lead to varying interpretations.
  • Debt continues to grow, and intangibles take a quantum leap. We now project total debt to grow to $6 billion in Q1 2016 with a pretax interest coverage ratio of 0.43x for FY 2016, taking non-cash items into consideration and adjusting operating profit for stock compensation, we project the operating profit interest coverage of 1.8x for 2016. Although this is not overly excessive, it does point to very little leeway if operating margins trend lower than expected. The wide range in EPS estimates described below make this risk more evident. D/E ratios declined from 175% to 49% due to the increase in intangible assets from $607 million in Q3:15 to $8.75 billion in Q4 2015, an increase of 14.4x. Tangible book value remains low, at $2.37 per diluted share.
  • Forecast update. Management doubled its long term forecast of GMV by 2020 (gross merchandising value), based on the recent investments. GMV describes the amount of transactional volume. We believe this is driving the overly enthusiastic view of CTRP. Rosy long term forecasts are one thing, but without providing more definitive guidance for 2016, we believe management is clearly lacking insight into how 2016 will unfold. Nothing wrong with that given all that management has on its plate, but this situation does not justify high earnings multiples.

CTRP reports in RMB and in $US, and street estimates are typically reported in RMB, which we believe can be confusing to $US based investors, so we put our forecasts in $US, and translate the consensus forecasts to $US. Management is guiding a range of pro forma operating profit of $(15.5) million to break even in Q1 2016 but is not providing guidance for the remainder of FY 2016. We believe this creates an increasing likelihood that guidance after Q1 2016 will drive estimates lower.

Integration of Qunar and eLong are driving the consensus estimate for a loss of $0.39 in FY 2016 The following table highlights our pro forma EPS estimate (adjusted for anticipated stock comp) compared with the consensus estimate and the range of estimates. We believe the wide range of estimates for FY 2016 and FY 2017 points to the likelihood that consensus for both years will change in the coming months. Due to the risk factors identified, we anticipate there is a higher likelihood the estimate change will be to the downside.

Valuation

As noted above, our pro forma estimates for 2016 and 2017 are above consensus, which also provides cushion to our sell rating. CTRP trades at 304x our pro forma 2016 estimate of $0.14, at an EV/EBITDA of 110.5x using our 2016 pro forma EBITDA. As a high-growth company, we value the company based on PE and PEG ratios and compare this with our DCF methodology. During high growth phases, many companies can trade at twice the sustainable growth rate and peak above that level during times of high growth spurts. CTRP has done just that, but at excessively high levels in our opinion, particularly for a Chinese company.

CTRP traded in a range of $21.93 to $55.84 in 2015, representing a PE range of 160x to 400x based on our pro forma 2016 EPS of $0.14, which is well above the consensus of $(0.39). We believe 2015 was the peak year for high multiple valuation since revenue and EPS growth were strong and increasing. For 2016, the integration of Qunar and eLong are driving revenue growth but EPS will decline, with a rebound in 2017. We believe an appropriate growth rate to apply to FY 2016 EPS is the compounded growth from 2015 through 2017, which minimizes the impact of the trough EPS in 2016. As the table indicates, our pro forma estimates describe EPS CAGR of 43.6% from 2015 through 2017. Applying a very generous 4x PEG ratios to our above consensus 2016 pro forma estimate results in a price target of $24.34.

Management is guiding for a sustainable CAGR of 30% through 2020. This implies lower growth in the outlying years given the 43.6% CAGR growth from 2015 through 2017. As growth ratchets down, investors typically apply lower multiples that approximate the sustainable growth rate. We expect the P/E multiple to decline in the coming year, and any quarterly misstep during 2016 could drive a valuation readjustment. For now, we believe a healthy PEG of 4x the compound growth rate through 2017, which is higher than the long-term sustainable growth rate, is an appropriate valuation parameter for 2016. We use $24.34 for our PE/PEG based valuation target.

We cross check our PEG and P/E valuation range with our DCF methodology. Our DCF incorporates our projections through 2017, which describes growth in after tax operating income of 55% in 2016 and 323% in 2017. We use a WACC of 6.25% which we believe is very generous for a Chinese company. Our assumptions describe a price target of $30.44. We equal weight our DCF-based target with our P/E and PEG method for a blended valuation target of $27.50.

We perceive there is a high risk for CTRP to miss consensus estimates in 2016. Given the significant downside suggested by our price target, we rate the shares a sell.

Disclosure: I am/we are short CTRP.

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.