Elevator Pitch
I maintain my “Neutral” rating on Hong Kong-listed Chinese aviation information technology services company TravelSky Technology Limited (OTCPK:TSYHF) (OTCPK:TSYHY) [696:HK].
The coronavirus pandemic resulted in TravelSky’s flight booking volume to fall by -52.87% YoY in 1Q2020, and market consensus expects the company’s full-year FY2020 revenue to decline by -15.7% YoY. The company will be very dependent on effective cost management and its balance sheet strength to weather the current storm.
In the medium to long term, TravelSky is a play on secular Chinese air traffic growth, and recent share appreciation rights granted to management should help to increase the alignment of interests between management and TravelSky’s minority shareholders. However, given that the company has limited options to diversify its revenue base and suffers from high operating leverage in the near-term, a “Neutral” rating for TravelSky is fair.
This is an update of my prior article on TravelSky published October 3, 2019. TravelSky’s share price has declined by -17% from HK$16.56 as of October 2, 2019 to HK$13.70 as of April 29, 2020. TravelSky trades at 14.2 times trailing twelve months’ P/E, which represents a discount to its historical five-year and 10-year mean trailing twelve months’ P/E multiples of 20.3 times and 16.3 times respectively. Market consensus expects TravelSky’s earnings per share to decrease from RMB0.87 in FY2018 to RMB0.53 in FY2019, which implies a consensus forward next twelve months’ P/E of 23.8 times. The stock also offers a consensus forward FY2020 dividend yield of 1.4%.
Readers are advised to trade in TravelSky shares listed on the Hong Kong Stock Exchange with the ticker 696:HK, where average daily trading value for the past three months exceeds $9 million and market capitalization is above $5 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.
Coronavirus Pandemic To Result In Fall In Flight Booking Volume And Revenue
The coronavirus pandemic has been a perfect storm for the global aviation industry, and TravelSky, whose core aviation information technology services business segment has a monopoly over the distribution of electronic air tickets in China, is no exception.
TravelSky’s flight booking volume fell -52.87% YoY to 76.4 million in 1Q2020, with domestic commercial airlines accounting for 87% of total volume, but bookings fees for international commercial airlines are significantly higher than that of domestic commercial airlines. Flight booking volume for domestic commercial airlines and international commercial airlines decreased by -52.23% and -56.41% YoY in 1Q2020.
But flight booking volume for domestic commercial airlines and international commercial airlines are moving in different directions. With the coronavirus pandemic showing signs of improvement in China as daily new confirmed cases of coronavirus infections drop, the YoY decline in flight booking volume for domestic commercial airlines narrowed from -84.34% in February 2020 to -68.78% in March 2020. On the other hand, the YoY decrease in flight booking volume for international commercial airlines widened from -79.07% to -90.56% over the same period.
At the company’s FY2019 earnings call on March 30, 2020, TravelSky quoted estimates suggesting that “global aviation profit will come down by 44%” this year due to the coronavirus pandemic and emphasized that “comparing with the SARS (Severe Acute Respiratory Syndrome) in 2003, now the epidemic is much more serious and the impact caused is much, much bigger.” Notably, the company acknowledged at the recent earnings call that “in the short run, we don’t think that there would be a lot of good effects or outcomes in terms of revenue expansion.” Market consensus expects TravelSky’s revenue to decline by -15.7% YoY from RMB8,121.7 million in FY2019 to RMB6,843.1 million in FY2020.
The coronavirus pandemic also brings TravelSky’s shareholding structure into the spotlight. The controlling shareholders of China’s three major state-owned airlines, China Southern Airlines (OTCPK:CHKIF) (ZNH) [1055:HK], China Eastern Airlines (CEA) (OTC:CHEAF) [670:HK] and Air China (OTCPK:AIRYY) (OTCPK:AICAF) [753:HK], have a combined 31% equity interest in TravelSky. The apparent lack of bargaining power between TravelSky and its customers (airlines which are also indirect shareholders) has been seen as the key factor why TravelSky’s core aviation information technology services business segment has a lower average selling price for domestic airlines via-a-vis international or foreign airlines.
TravelSky disclosed at its FY2019 earnings call on March 30, 2020 that “the government has put forth some requests about concessionary policies” and “the government encourage us to offer to airlines and travel agents some concessions.” The company added that “we are thinking of offering concessions in the cases of no-show and also cancellation or change of flights and so on.” Considering that its airline customers are the company’s largest indirect shareholders and there is national interest at stake in keeping the state-owned airlines afloat, one cannot rule out the possibility of TravelSky offering further concessions to its clients.
