Trip.com: China’s largest travel platform – Takeoff or crash landing?

Trip.com Group Limited operates as a travel service provider for accommodation reservations, transportation ticketing, packaged tours, corporate travel management, and other travel-related services in China and internationally. The company also provides its corporate clients with incentive trips, meetings and conferences, and a corporate travel management system, an online platform that integrates online booking, authorization and travel reporting systems. It also offers online advertising and financial services. It operates under the Ctrip, Qunar in China and Trip.com, Skyscanner internationally. Trip.com Group Limited was founded in 1999 and is headquartered in Shanghai, China. The company was formerly known as Ctrip.com International, Ltd. and changed its name to Trip.com Group Limited in October 2019 ^[1].

Corporate Structure

Management Overview

To truly understand a business, one must acquire extensive knowledge of how the company generates revenues and the primary factors that drive its future growth and profitability. Here in this section, our team of analysts will break down complex regulatory, financial and economic concepts for your convenience. Continue reading!

Trip.com business model

The business operates an open platform model by attracting partners to join an online platform and directly post their products and service offerings ^[1]. The partnerships are diverse in which some of the most common include hotels, airlines, train companies, car rental, travel insurance and other travel agencies. The platform primarily operates online and can be accessed through a range of website choices and mobile applications ^[2]. The primary website is Ctrip and Qunar which primarily target a Chinese audience and operates exclusively in China. On the other hand, the main international website is Trip.com which is available in over 20 languages and offers payment options in 31 currencies. Furthermore, in November 2016 Ctrip acquired Skyscanner for $1.7 billion which is a leading UK-based travel agency based in Edinburgh which also operates globally in over 30 languages and 52 countries ^[1][3] In September 2019, Ctrip completed a share exchange with Naspers and became the single largest shareholder of MakeMyTrip ^[4]

The Five Operating Segment

1. Accommodation: Trip.com receives a commission from hotel partners on bookings done on its platform. The commission is dependent on arrangements agreed with the partner which can be fixed or a variable rate. Some service providers are obligated to provide guaranteed rooms for booking, whilst others require a second confirmation from the hotel.
   
2. Travel Ticketing: The company acts as a platform for selling airline tickets, railway, ferry and bus services. Furthermore, it acts as a major agent in China for the reservation of flights across all major Chinese airlines including Air China, China Eastern Airlines, China Southern Airlines, and most of the international carriers.
   
3. Packaged Tours: The company primarily targets independent travellers and provides packaged tours that combine many services and arrangements as a complementary offer often at a discounted price.
   
4. Corporate Travel: Trip.com also provides bespoke travel-related services for business use, where firms get access to a platform that enables them to manage business travel costs, data collection and analysis, and industry benchmarks
   
5. Other Businesses: The company sells advertising services ^[5]

The company is planning to expand its operations towards providing offline services, where currently the company operates 7 customer service centres globally, alongside 6,000 walk-in stores in over 300 cities in China. In the future, Trip.com has expressed its desire to create more walk-in stores in lower-tier cities in China ^[1]. The likely rationale behind this is that residents of lower-tier cities (A unofficial term used in China to refer to a group of fast growing cities) prefer an in-person experience, where this strategic expansion attempts to capture the trend of a growing Chinese middle class and household disposable income from which the lower-tier cities are primed to benefit from ^[6].

COVID-19 and the travel industry

The COVID-19 pandemic is a major risk factor for the business operations of Trip.com wherein 2020 global travel fell by an estimated 73% resulting in a net decrease in Trip.com revenues by 49%. The pandemic has altered tourism and consumer behavior where travel demand is expected to recover throughout 2021 and beyond which is driven by several factors ^[7] as highlighted in the International arrivals in China in the figure below.

Vaccine supply and adoption

The successful development of vaccines has given cautious optimism to the travel industry and its prospects. As the supply and adoption of vaccines progress worldwide, this should increase travel confidence and reduce the risk of further travel restrictions ^[8].

