Moody's is materially overstating the credit risk of Expedia, Inc. (NASDAQ:EXPE) with its cross-over Ba1 rating. Our fundamental analysis highlights a much safer credit profile for EXPE, whose strong cash flows cover all their obligations including debt maturities through 2022. Moreover, their sizable expected cash build would allow them to service all obligations including debt maturities if their cash flows ever fall short. We therefore rate EXPE six notches higher at an IG3+ credit rating, or an A1 equivalent using Moody's ratings scale.
Cash bond markets are also overstating credit risk with a cash bond YTW of 4.342% relative to an Intrinsic YTW of 3.092%, while CDS markets are accurately stating EXPE's credit risk with a CDS of 100bps relative to an Intrinsic CDS of 124bps.
Cash Flow Profile
We produce a Credit Cash Flow Prime™ chart for Expedia, Inc., as we do for every company we evaluate. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (Valens' scrubbed cash flow number) expected to be generated based on consensus analyst estimates and Valens Credit's own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
The colored, stacked bars show the cash obligations of the firm in each year forecast. The most difficult obligations to avoid are at the bottom of each stack, such as interest expense. The obligations with more flexibility to defer year to year, such as pension contributions and maintenance capital expenditures, are at the top of the stacked bars. All of the calculations are adjusted for non-cash distortions that are inherent in GAAP accounting, including the highly problematic and often misused statement of cash flows.
If the company generates and has cash levels that are above their obligations, the risk of default is extremely low. Even if the cash generated yearly is close to the levels of the stacked bars, a company generally has the flexibility to defer payments of various kinds. For example, they can allow assets to age a little longer, or they can cut certain maintenance costs such as maintenance capex. While decisions such as those can create other business concerns, the issue in credit risk is simply this: Does the company have enough cash to service their credit obligations?
EXPE's cash flows would exceed all obligations including debt maturities through 2022. Additionally, if the firm were to experience a drop in cash earnings, their excellent liquidity profile indicates that they would have no issues servicing their debt obligations. Moreover, EXPE's strong asset backing drives a robust 123% recovery rate on unsecured debt. Overall, their robust recovery rate, sizable market capitalization, strong Adjusted ROA profile, and substantial cash generation would likely allow them access to credit markets to facilitate debt refinancing if necessary.
Like most people, senior executives and board members do what they are paid to do. This is why EXPE's Form DEF 14A is key to understanding this company's fundamentals, something that credit agencies seem to be missing. Our Incentives Dictate Behavior™ analysis focuses on AGN's senior executive compensation and governance. This analysis is meant to help investors understand corporate governance, how aligned a management team may be with shareholder interests, and the potential consequences of a management compensation framework to the business.
EXPE management's short-term compensation is based on stock price performance and worldwide hotel bookings, while their long-term compensation is based on adjusted EBITDA.
The adjusted EBITDA, stock price performance and worldwide hotel bookings growth metrics should drive management to grow the business, without necessarily focusing on controlling capex or leverage. As a result, they may be incentivized to overspend on capex (lowering cash available for servicing other obligations) and increase leverage, which could lead to an ROA' compression even as the management team successfully executes on driving growth. In addition, stock price performance is not a favorable short-term compensation metric. Management's decision-making, under such incentives, may not lead to long-term value accretive actions. Moreover, since management's framework is overly growth focused, margin compression as well as weakened asset utilization may occur. This would likely lead to weaker cash flows for servicing obligations and debt maturities, a net negative for debt holders.
We provide analyses of companies' statements on earnings calls, termed Earnings Call Forensics™. This analysis is meant to help assess a management team's confidence in their conference calls when discussing certain areas of the business such as operations, stability, strategies, their ability to manage business risks, and especially, their liquidity and solvency.
In the case of EXPE, the analysis of their Q1 2016 earnings call highlighted consistent highly questionable markers from management. Management may be downplaying concerns about the sustainability of unit growth momentum across their offerings and about margin pressures from discounting. They may also be exaggerating the potential of their strategic partnerships and the progress of their integration of acquisitions such as Orbitz and HomeAway.
Ultimately, a company's credit risk (or lack thereof) is driven by cash available against cash obligations. EXPE's credit risk is being materially overstated by Moody's and overstated cash bond markets. Given EXPE's strong cash profile, robust Adjusted ROA, and sizable market capitalization, ratings are expected to improve while cash bond market spreads are expected to tighten once the company's fundamentals are recognized.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with the lead analyst, Cheska Pablico. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.