Shares of Ctrip.com (CTRP: Charts, News, Offers), China’s leading online travel service provider, have slumped since it once again announced better-than-expected earnings accompanied by lower-than-expected guidance. Despite being one of the most recognized, most successful Chinese growth stocks in the past decade and receiving huge revenue boosts from the Beijing Olympics and the Shanghai World Expo, investors are concerned that Ctrip.com’s growth story has finally hit a growth bottleneck due to rising interest rates and an appreciation of the RMB. Ctrip.com provides airline tickets, hotel accommodations and packaged tours both domestically and internationally through its respective Chinese and English websites. The company owns over 50% of the online travel business in China and far exceeds the share of its closest rival, eLong (LONG: Charts, News, Offers), which is a unit of Expedia (EXPE: Charts, News, Offers). As China emerges as the second largest economy in the world and poised to challenge American dominance, is this lull in Ctrip’s stock price a buying opportunity, or is it the beginning of a long-term retracement to lower levels?
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The company’s revenue growth impressed analysts, increasing 39% to $119 million USD, edging out the consensus of $115 million. Its EPS of 30 cents beat the consensus of 24 cents, and gross margins increased from 77% to 78%. Operating margins came in at 38%. Ctrip has a habit of low-balling estimates and exceeding them, but its current projected guidance of 20% revenue growth for next year, which would signal a 50% slowdown, spooked investors. Conservative analysts had been expecting the company to at least provide guidance for 31% growth.
Starting in the start of the third quarter, when Ctrip began issuing lowered guidance, sales and marketing expenses increased by 33% while general and administration expenses increased by 69%. In the fourth quarter, these expenses increased by 30% and 25%, respectively, over the same period last year. Growth investors often watch the ratio between administration expenses and revenue growth, in hopes that the former (30%) is lower than the latter (39%). If administrative expenses outweigh revenue growth, decreasing margins are likely to occur. If 20% revenue growth is the future standard of Ctrip, the company will have to cut its expenses to maintain its high margins. Product development expenses decreased from 53% in the third quarter to 37% in the fourth. This has eased some concerns about the company trying too hard and spending too much to stay ahead of its increasing competition.
Competition is fierce in China, with rival eLong and e-commerce websites such as Taobao and Qunar all vying from a cut of the lucrative online travel pie. Search giant Baidu’s (BIDU: Charts, News, Offers) move towards mobile search and the increased adoption of smartphones has changed the game significantly for online travel providers, who all must cater to an upwardly mobile and increasingly fickle customer base. Another concern is airlines and hotels aiming to cut their ties with Ctrip due to commissions taking a bite out of their bottom lines, in a clash that mirrors the American battle between Orbitz and American Airlines. As airlines and hotels move towards direct sales from their websites, the selection on Ctrip’s website may narrow. Direct airline sales only comprise 10% of all ticket sales in China, signifying tremendous growth opportunity. However, this impact will be limited, due to the company’s loyal customer base and the popularity of its hassle-fee, all-in-one packages.
A disturbing technical fact is Ctrip’s high forward P/E of 31.11. If the company’s margins shrink to 20%, that would match Expedia’s margins – but Expedia currently trades with a far lower forward P/E of 9.6. This would mean that Ctrip’s current price levels would be unsustainable should its margins drop towards its forecast margins, which explains the stock’s current slide. Wall Street remains divided on Ctrip – analysts at Merrill Lynch and Citigroup have downgraded Ctrip, while Piper Jaffray and Morgan Stanley analysts have remained bullish. Morgan Stanley’s Richard Ji noted that despite the seemingly expensive P/E, it is the cheapest the stock has been in the last 18 months, and may present patient investors with a buying opportunity.
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
