Unlike most years, the stock market has shown no signs of going to sleep for the summer with few signs that the selling storm in both bond and equity markets might be petering to a close soon. This month, I have included in the lineup shares of two companies that have had a tough couple of years but as internet-only operators, they are winning market share and have none of the costly overheads that come with a presence on the high street.
First on my list is the largest internet-only travel agent, On the Beach, which looks set to emerge a winner. Its chief executive certainly thinks so having bought £2m of shares in August.
In the past two years, rival travel agent Thomas Cook has disappeared from our high street (which historically represented c.10% of the European online short-haul beach holiday market). This has left a huge opportunity for OTB to take market share although it didn’t show up as 2021 ended up a bit of a ‘stub’ year due to the Government restrictions on overseas travel and a wait for Covid passports. But the pent up demand was obvious when travel opened up again and OTB really began humming. In fact, in May, OTB said its Summer 2022 sales were 22% ahead of pre-COVID levels in H1 20 even though Spain was still closed to UK tourists at the time. Bookings were also stronger in higher value, more premium hotels, with sales for premium holidays that included 5-star hotels up 95%.
Staffing pinch points starting to ease?
But OTB’s share price has still endured a torrid time, dropping c.65% since the start of the year. This is because nobody had really appreciated that staff layoffs during Covid would have a near term effect of staff shortages at airports, which then caused travel disruption and flight cancellations and ended up costing the travel industry millions of pounds in missed profits.
In fact, the airline industry lost 7% of its workforce during the coronavirus pandemic, leaving supply out of balance with rebounding demand. Against the usual rate of 1% flight cancellations, OTB had to contend with, perhaps, 5% flights being cancelled, which has led to downgrades; forecasts for this year are £25m lower than where they were a year ago. But I think the time has come to alight on the shares because airports are showing signs that they have recruited staff and things are normalizing with some airlines planning increases to seat capacity.
Nice run of profit forecasts
For FY22, broker Panmure Gordon now forecasts revenue of c.£138m and pretax profit of c.£13m. For FY23, they forecast revenue of c.£163m and pretax profit of c.£35m and for FY24, the forecast revenue is c.£169m with pretax profit of c.£43m. Corresponding eps are 6.2p, 16.9p and 20.1p over the three years. On that basis the shares trade on a prospective PE of 7.2 for FY23, dropping to 6 the following year, compared to the pre-COVID forward PE multiple since IPO, which ranged from 10x-24x.
As a starting point, despite macro headwinds I think there is scope for next year to surprise on the upside. This year’s already-depressed numbers due to flight cancellations have been further depressed by the warm weather, which encouraged some of us looking for late bookings to staycation once again. And then, just as Covid restrictions were lifted, we were met with the Ukraine war.
That said, market share gains are set to provide structural margin benefits, for example, a more benign competitive environment means the profitability of the core business in terms of the required online marketing spend linked to sales reduces. In particular, since Thomas Cook perished, the Civil Aviation Authority website shows there have been perhaps 40 other corporate failures, which has opened up a potentially significant revenue pool for OTB, but the Covid crisis means this revenue opportunity has not yet come to fruition.
At the same time, as I describe below, overseas travel has proved fairly resilient in past recessions, much more than, say, purchases of big ticket appliances, carpets or sofas and rather than not going on holiday at all, customers are most likely to simply maintain the same sterling spend by opting for shorter stays, staying in slightly lower-quality hotels or similar hotels in cheaper destinations. The cost of living crisis has also made some all-inclusive resorts in Turkey and Portugal 50% cheaper than UK destinations like Devon. As a provider of value holidays, OTB should benefit from any such trading down.
Online holiday buying
Established in 2004, OTB is an internet-only travel agent with a focus on beach holidays and its systems can dynamically pull all the various prices under one roof.
Customers are allowed to pick and mix from a range of airlines, accommodation suppliers, car rental companies and also add on in-resort services (day trips, event tickets, attractions and entertainment). Departure dates and holiday durations are flexible. Prices can be higher or lower on a given day of the week: for instance, flying at 10pm might be cheaper than flying at a more popular time of 9am or you can fly out with one airline and come back with another in order to save money. This enables customisation of holidays from millions of flight and hotel combinations as opposed to being offered pre-packaged holidays, as is the case with many traditional tour operators and it allows customers to find the best deal to suit them.
OTB spends on marketing to drive traffic to its websites. By far the most important part of this is spending on Google Adwords to appear in the top four paid positions for desired keyword searches. The website then monetises these visitors by taking a commission on any bookings that are made.
Because OTB has been doing this for an incredibly long time, it has established superb ‘big data’ capabilities and its systems can collate large quantities of highly fragmented flight, hotel and other data better than most and certainly better than TUI, which along with Thomas Cook once dominated the UK short haul beach holiday mass market. TUI is still circumscribed by the fact that it has a vast network of shops and has cruise ships, hotels and planes to take trippers round the world and consequently has a fixed cost per booking 7-8x higher than OTB.