The distribution strategy of vaccines will affect the demographics of travelers, where the vaccines have been supplied to an older and more vulnerable age group first, who are less likely to travel ^[9]. The vaccines will then be progressively rolled out to a younger demographic who are more willing to travel longer distances and go on trips with more risk and adventure. This will lead to a transition in revenues from short to long-distance travel with increasing diversification in the long term. To capture these trends Trip.com has introduced “Novel products in the domestic market by transitioning marketing to promote local attraction and activities” ^[1].  However, the risk of rising infection rates and the unpredictable nature of virus mutations may affect vaccine efficacy which is a strong risk factor in the recovery of the travel industry worldwide ^[10]. Vaccine accessibility will also affect travel accessibility, for example, more advanced economies have been purchasing vaccines in bulk, meaning there is a shortage in vaccines in the emerging countries. This will lead towards a skewed global travel recovery for the foreseeable future due to more stringent travel restrictions and quarantine measures being put in place in high-risk emerging countries ^[11]. Please see the figure below.

Inflation

The COVID-19 pandemic led to the 2021 global inflation projections at 3.5% and has created pent-up demand as a result of national lockdowns in the leading economies ^[12]. Inflation will affect the Skyscanner and Trip.com segment the most which are more focused on travel in the UK and other developed countries. The Ctrip and Qunar sections will be less affected given that the Chinese inflation rate remains low with a consumer price index (inflation rate) of 1.1% despite a GDP growth of 7.9% in 2021 ^[13].

There has been a longstanding debate on whether inflation is good or bad for stocks ^[14]. The consensus argues that a rise in inflation leads to an increase in service prices, including hotels, car rentals, flight tickets which can negatively affect consumer spending. At the moment the UK’s core CPI is 2.5% in August 2021 rising from 0.33% in February 2021 and is projected to rise to 3.9% before falling to 2% in the long term according to leading economists ^[15]. Other developed countries have experienced similar trends.

Furthermore, a rise in inflation should theoretically lead to a decrease in stock valuation due to higher discount rates and making bonds relatively more attractive ^[14], however, some such as Sebastien Page – The head of asset allocation at T. Rowe Price have argued that a rise in inflation is indicative of a recovering economy resulting in higher revenues and increases the likelihood of EPS surprises which is good for stock valuations ^[16].

Higher-than-normal unemployment rates in Europe, the US and China ^[13] alongside the Russian-Saudi Oil Price war are factors that suggest that inflation is transient ^[17]. However, others such as Peter Schiff a respected economist who predicted the 2008 financial crisis argues that inflation is not transient citing an increase in the circulation supply of the US dollar which will lead to prices increasing due to the devaluation of the dollar ^[18].

Travellers prefer short-distance destinations

In the near-term short distance travel domestically should recover first given that international travel is difficult due to restrictions and quarantine measures. This suggests that there will a shift in travel by air to the road which means Trip.com rental service offerings may benefit in the short term ^[19].

In the medium term, it’s expected that international travel should recover starting from 2022. Short-haul travel to established economies should be the first type of international travel to normalise given higher vaccination rates. Furthermore, leisure travel should experience greater recovery than business travel where businesses have begun to adopt cost-cutting measures and using virtual platforms as a substitute for office spaces ^[20]. This is particularly positive for Trip.com given that leisure flights have constituted a higher share of revenues (33%) compared to business trips (2%) historically ^[1].

Regulatory hurdles

The Chinese government through the Cyberspace Administration of China (CAC) has been cracking down on foreign listed Chinese companies which hold large data on Chinese citizens citing national security concerns. This started in early July 2021 on the ride-sharing company Didi Chuxing. Where in an interview with Fortune Magazine our analysts stated that with the probes, Beijing is indicating that “business goals should be fully state-aligned” ^[22]

In a Reuters interview, a ChineseAlpha Senior Analyst successfully predicted a tightening of regulations “This is just the beginning of these security concerns. We will likely see more crackdowns on companies that rely on storing large data on Chinese users” – Kevin Francis Marcaida ^[23].  To which just two days later the Chinese government announced more crackdowns on companies that store large data on over 1 million Chinese citizens ^[24].

These regulations may put Trip.com at risk given that it is the leading travel agency in China which services millions of Chinese citizens nationally but also abroad. According to the 2020 annual report Trip.com has strict policies to govern the use of personal information so that they are not disclosed inappropriately. Furthermore, Trip.com management has stated:

“We limit access to our servers that store our user and internal data on a “need-to-know” basis. We adopt a data encryption system intended to ensure the secured storage and transmission of data, and prevent any unauthorized member of the public or third parties from accessing or using our data in any unauthorized manner”

“Furthermore, we implement comprehensive data masking of user data for the purpose of fending off potential hacking or security attacks. We engage legal counsel in and outside China to advise on our data protection policies and ongoing compliance with applicable laws and regulations. As part of our internal procedure, we engage overseas legal counsel to advise on the applicable licensing and compliance requirements before entering into new markets” ^[1].

