A Bit Of Context

China internet stocks have been particularly volatile in the past years. That has been a result of a series of factors. For example, they posted a significant correction as a result of the fears of an economic deceleration in 2015, but recovered soon when the market realized the excessive negativity.

In more recent times, we have seen a higher volatility as a result of the trade war between the United States and China and the negative effects the market is discounting. The market’s reaction is generating interesting buy-on-the-dip opportunities, and one of the most interesting names is Ctrip.Com International Ltd  (Nasdaq: CTRP).

Citrip.com is the market leader in the Chinese online travel industry, and is basically the Chinese equivalent of Expedia (Nasdaq: EXPE) or Booking holdings (Nasdaq: BKNG). In this context of market panic affecting the whole Chinese internet space due to the concerns about the potential effects of a trade war on the country’s economy and regardless of the potential impact of tariffs, Ctrip’s prospects remains solid thanks to the favorable conditions of the Chinese market, where the strong economic growth and the rise of the Chinese middle class will support growth in the travel industry for many years.

These factors have already driven Ctrip’s growth in the past years, and the stock has essentially quadrupled from $10 to more than $40 between 2012 and 2017, while sales per share more than tripled and FCF per share grew from $0.62 to $1.41.

Growth has slowed down in the recent past due to the aforementioned concerns about the effects of a trade war on the Chinese economy and the evidence of a deceleration in the past few quarters. While it’s true that growth is slowing from the 35% - 75% area in the past few years to just low-double-digit growth in Q1, long-term growth prospects remain solid and the management’s guidance actually implies an acceleration in the short term, to a growth rate in the 20% to 25% range. In any case, Ctrip’s business is driven by favorable long-term trends that will support sales growth.

Growth Prospects In The Industry Remain Solid

Ctrip’s revenue growth rate has declined significantly but the conditions in the Chinese online travel market remain favorable. Chinese GDP growth is constantly above 6%, with consumption trends growing at a multiple of that rate. The fast growth of the Chinese middle class and the growing spending it brings support growth in many areas of the consumer space. Chinese consumers are estimated to travel 70% more overseas in 2020 compared with 2015 and BCG expects the market value of leisure trips to grow more than 300% by 2020, while the demand for domestic accommodations is expected to double.

It’s not just a matter of GDP growth and rising middle class. The changing consumer habits play an important role, and all the main trends seem to work favorably for the Chinese company. For example, it’s natural to expect the online travel players to continue to gain market share at the expense of traditional operators. That’s an obvious result of the low internet penetration of internet usage among the Chinese population (just above 50% vs. 80% or even 90% in the western world). There is a large room to grow at the expense of traditional operators if we consider that online penetration is the industry is currently only between 20% and 25%.

In the online travel industry, who can benefit from these favorable trends better than CTRP? I think nobody. Ctrip remains by far the market leader with a 35.19% market share in China's online travel market, followed by Qunar (17.28%), and Alitrip (13.57%). In addition to that, the relatively new Skyscanner segment will surely drive international growth in addition to the domestic growth, especially in the European markets, where the platform is experiencing a strong and constant increase in popularity.

Margin Trends And Valuation Multiples

Ctrip’s margins have been quite volatile over the years, due to a combination of factors such as acquisitions and various types of investments.

Nonetheless, the management expects operating margins in the 20% - 30% area, significantly above the levels of the past 6 years, when operating margin has never risen above the 18% level. With this kind of margin expansion implied in the guidance, EPS growth should be significantly above the 20% - 25% growth rate expected for revenue, and reasonably in the 25% - 30% range assuming that the company is able to perform in line with the management’s expectations.

Now let’s consider that after the recent correction, CTRP currently trades at roughly 38x full-year EPS expectations:

(Click on image to enlarge)

Source: sentieo.com

A P/E multiple of 38, with a 25% EPS growth rate translates into a PEG rate of 1.52, quite an attractive level if we consider that the company is a market leader in a fast–growth market supported by secular tailwinds. The risk is that the company will fail to perform in line with the management’s expectations. Nonetheless, the long-term attractiveness at these levels seems to be quite evident.

Final Thoughts

While it’s true that Ctrip.com’s top-line growth has recently slowed down, I think the recent correction has overextended. Revenue growth is expected to re-accelerate and the company’s position in the booming online travel industry implies a favorable long-term growth trend. Operating margin is also expected to widen nicely and the combination of revenue growth and margin expansion does make the current valuation multiples look excessively conservative.

Even if the management’s estimates were too aggressive, the company’s long-term prospects would remain strong thanks to the low penetration of online travel services in China, the favorable economic growth, and the increasing internet usage, with a particular benefit from the company’s deeper penetration into lower-tier cities. While some short-term volatility is evident and may continue to affect the business, CTRP may appeal to investors who have a long-term time horizon.