These days, OTB, as per ATOL licence data, is the number three UK ATOL licence holder. A note in the last near normal year, 2019 (ie. pre COVID), showed that OTB had 1.86m passengers licensed and held a 20%+ share of the online short haul beach holiday market. However, with c.6m UK package beach holidays sold online, and a further c.6m still sold offline, there is plenty left to play for.
Flanking brand
Most of its growth to date has been organic although there have been two interesting acquisitions. In May 2017, OTB acquired sunshine.co.uk. This was basically just a small version of OTB with a bias to the value end of the market. Within three months of buying it, although the website still retained the same old look and feel, sunshine.co.uk had been migrated to OTB’s existing technology with all the 25 staff that had come with the business eliminated.
In the past few years, across both these B2C sites OTB has been growing by gradually adding new destinations although the focus has remained on short haul beach holidays. In normal times, key destinations are Spain and the Canaries, which account for c.65% of all holidays. Egypt, Turkey, Greece and Malta make up the balance. OTB is fast becoming the ultimate beach holiday retailer but it has many new countries still to conquer including long haul (which has grown to 8% of sales from 2% a year ago).
Flexibility of business model
What makes OTB really score is that it has flexibility in its business model because it gets its traffic from pay-per-click on Google (the latest H1 showed a whopping 30% revenue spent on online advertising and 23% on offline advertising).
As an example, if OTB bids to appear at the top of a Google search, every time its link is clicked, it will be charged a certain amount – for simplicity’s sake, say that is £1. So, to drive 500 visits to its site, it needs to spend £500. Crucially, it needs to convert those 500 visits into bookings worth at the very least £500 worth of gross profit to break even and then anything else is its profit.
If market conditions are difficult and there are fewer people looking online for holidays, OTB’s custom Google Adword bidding tool is also tactically able to dial down its campaigns (eg. bid less for keywords) and also reduce the total amount it is willing to spend, rather than seeing diminishing returns and losses. All this marketing competence has been gradually reducing the average cost-per-click paid to search engines.
Clearly anyone wanting to compete against OTB has a big hill to climb. What I think has also made it an unassailable leader is that it is building a hugely loyal user base as 60%+ of its traffic is now “branded” or “free” from people going directly to its website rather than using a search engine and over a third of its customers are repeat, having travelled with it before.
OTB has also fundamentally re-engineered the architecture behind its website to refine its personalisation technology. In much the same way as you might go into a retail travel agent and if you have children, ask to see hotels with pools or kids clubs, the site learns about the visitor from their searches and uses that data to show them products that are more likely to convert into a booking.
Such scale and continued improvement in marketing efficiency are the first two barriers to any would be rival. A third “moat’ is that as OTB has become larger, there has been an increase in the volume of inhouse accommodation bookings. Most online travel agents receive their supply of hotels via third-party “bed banks,” which aggregate the fragmented hotel market. While that is convenient and allows for a rapid scaling of supply, by doing this the travel agent loses out on part of the available commission and increasingly OTB has been directly contracting with hotels; it earns a better gross margin (c.5% higher) when it sells directly contracted hotel beds rather than when it has booked via a third party bed bank and since the pandemic, 90% of all rooms are purchased with direct contracts. Both these factors mean that a return to normal conditions will see its core B2C EBITDA margin increase sharply - Panmure expects 40% in FY23.
Financial strength at a time of crisis
Customer payments made to OTB in advance of travel are deposited in the trust account ie. they are not used to fund the day-to-day activities of the business. These amounted to £99m at H1 22 and will have unwound as customers travelled over the summer months. In cases where flights were cancelled, OTB refunds for flights on request, whilst waiting for airlines to refund it. The hotel is only paid when the customer arrives so if it was cancelled they wouldn’t be paid. Alongside customer deposits, it also has £16.8m of its own cash and a £75m undrawn facility, which has allowed it to invest in winning market share.
On The Beach moves to B2B
Since 2015, OTB has also launched sites for the international market with Sweden and Norway under its ebeach.se brand but this remains a nascent opportunity. But a second strand to the business has been added in the form of Classic Online, which is a B2B operation. Although much reduced, 40% of holiday bookings are still made in person at a bricks and mortar travel agent or through a homeworker and Classic presents an opportunity to access this market. It operates as a tour operator selling high end, short haul beach holidays (£2,000 per person versus £500 for OTB) to 1,800 travel agents via an online booking portal. Despite the lack of high street footfall, last reported total year to date sales were up 43% versus FY19. Unlike the B2C core online platform, however, which is based on cost per click just to bring traffic to the website, Classic Online only pays a commission to the travel agent when a holiday is actually sold, which means margins are strong.
Vesting for LTIP: eps of 23.4p in FY23
The latest H1 reflects a period that was impacted by Covid and whilst the past may be a poor guide to what is ahead, what is certain is that OTB is the lowest cost operator in its space and there is a lot of value to be unlocked. The director of corporate development thinks so, having bought 38k at 131p last month, followed not long after by chief executive Simon Cooper’s 1.53m at 129.5p (£2m). What’s also interesting is the vesting thresholds of the management LTIP scheme: 25% of the award vests if adjusted eps in FY23 hits 17.27p, and 100% vests if eps reaches 23.37p. I think the shares are a buy.
