Priceline Group (NASDAQ: PCLN ) is a rare bird, a first-generation Internet stock that seems to appreciate steadily year after year. Owner of prominent travel properties including priceline.com, Booking.com, Agoda.com, rentalcars.com, and Kayak, Priceline has grown into a sizable company, with annual revenues approaching $7 billion; yet it's maintained tangible revenue and earnings growth, making it a popular choice among investors in the Internet travel sector. Let's review three major reasons Priceline has appreciated more than 37% during the last 12 months, and draw some conclusions for the future in the process.
1. Cash is invested to increase operating margin
Priceline has exhibited recent strength in its operating income margin. This is the company's profit margin before accounting for "other" income and expenses, such as interest income and expense, and non-recurring items. Below is a chart of Priceline's operating margin since the beginning of 2013:
The chart shows a very healthy operating margin that has grown by roughly 1 percentage point during the last five business quarters, for a total improvement of 2.43%. This, by itself, is impressive, but not overly remarkable. Now let's overlay one more piece of data:
As the second chart indicates, Priceline is growing revenue at a very aggressive clip while maintaining its operating margin. The inference is that Priceline is investing quite efficiently in its growth, and not sacrificing operating profit for revenue expansion. Often, companies that scale revenue rapidly do so at the expense of margin, often through greater marketing and advertising expenses.
Of course, to pull off this feat without undue marketing expense, you need a margin catalyst. The most prominent recent driver is the company's acquisition of travel metasearch site Kayak, which was completed in May of last year. Kayak has proven to be a significant addition to Priceline's travel properties. In the company's first full quarter as an acquired entity, Kayak contributed an increase of 5 percentage points of inorganic gross profit growth to Priceline's total gross profit, and, in the company's first quarter of 2014, Kayak contributed 7 percentage points of inorganic gross profit growth.
At $1.4 billion of gross profit last quarter, each percentage point of gross profit improvement is worth in the neighborhood of $14 million. Thus, last quarter's $98 million of gross profit improvement contributed by Kayak indicates an impressive return on investment, given that Priceline paid only $2.1 billion total for the company.
2. Priceline is a beneficiary of pricing power
Growth in one of Priceline's primary focus areas, the hotel industry, is another factor underpinning recent financial performance. In the five years since the recession of 2009, the hotel industry has steadily rebounded. Hotel average daily rates, or ADRs, a measure of average room pricing, have climbed consistently since hitting a low mark in the second half of 2009.
As the following chart of global hotel room prices shows, global rates have been rising at a pace in excess of 5% per year since the recession:
Hotels.com Hotel Price Index: Global Price Changes (2004 Baseline = 100)
Spiraling room rates create a leveraging effect for Priceline. Each year, the company adds more properties to its various networks, and seeks to facilitate an increase in the number of room nights sold each day. While this alone would expand revenue notably, the hotel industry, due to tighter lending during and after the recession, has not added capacity at its former rate. This has led to higher occupancy at higher prices, as an increase in business and leisure travel means more travelers chasing fewer rooms. Thus, Priceline enjoys a greater commission per room as ADR inflation continues.
In the company's most recent earnings call, CFO John Finnegan mentioned that ADRs were up 3% versus the prior year during the first fiscal quarter of this year, indicating the strength of the room pricing trend, and perhaps giving us some insight into the strength of the hotel sector for the rest of this year.
3. The reward of long-term growth: Economies of scale
A consequence of Priceline's longevity is its global reach and ubiquity. In its SEC filings, the company discusses its three major revenue sources -- hotel rooms, rental cars, and airline flights -- in unit terms: hotel room nights, rental car days, and airline tickets. Booking.com, Priceline's largest travel property, has more than 512,000 hotel rooms in its system. As a company, Priceline sold 83.4 million hotel room nights last quarter.
This type of scale illuminates how Priceline's recently announced acquisition of Internet restaurant reservation site OpenTable will benefit the company. OpenTable has seen a compounded annual growth rate, or CAGR, of 17% during the last three years. Yet it has failed to crack important international markets, including Europe, where it failed against TripAdvisor's LaFourchette. Within Priceline's system, OpenTable should be able to expand more efficiently, boosting its new parent company's profits in the process.
Various Priceline sites, such as Booking.com and Agoda.com, are natural cross-sell vehicles for OpenTable's services. We can guess that, in the very near future, travelers who reserve a hotel room on Agoda.com will be offered the opportunity to reserve local restaurant tables on their travel dates -- while in the same browser session.
Risks: Valuation and damp gunpowder
Priceline and other Internet travel-related stocks may be at risk for some payback of their recent outsize successes. With the major indexes continually pushing through new highs, any sign of retracement in the broader market may affect stocks whose prices are predicated on vigorous earnings potential. Priceline's trailing-12-month P/E ratio, at 33, is slightly lower than competitor Expedia's 35 times earnings, and a bargain in light of competitors TripAdvisor and Orbitz, which carry current P/E ratios of 73 and 85, respectively. Priceline's status as a longtime leader in this group, along with its stable cash flows and more realistic valuation vis-a-vis its peers, may provide some insulation should the market enter a correction phase.
Another risk investors should be aware of is the slight bit of dampness in Priceline's acquisition gunpowder. The company holds $6.7 billion of cash and short-term investments on its balance sheet, but, of this total, approximately $4.9 billion has been earned and is held overseas, primarily in euros and sterling (the British pound). If the company repatriates this money to the U.S., say, for more stateside acquisitions, it will face U.S. taxes after utilizing existing net operating loss carryforwards. This may limit somewhat the company's ability to pursue further accretive deals such as Kayak and OpenTable. However, Priceline holds just $567 million of net debt (long-term debt less available cash and cash equivalents), so an alternate path available to management is to issue more debt for future acquisitions. We shouldn't be surprised if we see long-term debt increase during the next several quarters.
Positive travel trends have kept the wind in Priceline's sails for several quarters running, and the company has taken advantage of its profits and financial strength to invest in several Internet travel companies that continue to fuel its growth. For investors with a long-term horizon, the stability of Priceline's cash flows, coupled with its aggressive acquisition strategy and ample margins, make it an attractive buy candidate, despite some near-term worries about valuation.
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