Consider Trip.com As A Turnaround Bet

Summary

• Trip.com Group Limited is one of the world’s biggest travel companies based in China.
• Given multiple headwinds, the stock is down approximately 50% since February 2021 and now trading at a 2023 forward P/E < x20.
• While the company recorded net losses in recent quarters, investors should note that the company is structurally profitable.
• In this article, I value Trip.com with a residual earnings framework based on analyst consensus and calculate a fair base-case target price of $44.25/share.

Investors who wish to bet on a rebound of Chinese ADR stocks (1) on the reopening of China’s economy and international travel (2) and on the fundamentals of an attractive business (3) might want to get exposure to Trip.com. The stock of China’s leading travel platform is down approximately 50% since February 2021 and now trading at a 2023 forward P/E < x20. The risk/reward looks attractive. In this article, I value TCOM with a residual earnings framework based on analyst consensus and calculate a fair base-case target price of $44.25/share.

About Trip.com

Trip.com Group Limited is one of the world’s biggest travel companies based in China. The company operates a one-stop travel platform that connects buyers and sellers of travel products/services. That said, the company offers prospective travellers the possibility to explore, get inspired, make travel decisions, cost-effective travel bookings, and share/review travel experience. Notably, the company operates a portfolio of leading brands, including Ctrip, Qunar, Trip.com and Skyscanner. As of December 31, 2021, Trip.com covers business activities in 5 countries, provides over 1.2 million global accommodation offerings and collaborates with approximately 480 airlines. Trip.com was founded in 1999 and first sold shares to the public in 2003 through listing on the Nasdaq. Since 2021, Trip.com has also been listed on the Hong Kong stock exchange.

Investment Thesis

While Trip.com’s earnings will undoubtedly suffer amidst the economic slowdown and wide-spread travel lockdown in China, the company’s long-term outlook remains robust. Moreover, the company’s leading position in China is very unlikely to be challenged for the foreseeable future, and international expansion – especially in Southeast Asia – unlocks additional business opportunities. According to management, Trip.com is committed to achieving 50% revenues share from international markets within a 3-4-year time horizon. Moreover, Trip.com’s increased focus on content, with initiatives such as live-streaming and travel blind boxes, provides new verticals for business monetization.

From a financial perspective, Trip.com appears solid. In 2021, still impacted by Covid-19 challenges, the company generated revenues of $3.1 billion and recorded a net loss of $75 million, or -0.12/share. However, while a net-loss is not something to like, investors should note that the company is structurally profitable, as Trip.com achieved net-income of $570 million in 2018 ($1.01/share) and $697 million in 2019 ($1.17/share). By end of 2021, Trip.com held $7.77 billion of cash and cash equivalents and financial debt of $8.14 billion. While Trip.com is a net debtor, the company’s significant net-cash position could imply growth through M&A optionality, in my opinion.

Going forward, analyst consensus indicates that Trip.com will find back to pre-covid profitability. Revenues for 2022, 2023 and 2024 are estimated at $3.0 billion, $4.6 billion and $5.6 billion. Respectively, EPS is estimated at $0.24, $1.18 and $1.59 (Source: Bloomberg Terminal, June 2022). If analysts are correct, the fundamentals would imply significant upside potential. Personally, I believe the estimates are very reasonable, as they anchor on Trip.com’s pre-covid profitability. However, investors who do not believe in a travel revival after Covid might support a different opinion.

Valuation

What would be a fair valuation for Trip.com if analyst consensus accurately reflects future fundamentals? I would like to quickly present a valuation based on the residual earnings framework. Arguably, my assumptions are simple and conservative:

• I base my EPS estimates on the analyst consensus estimates until 2025. I find these are very reasonable, so I don’t see a reason to challenge them.
• After 2025, I extrapolate business activities into infinity (terminal value).
• I apply a conservative 10% WACC.
• For the terminal growth rate, I apply expected nominal GDP growth at 3.5%.

Based on the above assumptions, my calculation returns a base-case target price for Trip.com of $44.25/share, which indicates an approximate 80% undervaluation.

Investors might have different assumptions with regards to Trip.com’ required return and terminal business growth. Thus, I also enclose a sensitivity table to test varying assumptions. For reference, red-cells imply an overvaluation as compared to the current market price, and green-cells imply an undervaluation. The table definitely confirms the value thesis.

 

 

Risks

I would like to highlight the following downside risks that could cause Trip.com stock to materially differ from my price-target of $44.25/share.

First, will the travel industry return back to pre-covid profitability, and what is the probability that the industry’s growth can match nominal GDP growth going forward? In my analysis I (and analyst consensus) model that Trip.com will find back to pre-covid profitability and I model growth equal to nominal GDP growth. But obviously, there is no guarantee that the future will turn out to be like the past.

Second, much of Trip.com’s share price volatility is currently driven by investor sentiment towards Chinese ADRs and risk assets. Thus, Trip.com stock price might show strong price volatility even though the company’s business fundamentals remain unchanged.

Third, as Trip.com is based and operating in China, the company is exposed to heightened political risks as the CCP aims to regulate tech/internet companies. In addition, Trip.com collects user data, which might draw CCP’s attention.

Finally, the economy in China is currently pressured by multiple headwinds including inflation, real-estate crisis and COVID-19 lockdowns. If the Chinese economy would slow more than what is expected and priced in, investors should adjust expectations for Trip.com’s short/mid-term business monetization accordingly.

Conclusion

The biggest driver for Trip.com short-/mid-term is arguably investor sentiment in relation to risk-assets and China Covid-lockdowns. The second biggest driver is the insecurity about the future of the travel industry. In 2023 and later, will travel rebound to pre-covid levels? Although one can never be sure of anything in markets, it might be a good opportunity to bet that these challenges are temporary. That said, I remain focused on fundamentals and based on a residual earnings framework and calculate >80% upside. Thus, I conclude with a buy recommendation and a base case target price per share of $44.25.

Author: Cavenagh Research, Seeking Alpha