Last quarter, management at Ctrip.com (CTRP 0.40%) -- China's largest online travel agency (OTA) -- signaled that shareholders needed to adjust expectations. After years of investing heavily in capturing market share, the company's heady top-line growth would be coming to an end.
While part of this has to do with the Chinese government cracking down on Ctrip's practice of automatically opting consumers in to high-margin "value-added services" like trip insurance, it's also simply what happens after one company comes to capture such a large portion of a market.
But investors who were worried about the future of the company breathed a sigh of relief when the company reported earnings this week. While sales were predictably slower than in the past, profitability boomed as the company was able to benefit from the network effects and scale.
More and more families are booking their travel from China on Ctrip's mobile app. Image source: Getty Images.
Ctrip.com earnings: The raw numbers
Before we dive into the why behind the company's encouraging report, let's take a look at the headline numbers for the first quarter of 2018.
| Metric | Q1 2018 | Q1 2017 | Year-Over-Year Growth |
|---|---|---|---|
| Revenue | 6.7 billion yuan ($1.1 billion) | 6.0 billion yuan | 11% |
| EPS | 3.48 yuan ($0.55) | 1.04 yuan | 235% |
Data source: Ctrip investor relations. Earnings per share (EPS) presented on non-GAAP (adjusted) basis. Note that revenue figures for 2017 are restated following updated accounting rules.
Profitability increased thanks in particular to the leverage Ctrip.com now gets because of its stature in the Chinese OTA market. Gross margin expanded by 118 basis points to 81.51% -- meaning that the company gets to keep more of every dollar spent on its platform. The rest of the boost came from significantly increased interest income.
At the same time, the company continues to invest heavily in its future. Operating expenses grew by more than sales even after backing out stock-based compensation: Product development expenses jumped 16%, general and administrative costs went up 15%, and sales and marketing grew 12%.
One segment's growth stalls while others continue to boom
For the vast majority of the past five years, growth in transportation -- particularly airline ticketing -- was the key driver for sales growth. With the change in how customers opt in or out of value-added services, that growth has ground to a halt.
At the same time, the rest of the divisions continue to perform well.
| Division | Q1 2018 | Q1 2017 | Year-Over-Year Growth |
|---|---|---|---|
| Transportation | 2.888 billion yuan | 2.875 billion yuan | 0% |
| Accommodation | 2.487 billion yuan | 2.023 billion yuan | 23% |
| Packaged tour | 834 million yuan | 709 million yuan | 18% |
| Corporate travel | 180 million yuan | 144 million yuan | 25% |
Data source: Ctrip investor relations.
Declines in airplane tickets were offset by gains in train and bus tickets, as well as the opening of a car-hailing service for business clients.
It was clear from the company's conference call that management realizes it may have been a long-term mistake to reap so much high-margin revenue from automatically charging customers for value-added services.
Founder and Chairman James Liang said during a conference call with analysts, "we continue to push customer-centric as a core priority in order to strengthen our foundation as China's leading online travel company." He specifically noted transparency on pricing, being able to opt out of value-added services, consistency in prices and policies, and impartiality in ratings as the core actions management is taking to address these concerns.
He also made it clear that cleaning up its act may cost Ctrip in the short run:
Some of you may ask whether being customer-centric will hurt our earnings. Yes, it may require us to sacrifice short-term earnings. However, from a long-term perspective, a company that creates the maximum value for customers is the right foundation to grow market leadership and long-term shareholder value.
The moves appear to be working, as the company's net promoter score, which measures how much customers like a copmany, increased 15% from just one quarter ago, according to what CEO Jane Sun had to say on the company's conference call.
Looking ahead
For the current quarter, management expects revenue to grow between 12% and 17% versus last year's second-quarter results. Investors should keep an eye on outbound travel from China, and Skyscanner in particular -- which contributed about 10% of transportation revenue -- to see if these segments can give transportation revenue a boost throughout the rest of the year.
