Priceline’s Earnings Growth Could Be Offset By A Slowdown In Europe

Priceline (NASDAQ:PCLN), a leading online travel company, has been growing at a phenomenal rate backed by growing strength in its hotel business and expansion in international markets. The company has been reporting increasing quarterly revenue since the start of 2012, albeit at a slower pace compared to previous years. Priceline is expected to report its Q3 2012 earnings today, and though we estimate the company to post another quarter of revenue growth, we expect to see a decline in the growth rate.

With an expanding presence in international markets, increasing opportunities in mobile travel space and strong growth in hotel bookings, we expect Priceline to register growth for the rest of our forecast period. However, certain factors such as pressure on operating margins with intense price competition and increasing threat from leading online search engines make us believe that the growth rate will decline in the years ahead.

While we believe there are certain positive factors which will contribute to Priceline’s growth this quarter, we think this could be offset by the weakness in demand from Europe.

See our complete analysis for Priceline

Expanding Presence In International Markets

With the acquisition of Booking.com, Agoda and TravelJigsaw, Priceline has been increasing its focus on growing its business internationally. Gross bookings from international markets as a percentage of total bookings have gone up from 55% in 2007 to around 78% in 2011, and we expect the upward trend to continue in the future.

With a fragmented hotel market in Europe and high GDP growth rate as well as a growing middle class in emerging economies, we believe the international markets offer tremendous growth opportunities for online travel agencies (OTAs) such as Priceline and Expedia (NASDAQ:EXPE). While growth in US is nearing saturation, the relatively low Internet penetration, especially in emerging economies, provides a higher scope of growth for OTAs. (Read: Priceline’s Stock Rides Big On International Growth Opportunity)

Expanding Hotel Offering

Contributing over 86% to Priceline’s valuation, as per our estimate, hotel bookings is the most important division in the company’s portfolio. Not only do hotel bookings account for the majority of Priceline’s revenue, but with 23% revenue margin, it is also the most profitable division compared to airlines (3%) and car rentals & cruises (9%). Priceline’s opaque bookings model “Name Your Own Price” and the newly launched “Express Deals” for hotels facilitate even higher premium pricing, leading to revenue margins in excess of 30%.

The hotel markets in Europe and Asia are much more fragmented with smaller, independent lodgings compared to the US where the hotel market is dominated by large hotel chains. Hotel chains are more likely to offer online bookings through their own websites, while online travel agencies are more appealing to small, independent hotels outside the  US. We believe that Priceline has benefited from this trend as it has registered a significant increase in its share in international markets.

With Booking.com and Agoda.com in its portfolio, we believe that Priceline is well equipped to leverage growth in this segment and estimate a slight increase in its market share over our forecast horizon.

Weakness In Europe To Impact Growth

While expanding its presence in international markets is clearly an important growth driver for Priceline, its increasing share in European market makes the company more vulnerable to the debt crisis in the region. Post the acquisition of Bookings.com in 2005, the company has been steadily increasing its market share in Europe. Key European markets represent around 60% of Priceline’s total booked room nights, and we estimate hotel bookings to contribute over 87% to the company’s valuation.

Thus, although the weakness in European economies impact the online travel industry as a whole, we think Priceline is probably the most sensitive to any adverse developments in the region due to the high contribution of hotel bookings from the European markets to its revenues.

Downward Pressure On Operating Margins

Online travel services remain a competitive niche segment with stiff competition among Expedia, Priceline, Orbitz (NASDAQ:OWW) and Travelocity. Macroeconomic headwinds have further intensified competition leading to lower revenue margins and high promotional spending, thereby squeezing operating margins. Additionally, the relatively low entry cost makes the industry vulnerable to potential threats from new players.

In an effort to gain competitive advantage, travel companies are creating new promotions and consumer value features such as eliminating processing fees, waiving cancellation and change fees, etc. The intense price competition affects operating margins in two ways: first, it puts a downward pressure on prices and, second, it increases the company’s promotional spending to lure more customers to its websites.

The promotion of Priceline’s brands in international markets will involve significant operational expenses through utilization of online search, affiliate marketing, and online advertising strategies to name a few. We think the above factors will restrict margin growth for the rest of our review period.

We will update our price estimate of $564 for Priceline post the Q3 2012 earnings release.

Understand How a Company’s Products Impact its Stock Price at Trefis