On the Beach (OTB) – A hot summer survivor

On the Beach (OTB) – A hot summer survivor

On the Beach (OTB) has come through a tough summer that has seen the major tour operators struggle. Fortunately, this online travel agent (“OTA”) has a very flexible and low cost base. Marketing is the main expense.

The big question is whether other online travel agents like Love Holidays may be able to overcome On the Beach’s competitive moat. (See our previous article.)

In terms of valuation, the rolling forecast P/E rating for On the Beach is not demanding at 16.7X (latest share price 418p, market cap £550 million).

(Source: On the Beach)

On the Beach share price since IPO

(Source: Google finance)

Key results takeaways

On the Beach has just reported results for the financial year to September 2018.  There are a number of key takeaways that are worth considering:

1) Hot weather reduces demand and leads to discounting

Hot weather in the UK and Scandinavia reduces overall holiday demand and leads to significant discounting from tour operators. These two factors had a significant effect on On the Beach sales in the summer 2018.

This summer was the joint hottest on record in the UK and hit the peak holiday travel periods of July and August.  It is unlikely that the summer of 2019 will be such a scorcher and this bodes well for a rebound in holiday demand.

An interview with Thomas Cook (TCG) CEO, Peter Fankhauser, highlighted the impact of hot weather: Interview.  Thomas Cook has issued multiple profit warnings this year: coverage.

UK travel declined in June and August on a year ago

(Source: On the Beach)

Thomas Cook share price: a tough summer

(Source: Google finance)

2) OTB UK customer loyalty continues to improve

Repeat booking volumes were 44.5% of On the beach’s total bookings in fiscal 2018 versus 40% in the previous year. This suggests customers are satisfied with On the Beach, which helps reduce marketing costs going forward.

On face value, an online travel agent provides a commodity service with the next competitor only a click away.  However, trust is important given that a number of holiday operators have failed in recent years, e.g. Monarch and Low Cost Holidays.

(Source: On the Beach)

3) UK website traffic growth stalled

Daily unique visitors to On the Beach’s website in the UK increased marginally from 70 million in fiscal 2017 to 70.4 million in fiscal 2018.  The 0.6% increase is well below the 12% annual growth from 2013 to 2018.

4) Direct hotel contracting will continue to drive margins

On the Beach directly contracted around 70% of hotels in fiscal 2018 with these bookings generating 50% of group revenue. By way of comparison, direct contracting was 65% of all hotel buying in fiscal 2017 and 57% in fiscal 2016.

The second half of fiscal 2018 also saw 31% of total bookings on an exclusive basis versus 23% last year. Hotel contracting is described as an opportunity to both grow booking volumes and improve profit margins.

(Source: On the Beach)

5) Marketing efficiency drives margins

On the Beach’s UK marketing costs as a percentage of revenue fell to 41.8% in fiscal 2018 versus 45.2% in the previous year. This reflected a 9% jump in UK revenue and a 1% increase in UK marketing costs.

Revenue after marketing spend has tended to increase at a faster pace than revenue.  In the five year period to 2018 revenue increased at a 19% annual pace while revenue after marketing spend increased at a 23% annual pace.

(Source: On the Beach)

6) Cashflow remains strong

Operating cash flow was 79% of EBITDA profit in fiscal 2018 with the figure unchanged on the previous year. However, free cash flow conversion (earnings per share into free cash flow) did decline in 2017 and 2018 versus previous years.

On the Beach: free cashflow conversion weakened in 2017 and 2018

(Source: SharePad)

7) Continental Europe is challenging

The results from the European operations remain disappointing. On the Beach remains sub-scale in Scandinavia with only £1.6 million revenue generated in fiscal 2018.

The group remains optimistic with the business recently having been launched in Denmark.  Whether On the Beach can repeat the success it has had in the UK remains to be seen.

Financial results: fiscal year to September 2018

The UK is currently the main focus of On the Beach and generated a 9% increase in revenue to £89.3 million.  First half revenue improved by 18% on a year ago but second half revenue was up only 1% on a year ago.

Fixed and variable UK costs (ex. marketing) rose as a percentage of revenue increased due to: “operational investment ahead of Package Travel Regulations.” The EBITDA profit margin in the UK nevertheless improved to 42.4% from 40.5%.

On the Beach UK numbers

(Source: On the Beach)

On the Beach acquired Classic Collection Holidays on 15 August 2018 for £20 million and its results were reported separately. The business generated £13.2 million revenue in the financial year and EBITDA of £1.1 million.

The international division saw revenue decline 6% to £1.6 million and the EBITDA loss up 10% to £2.2 million. The group blames this on “exceptional summer weather in H2 in Scandinavia” and related tour operator discounting.

On the Beach overall financial result

(Source: On the Beach)

Valuation

On the Beach trades on a rolling (next 12 months) P/E ratio of 16.7X.  This is around the middle of its recent valuation range.  Growth in the current year will be driven by the takeover of Classic Collection Holidays.

On the Beach’s P/E rating evolution

(Source: SharePad)

Looking further out and the forecast P/E ratio declines to 14X in fiscal 2020 and 12.4X in fiscal 2021.  This is dependent on continued revenue growth and profit margin improvements.

On the Beach consensus forecasts (5 brokers)

(Source: SharePad)

Summary

On the Beach appears to have kept the competition at bay with margins in the UK continuing to improve.  The ability to successfully develop the business in continental Europe remains open to question.

In my view, On the Beach is an attractive investment as long as it can keep online rivals at bay (see previous article, “Assessing the Moat”). Package holiday demand continues to grow. In the short-term, Brexit-related uncertainty could prove to be a headwind in 2019.

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