It is also possible that Trip.com, given its leading place as China’s top travel agency which has undergone several M&A transactions, may be targeted by anti-monopoly regulations to which the Chinese government has issued out several fines in 2021 to Tencent and Baidu and has recently halted the mega-merger of the two largest Esports companies Huya and Douyu. As Trip.com’s market share continues to expand, the likelihood of regulators stepping in increases ^[25].

Competition

Given that Trip.com is a multinational company its main competitors are three of the largest international travel platforms, Expedia Group, Booking Holdings and TripAdvisor. Airbnb may also act as a competitor in the hotel booking segment of Trip.com. Compared to its three main competitors Trip.com is the fourth largest travel platform by revenues in 2020. Its revenues have taken less of a hit which is driven by competitive pricing and a diversified global revenue stream. This puts Trip.com in a relativity better place in the post-pandemic world compared to Bookings.com and Expedia ^[26]. See figure below.

The main competitive advantage of Trip.com is the use of AI and big data analytics which is used to inform tourism forecasting, client behaviour, flight delay prediction among many others. This data enables Trip.com to optimise search rankings, personalise recommendations and enhanced user engagement and most importantly offer travel services at competitive prices [1]. These factors strongly contribute to improved user conversation and the highest stickiness rate out of its competitors as highlighted below [27].

On top of this Trip.com is better positioned to take advantage of the growing Chinese economy which is projected by 2030 to become the largest economy in the world. The Chinese middle class is fast developing alongside growing disposable income ^[28][29]. Trip.com given its size is well-positioned to ride these trends as they are planning to expand to providing offline stores in low tier Chinese cities where the middle class is thriving ^[27].

Here is the most important section when making an investment decision that separates the amateur from the professional investor. At ChineseAlpha want our readers to have the best quality reading experience to make the best investment decisions. Continue reading and we will break down the financial statements (income statement, balance sheet, cash flow statement) and valuation metrics for your ease.

Financial Performance

In the 2020 Trip.com annual report, the financial statements are among the very first to appear to Investors. A subtle detail intended to have a bold statement. In regular reporting standards, the financial highlights are generally found near the middle. By the management formatting, the report in this way is a statement to investors and competitors – “We have amazing financial statements”. Our dedicated analyst team will put this statement to the test.

Revenue growth is positive from 2018 to 2019 rising by 14% marked by a rising middle class and an increasing sentiment in travel. However, from 2019 to 2020 revenues shrank by 49% which is the result of the corrosive effect of global lockdowns on international travel. Quite impressively the gross margin is unaffected at 78% during the pandemic compared to 79% in 2019 and 2018 which is an indication that Trip.com’s management and business model are very effective in downsizing the cost of goods even with a rapid contraction in revenues which is a very positive sign for investors. Operating expenses in 2020 have decreased compared to pre-pandemic levels which is a cost-cutting decision made by management. This reduction in operating expenses was not enough to keep the operating income positive for the year which can be interpreted as negative in the short-term implying that Trip.com has lost money in 2020, however, this can also be seen as positive in the medium-term given that there has been continued capital flow in SG&A and R&D which is a sign that management is confident in the future development of new features and products which can enable Trip.com to bounce back in the post-pandemic stronger than ever. What is particularly concerning are the large capital outflows in the loss from affiliates and loss on sale of investment in 2020, digging into the annual reports deeper this is caused by losses incurred from equity method investments, mainly in MakeMyTrip, whose operating results were significantly impacted by the pandemic. Overall given the circumstances, Trip.com has a good income statement.  

The first thing that comes to mind is a healthy amount of capital in cash and short-term investments, which highlights a company that is highly liquid and can easily pay of its short-term obligations (1-fiscal year) this can be measured by the 2020 current ratio at 1x respectively. The asset turnover rate increased from 3.5x to 5.4x from 2018 to 2019 meaning that the company’s assets are generating more sales and becoming more efficient. Not, surprisingly asset turnover decreases to 2.6x in 2020 as revenues are hit by the pandemic.

Current assets and liabilities have been decreasing year on year, caused by a decrease in cash and short-term investments this is likely due to an aggressive business acquisition strategy which is highlighted by increasing goodwill year on year. Interestingly there has been a decrease in long-term assets coupled with an increase in short-term borrowings in 2020. This is likely a response from management to boost short-term liquidity to ensure the survival of Trip.com which is a sign of good cash flow management. A questionable decision is accounts payable decreasing by 49% which suggests that Trip.com is opting to pay off its debtors rather than keep the cash which is not good in the context of an economic crisis where cash is king. Overall a good balance sheet.

