Where Is the Best Travel Investment Opportunity?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The business of online travel is thriving, and years of strong stock performance as proof. The undoubted leaders of the space are Priceline.com (NASDAQ: PCLN) and Expedia (NASDAQ: EXPE), but according to investors, Travelzoo (NASDAQ: TZOO) is also a serious player in the space. So which company is presenting the best investment opportunity?

A Rising Star?

Travelzoo has produced gains of 55% in 2013, and prior to last Thursday, those gains were closer to 75%. Travelzoo has continued to produce modest growth, which has fueled the stock’s gains.

<table> <thead> <tr><th> <p><strong>Quarter/Year</strong></p> </th><th> <p><strong>Revenue Growth Over Previous Year</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Third/2012</p> </td> <td> <p> ~8%</p> </td> </tr> <tr> <td> <p>Fourth/2012</p> </td> <td> <p>5%</p> </td> </tr> <tr> <td> <p>First/2013</p> </td> <td> <p>7%</p> </td> </tr> </tbody> </table>

You can see that revenue growth for the previous three quarters had accelerated. However, revenue grew just 5% in its (second) quarter announced on Thursday.

Both Expedia and Priceline continue to produce growth over 20% year-over-year, and control the majority of the online travel space. Priceline has revenue of $5.5 billion and Expedia has recorded $4.23 billion in the last 12 months. Travelzoo has revenue of just $155 million in the same period.

Travelzoo continues to lag in an industry with double digit growth. The company has more than 26 million subscribers. Therefore, Travelzoo has a large presence to monetize, but simply cannot grow.

What Do These Leaders Do?

Expedia and Priceline both offer near identical services. A customer visits either site then searches for flights, hotels, cruises, etc. The customer can then purchase the product. Both companies offer some vacation packages that include car, flight, and hotel, but are not reliant upon these vacation packages for fundamental growth.

Travelzoo also offers airfare or hotel only products, but operates around its travel, entertainment, and local deals. The company sells packages at a discounted price, but only for certain cities. Travelzoo then has to push its subscribers to competing sites such as Expedia or Priceline when it does not offer packages for the desired city.

Travelzoo spends most of its resources on creating such vacation packages with its sales team, and also trying to grow its subscriber base. Expedia and Priceline spend most of their cash on marketing, advertising, commercials, etc. Clearly, growth shows which of these two strategies is most effective.

The Most to Gain and Least to Lose

I can’t justify an investment in Travelzoo. The company has an industry-best 46% return on equity and very strong operating margins of 17.5%. This may appear as a strength, but with such efficiency, the company has near peaked its profit and is not reinvesting enough of its income back into the business. This was evident by the company’s near 30% loss in net income year-over-year.

With limited growth, Travelzoo’s upside is tied into its profit, and margins have peaked. Therefore, I would not revisit Travelzoo unless its operational approach became more like its competitors.

My problem with Travelzoo is the same issue I have with Priceline. Priceline’s 42% return on equity and its 35% operating margin leave very little room for operational error, as investors expect continued margin strength.

Priceline has over $5 billion in cash but is yet to buy any of its own stock. Expedia purchased two million shares in the last quarter alone. This is just one reason that I like Expedia.

Expedia has the lowest valuation relative to next year’s earnings, with a forward P/E ratio of just 16. The company also has a lot of room to improve, having a 12% return on equity and operating margins of 12%. Expedia operates the same business as Priceline but is significantly cheaper. Since Expedia has equal growth, I think it has the most to gain and the least to lose. 

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Priceline.com. The Motley Fool owns shares of Priceline.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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