On the positive side of things, airlines which are also indirect shareholders highlighted at its FY2019 earnings call on March 30, 2020 that the company believes “that after the epidemic, people’s desire to travel will recover” and “we will see fast and strong growth after the epidemic.” But TravelSky will have to first weather the storm with effective cost management and its strong net cash balance sheet, as discussed in the next section of this article.
Cost Management And Balance Sheet Strength
Market consensus expects TravelSky’s earnings per share to decrease by -39.2% YoY, compared with a relatively milder -15.7% YoY decline in revenue this year. This is largely attributable to the negative effects of operating leverage. At the company’s FY2019 earnings call on March 30, 2020, TravelSky acknowledged that “from our cost structure, there are a number of fixed cost items” and it highlighted “staff cost”, “technology, innovation cost, product innovation cost” and “depreciation and amortization” as fixed costs that do not decrease in tandem with revenue and flight booking volume.
TravelSky’s cost management initiatives are expected to be targeted at the commission & promotion expenses and other operating expenses (which includes general & administrative expenses) line items. Commission & promotion expenses and other operating expenses accounted for approximately 9.8% and 5.5% of TravelSky’s FY2019 revenue respectively. The success of TravelSky’s efforts to manage commission & promotion expenses and other operating expense will be key in mitigating the negative impact of the coronavirus pandemic on the profitability of the company in FY2020.
Notably, TravelSky does not intend to cut back on research & development or R&D expenses, which forms part of technical support & maintenance fees and personnel expenses. While this is the right approach from a medium to long-term perspective, it will inevitably hurt TravelSky’s financial performance in FY2020. TravelSky emphasized at the company’s FY2019 earnings call on March 30, 2020 that “we attach a lot of importance to new product development and utilization, application of new technologies” and “we have not seen any change in the customer’s demand for R&D investment.”
More importantly, TravelSky has a strong balance sheet to weather the current storm. As of December 31, 2019, the company was debt-free with cash of RMB4,546.8 million on its books which accounted for approximately 12% of its market capitalization. Assuming a worst-case scenario with zero revenue, TravelSky’s cash can cover at least nine months of operating expenses (based on FY2019 numbers).
Share Incentive Scheme To Increase Alignment Of Interests Between Management And Minority Shareholders
Putting short-term headwinds from the coronavirus pandemic aside, it is noteworthy that TravelSky granted 35,958,950 share appreciation rights to 502 managers under its share incentive scheme in January 2020. According to the company’s announcement, the share appreciation rights accounting for 1.23% of issued share capital with an exercise price of HK$18.66 (well above the company’s current share price) will come into effect “by the end of the second anniversary (24 months), the third anniversary (36 months) and the fourth anniversary (48 months) from the Initial Grant Date in three equal installments.”
TravelSky disclosed at FY2019 earnings call on March 30, 2020 that the key performance indicators for the share appreciation rights are average net profit yield rate, three-year revenue CAGR and Economic Value-Added. Notably, the company added at the recent earnings call that the key performance indicators “will not change” despite the coronavirus pandemic and it “will work very hard towards the indicators and the targets.”
The share incentive scheme should increase the alignment of interests between management and TravelSky’s minority shareholders, and I see this as a key positive for the company in the medium to long term.
Valuation
TravelSky trades at 14.2 times trailing twelve months’ P/E and 23.8 times consensus forward next twelve months’ P/E based on its share price of HK$13.70 as of April 29, 2020. In comparison, the stock’s historical five-year and 10-year mean trailing twelve months’ P/E multiples were 20.3 times and 16.3 times respectively. Historical averages for trailing twelve months’ P/E multiples (rather than consensus forward P/E multiples) are used as a means of comparison, as I expect an eventual normalization of TravelSky’s revenue and earnings when the coronavirus pandemic is contained.
TravelSky offers a historical FY2019 dividend yield of 2.3% and a consensus forward FY2020 dividend yield of 1.4%. The company’s dividends per share increased by +7.4% YoY from RMB0.269 in FY2018 to RMB0.289 in FY2019, but market consensus expects TravelSky’s dividends per share to fall by -38.5% YoY to RMB0.177 in FY2020 in line with a similar level of decrease for its earnings.
Risk Factors
The key risk factors for TravelSky are weaker-than-expected aviation traffic due to the coronavirus pandemic, a failure to manage costs well to partially offset the drop in revenue, and a deterioration in the company’s financial position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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