The performance of Priceline (PCLN) has been stellar in 2012, rising nearly 50% to date. The relative performance of PCLN is shown in the figure below compared to several of its industry peers, TripAdvisor (TRIP), Expedia (EXPE), Travelzoo (TZOO) and Orbitz (OWW). Recently, PCLN shares have come under pressure after guidance came in below expectations. The question arises if this recent pull-back is an opportunity to open a new position in PCLN? Technically, PCLN looks weak, recently tracing out a double top and falling through some support levels. From a longer term perspective, this article will assess PCLN using several key fundamental metrics.
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PCLN's profit margin based on trailing twelve month (TTM) data is shown in the figure below relative to its industry peers. With profit margins of around 25%, both PCLN and TRIP are industry leaders with regard to profitability.
PCLN also boasts an impressive Return on Equity (ROE) of nearly 44% which has grown from around 7% in 2003. Surprisingly, ROE is on-par with other peer-group members as both TZOO and TRIP have an ROE of ~50%.
The interest coverage ratio (ICR) is a metric showing the ability of a company to pay the interest it owes on its debts. Generally, ratios greater than 3 are considered attractive. PCLN has an ICR of 44; quite a high number which signifies PCLN's ability to service its debts. It is also noted that this industry is typically characterized with high ICRs; for example both TZOO and EXPE have ICRs of 39 and 22, respectively. OWW is a bit of an outlier with an ICR of ~0.2.
The chart below compares the debt-to-equity ratio (calculated as total liabilities divided by shareholder equity) for PCLN and its industry peers. From a shareholder perspective, a lower debt-to-equity ratio is preferred. Hence, PCLN is an industry leader in this regard. Sometimes, the debt-to-equity ratio can give a distorted view of a company's true debt to the allowance for off-balance sheet items. A common off-balance sheet item is an operating lease which has shown to be a major liability for firms. Reviewing operating leases for PCLN and the four companies selected as its peers, it was found that operating leases ranged from a mere 3% of total assets up to 20%. PCLN's operating leases were ~5% of assets; not insignificant, but not enough to raise a red flag.
A simple metric to assess the quality of earnings is the ratio of Cash Flow from Operations (CFFO) to net income. Ratios greater than one are a healthy indicator. Sometimes aggressive accounting and loose interpretations of accounting standards can make net income appear better than it really is. However, cash flow is not easy to manipulate. PCLN has consistently had a higher CFFO than net income for the past five years - a positive with respect to earnings quality.
As with most companies, PCLN and other on-line travel companies are the defendants in series of lawsuits. These particular lawsuits are related to the way on-line travel companies tax hotel rooms. PCLN mentions they are the defendant in approximately 50 such lawsuits. The plaintiffs, often municipalities, estimate nearly $400M per year is lost due to the taxing practice of on-line travel companies (Reagan, "Update on Online Travel Company Litigation," 2011). There have been recent large victories by the plaintiffs, for example a $184M award against EXPE by the Washington State Court. Other lawsuits have been dismissed while others have been settled out of court. The threat of loss in a number of these lawsuits is sufficiently reasonable; hence PCLN has set up a reserve on its balance sheet currently totaling ~$33M to account for potential awards or settlements - a small amount relative to PCLN's assets.
To recap, PCLN excels relative to its industry peers with respect to profit margins. Return on Equity (ROE) currently stands at 44% which has also grown considerably over the past decade - on par with the best of its peers. Debt ratios are low and the ICR signifies PCLN is quite capable of servicing its debt. Off-balance sheet debts are in check and the quality of earnings as represented by the ratio of CFFO to net income is good. This shows why PCLN is an industry leader with respect to price appreciation. However, with a 50% increase in 2012, is PCLN overvalued?
Based on its PEG ratio of ~1.5 (as indicated by FinViz.com), its current market price may be overextended, along with several of its peers. A residual income (RI) valuation model can help validate or dispel this notion. A RI model uses a firm's current book value, dividend payout ratio, estimates of future ROE and an investor's return on investment to account for holding a 'risky' asset. The latter term is a bit contentious in finance, but a reasonable estimate is 12%; a little higher than what would be expected by holding an S&P 500 index fund given PCLN's beta of ~1.2. Both the book value and dividend payout ratio of PCLN are easily found. While PCLN currently accounts for $33M on its balance sheet, this seems to be low based on the size of some of the awards. Hence, for the sake of this analysis, reserves will be doubled which will have a slight impact on PCLN's book value. All that is left is an estimate of the future ROE. PCLN currently has a high ROE of nearly 44%. However, five year growth estimates are around 22% based on data from MSN.com. For this analysis, a more aggressive 5-year growth rate of 33% will be used (in-line with its historical average), followed by a 15-year growth rate of 25%. After 20 years the residual income will be taken as zero. With these assumptions, a market price of ~$680 is calculated; very close to PCLN's current market valuation. It should be noted that valuations at these high levels of growth are very volatile with small tweaks in assumptions.
In summary, it is understandable that PCLN is a leader in price performance in 2012. Its fundamentals are excellent. PCLN is fairly valued albeit based on aggressive growth assumptions. From a fundamental perspective, I prefer to buy at a discount and would like to dig deeper into PCLN's valuation, perhaps using a cash flow model to further validate the results discussed here. For me a further pullback is in order before I open a position in PCLN.