Booking Holdings Stock Is Turning A Corner (NASDAQ:BKNG)

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By The Valuentum Team

As leisure and corporate travel activities have recovered at a robust pace since the worst of the COVID-19 pandemic decimated demand in 2020 and large portions of 2021, Booking Holdings Inc’s (NASDAQ:NASDAQ:BKNG) longer term outlook has improved considerably. During the worst of the pandemic, Booking Holdings’ financials took a beating though more recently, the firm is starting to turn a corner and its capital appreciation upside could be quite significant.

Substantial near term headwinds remain due to recessionary clouds building on the horizon and in light of inflationary pressures weighing negatively on household’s discretionary budgets, but over the long haul (once inflation is brought under control and central banks can cut interest rates to restimulate economic growth), travel activities (both domestic and international) should recover to their “normalized” levels. Year-to-date, shares of BKNG have sold off sharply alongside broader declines in US equity markets, though the selloff appears overdone when considering Booking Holdings’ longer term potential, in our view.

Booking Holdings’ Key Investment Considerations

Investment Considerations

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Booking Holdings is a leader in global online hotel reservations. The firm is composed of four primary brands – Booking, Booking Holdings, Agoda, Kayak, and Rentalcars – and several ancillary brands. The company was founded in 1997 and is headquartered in Connecticut.

Demand in Booking Holdings’ business model is boosted by a virtuous cycle. Its partnerships allow it to offer an enhanced customer experience, driving increased conversion and traffic. Growing traffic levels give it the opportunity to test and improve customer and partner satisfaction. As it rides the wave of secular growth in internet penetration in travel, Booking Holdings will also benefit from expansion into new markets in North America, the Asia Pacific, and South America. Increasing competition should not be ignored, however.

Earnings Update

On August 3, Booking Holdings reported second quarter 2022 earnings that beat both consensus top- and bottom-line estimates. Its GAAP revenues rose by 99% year-over-year to hit $4.2 billion with agency revenues (up 73%), merchant revenues (up 165%), and advertising and other revenues (up 43%) all boosting its performance here. The ongoing recovery in travel demand went a long way in boosting Booking Holdings’ bottom-line. In the second quarter, Booking Holdings reported $1.0 billion in GAAP operating income (up from an operating loss in the same period last year) and $21.07 in GAAP diluted EPS (up from a loss in the same period last year).

Defining free cash flow as net operating cash flow less capital expenditures, Booking Holdings generated $4.2 billion in free cash flow during the first half of 2022. Its asset-light business model requires a relatively modest amount of capital expenditures to maintain a given level of revenues, making free cash flows easier to come by. During this period, Booking Holdings spent $2.3 billion buying back its common stock, and the firm does not pay out a common dividend at this time.

At the end of June 2022, Booking Holdings had a nice net cash position of $2.4 billion (inclusive of short-term debt, exclusive of long-term investments) on hand. We are huge fans of its pristine balance sheet as that positions the company well to ride out a potential global recession and ongoing inflationary pressures with its growth runway intact. During the company’s second quarter earnings conference call, management noted that:

For the remainder of the summer period through the end of Q3, we see higher gross bookings on the books than at this point in 2019, which we believe will result in a record revenue for the third quarter, which is our seasonally largest revenue quarter. – Glenn Fogel, CEO and President of Booking Holdings

We appreciate management’s confidence in Booking Holdings’ near term outlook, as the company’s underlying business has performed well of late.

Booking Holdings’ Economic Profit Analysis

The best measure of a firm’s ability to create value for shareholders is expressed by comparing its return on invested capital [‘ROIC’] with its weighted average cost of capital [‘WACC’]. The gap or difference between ROIC and WACC is called the firm’s economic profit spread. Booking Holdings’ 3-year historical return on invested capital (without goodwill) is 61.7%, which is above the estimate of its cost of capital of 9.2%.

In the chart down below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate. After a brutal 2020, Booking Holdings’ ability to generate shareholder value recovered significantly in 2021 and we expect the firm will remain a solid generator of shareholder value going forward.

Adjusted Return on Invested Capital

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Booking Holdings’ Cash Flow Valuation Analysis

Cash Flow Generation

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Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows, net of balance sheet considerations. We think Booking Holdings is worth $2,225 per share with a fair value range of $1,780.00 – $2,670.00.

The near-term operating forecasts used in our enterprise cash flow model, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 16.4% during the next five years, a pace that is higher than the firm’s 3-year historical compound annual growth rate of -9%. Our model reflects a 5-year projected average operating margin of 31.8%, which is above Booking Holdings’ trailing 3-year average. Beyond Year 5, we assume free cash flow will grow at an annual rate of 3.1% for the next 15 years and 3% in perpetuity. For Booking Holdings, we use a 9.2% weighted average cost of capital to discount future free cash flows.

Valuation Assumptions

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Valuation Breakdown

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Booking Holdings’ Margin Of Safety Analysis

Range of Potential Outcomes

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Although we estimate Booking Holdings’ fair value at about $2,225 per share, every company has a range of probable fair values that’s created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn’t see much volatility in the markets as stocks would trade precisely at their known fair values.

In the graph up above, we show this probable range of fair values for Booking Holdings. We think the firm is attractive below $1,780 per share (the green line), but quite expensive above $2,670 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion. Shares of BKNG are currently trading below the low end of our fair value estimate range as of this writing, offering investors a potential capital appreciation opportunity.

Concluding Thoughts

Headwinds such as inflationary pressures and a potential recession across North America, Europe, and parts of East Asia can’t be ignored when looking at Booking Holdings. It will be a bumpy ride over the next few quarters, though its nice net cash position on hand and relatively modest capital expenditure obligations should help see Booking Holdings through the storm with its bright longer term growth runway intact. When the technical performance of shares of BKNG start to turn positive (currently shares of BKNG are contending with major selling pressures), that could mark a nice entry point to consider on the name.

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