Net income increased by 680% from 2018 to 2019 and became negative in 2020 driven by lower sales and decreasing operating margins, on the other hand, cash flow from operations is consistent from 2018 to 2019 and decreased in 2020 and became negative, this is primarily driven by net cash outflows in a decrease in accounts payable, as the company decided to prioritise paying its debtors rather than keep the cash. Furthermore, there are negative cash outflows in cash from investing specifically in capital expenditures and marketable securities which is bullish for the company’s long-term outlook as asset turnover ratios is historically consistent at 0.2x meaning that as long as the asset turnover ratio remains steady then buying assets will result in increased revenues. Lastly, cash from financing turned negative in 2019, this was due to $2.4 billion of long-term debt being paid in that year. Furthermore in 2020 cash from financing is positive where $3.3 billion worth of debt was issued. This is a savvy decision from management that takes advantage of record low Chinese interest rates. Overall given the circumstances, Trip.com has a good cash flow statement. 

Valuation

We will take you through each phase of the Discounted Cash Flow Model (DCF) and provide our key assumptions. Our analyst selected the DCF Multiple Exit model, where the driver of value is based on the forecasted cash flow of the company alongside the pricing of similar assets in the market. Furthermore, our analyst extent the growth period for 10 years, which reduces ‘valuation drag’ the reliance of the intrinsic value on the terminal value which is important to shift value away from an abstract to a more tangible concept.

Step 1: Calculate the Weighted Cost of Capital (WACC)

Cost of Equity (CAPM)

We will treat Trip.com as a Chinese business given where it is incorporated and also as the company does not break down its revenues by country. Furthermore, treating the company this way should produce conservative estimates. We will factor in the value of a “bottom-up levered beta” which is the volatility (risk) of a stock compared to similar businesses within an industry alongside a regression beta – The risk of a stock compared to the risk of the market.

Using the Capital Asset Pricing Model (CAPM) the inputs used is as follows:

10-Year Risk-Free Rate = 2.44% (10-year China Government Debt) – Capital IQ

Damodaran Equity Risk Premium = 5.40% ^[30]

Country Risk Premium = 0.68% ^[30]

Beta = 1.25% – Capital IQ

Plugging these figures into the equation:

Cost of Equity = Risk Free Rate + Beta * (Equity Risk Premium) + Country Risk Premium 

Cost of Equity = 9.87%

Cost of Debt (Synthetic Credit Rating Approach)

Trip.com doesn’t have an official credit rating therefore by calculating its interest coverage ratio (EBIT/Interest Expense), a ‘synthetic’ credit rating can be created using professor Aswath Damodaran’s lookup table.

Interest Coverage Ratio = 0.83

Credit Rating = Caa/CCC  ^[31]

Default Spread (Caa/CCC) = 9.97%

Country Default Spread (China) = 0.62% ^[30]

Average Corporation Tax (China) = 25% – 2021 CN PWC Tax Report ^[32] 

10-Year Risk-Free Rate = 2.44% (10-year China Government Debt) – Capital IQ

Plugging these figures into the equation:

Cost of Debt = (Risk-Free Rate + Default Spread + Country Default Spread) x (1-T)

Cost of Debt = 9.7725%

Weighted Average Cost of Capital (Discount Rate)

Total Debt = Current Debt + Long Term Portion of Debt + Current Leases + Long Term Leases + Short Term Borrowings

Market Equity Value = Diluted Shares Outstanding x Current Share Price 

Weight of Debt = 36.1%

Weight of Equity = 63.9%

Weight of Preferred Shares = 0%

WACC = 9.8348025%

Discounted Cash Flow Analysis

Using 5-year historical financial statements and forecasts up to 2025 provided by Capital IQ and Oxford Economic Projections. We extend the forecast period to 2032 and by using conservative assumptions provided by our internal team and corporate partners. Our analyst used the XNPV function (XNPV = Discounted rate, cash flow, date) with midpoint discounting alongside the year fraction to ensure cash flows are discounted appropriately according to the fiscal year-end date. We use a 2.44% perpetuity growth rate which is appropriate as GCBC by the end of 10 years should be nearing maturity in a high growth Chinese emerging market and is in line with the 10-year risk-free rate of 2.44%, which is a reliable proxy to estimate the 10-year future growth of an economy and should produce conservative assumptions.

