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CTRP's Net Income Will Be Revised Downward, Causing Rapid Revaluation Of Share Price

|Includes: International, Ltd. (CTRP)

CTRP's share price broke out below its recent low on Tuesday (December 2), and will likely continue trending downward in the next few weeks. The company's growth is starting to slow down amidst (1) intensifying competition from Qunar, eLong, Alitrip, and Amazon, and (2) a slowing Chinese economy, neither of which were baked into previous analyst forecasts. Against this unfavorable competitive and macroeconomic backdrop, it's doubtful that the company will be able to achieve it's current forward revenue growth estimates of 33%+ in each of the next 2 years. Furthermore, in order to try to achieve these unrealistic revenue growth rates and stave off competition for as long as possible, the company is now being forced to invest far more money into sales and marketing than it had in the recent past or was expected to spend in analyst estimates, which will consequently lower net income by a significant amount. In fact, management has now guided its net income margin for the next quarter (Q4 2014) to below -12% from a net income margin of 35.8% a year ago.

As is, the company is already being over-valued at ~21x P/E relative to a clearly optimistic CY2016E net income estimate of $323m (in comparison, LTM net income was only $119m). This P/E ratio will seem even more excessive once the company's forecasted net income is revised downward in subsequent quarters, which will likely happen several times over the next 2 years. The company is essentially in a catch-22. If it spends enough money on sales and marketing to actually achieve 33%+ revenue growth rates in each of the next two years as forecasted, then the company will also necessarily suffer net losses from the substantial sales and marketing expenses and subsequent margin erosion. There is no way that the company will be able to achieve both the estimated revenue growth rates and net income margins in the next 2 years. As a result, the net income for future periods will almost certainly come in far lower than estimated, causing a rapid revaluation of the company downward as institutional investors finally catch on to the changes in the company's fundamental outlook.

Disclosure: The author is short CTRP.