Base case – $37.09

The base case is the most probable course of action of the growth and operations of a company as predicted by our analysts.

• Implies 28% CAGR from 2021 to 2025
• CAGR of 7% to 2031 
• EBIT Margin growing to 22%

According to the base case, there is a potential 24% upside from the current price at $25.99. Furthermore, by testing this assumption using the sensitivity analysis, which is a model that tests out the inputs of a model in case our analysts misjudged the values. Even with an ultra-conservative discount rate of 11% and a perpetuity growth rate of 1.5%, the lowest intrinsic value would still be $29.23 which is a 12% upside from the current price making Trip.com undervalued.

Grey sky case – $29.85

The grey-sky case is an alternative assumption that there is a worse than expected outlook for the growth and operations of a company.

• Implies 25% CAGR from 2021 to 2025
• CAGR of 6% to 2031 
• EBIT Margin growing to 20%
  

Blue sky case – $47.24

The blue-sky case is an alternative assumption that there is a better-than-expected outlook for the growth and operations of a company.

• Implies 29% CAGR from 2021 to 2025
• CAGR of 9% to 2031 
• EBIT Margin growing to 27%

• Global travel demand is dependent on the COVID-19 pandemic and the response of government agencies to manage the spread of the disease. If the infection and death rate increases alongside the emergence of novel virus mutations, then the higher the likelihood of tougher regulations being imposed on travel which can severely affect the operations of Trip.com. This is a strong risk factor.

• Trip.com may be targeted by the Chinese regulators as the government has been cracking down on business monopolies which may be problematic for the market dominance of Trip.com is the leading Chinese travel sector which could make the business vunerable to Chinese regulations resulting in fines, lower margins, or the divestiture of the company. This remains a constant theme in 2021. Furthermore, new regulations on cybersecurity may also present a risk to Trip.com given that the platform stores millions of Chinese user data, if the CAC decides that Trip.com’s data security is not stringent enough, there could be severe consequences for the company.

Technical Analysis

Technical analysis is a pricing method used to predict the future price action of a stock history. Pure technical analysts fully or partially believe in the “efficient market hypothesis” meaning that all information both private and public are fully represented in the price. Technical analysis is often disregarded in academia and the “purist” investing community as akin to horology, or astrology, and hence why it is not widely taught in business schools. However, the consensus of academic papers has shown that the usage of technical analysis significantly outperforms strategies purely based on fundamental analysis alone. ^[33] This is why our analysts at ChineseAlpha believe in the importance of technical analysis.

Trip.com’s share price is currently in a strong downtrend since March 2021 and has remained volatile for the last 3 years. Given the strength of the downtrend, the last major support band (purple band) is at March 2020 where price has previously bounced from and has subsequently triggered a strong uptrend. We predict that price will continue to fall for a month until it reaches the support band between $19-$21. From here given the strong momentum to the downside, price will likely consolidate for a few months. A break to the downside at this level would result in massive losses with no other support line below, unfortunately, the price appears to be forming a double top pattern which is infamously known as a sign for continued momentum to the downside. ^[34]

Volume from the last 4 months has been rising indicative of increasing interest in the stock, alongside a relative strength index (purple band indicator) below 25 suggesting that Trip.com is oversold. Overall, the technicals suggest that price will continue to move to the downside until it consolidates. A strong fundamental positive catalyst (good news) will have to trigger a shift of momentum to the upside during the consolidation phase which is denoted by rising volume and a break out of price from the $23-25 resistance zone which is a strong sign to enter the trade.

Recommendation

Based on the Peter Lynch 6 categories we describe Trip.com as a Stalwart. Our analysts recommend that Trip.com is a long-term hold as there are near term causes for volatility primarily driven by increased regulatory crackdowns. Based on the technical analysis traders should continue to be patient and wait for the price to reach a strong support level and a shift in momentum to the upside. This could take a couple of months given the strong momentum to the downside.

Trip.com is currently undervalued based on the DCF model with conservative assumptions. This alongside growing secular trends particularly in a growing middle class, easing of travel restrictions and good financial data suggest that Trip.com is a good investment in the long term. However, there are major risks relating to government regulations where we will likely see more crackdowns on Chinese companies which is detrimental to the stock price in the short and medium-term.  Given all these factors our analysts issue a hold recommendation.