Orbitz Looks Like a Bargain
Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Orbitz (NYSE: OWW) is an online travel company providing bookings for hotels, airline tickets, rental cars, and related services. The company competes with much larger competitors Priceline (NASDAQ: PCLN) and Expedia (NASDAQ: EXPE). The TTM revenues for the three companies are shown below.
| Company | TTM Revenue (millions $) |
|---|---|
| Orbitz | $771 |
| Priceline | $4,808 |
| Expedia | $3,664 |
Orbitz is nearly a factor of 5 smaller in terms of revenue than Expedia. This small size could be a benefit, as there is plenty of market share for Orbitz to grab from competitors.
Orbitz recently reported disappointing Q2 results, sending the stock plummeting.
The stock market has a tendency to overreact to earnings results, being overly optimistic or, in this case, overly pessimistic. I'll examine Orbitz's financial data and determine if this steep drop in market price has created an opportunity to buy the stock at a discount to fair value. First, let's take a look at revenue and free cash flow for the past five years.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Revenue | $859 | $870 | $737 | $757 | $766 |
| Operating Cash Flow | $96 | $76 | $105 | $98 | $117 |
| Capital Expenditure | $-53 | $-58 | $-43 | $-41 | $-45 |
| Free Cash Flow | $43 | $18 | $62 | $58 | $73 |
Like many companies, Orbitz sufferred decreased revenue due to the financial crisis of 2008-2009. Weakness in the global economy will continue to affect Orbitz for the next few years, but the situation is temporary. Capital expenditure has been fairly consistent over the last five years, while free cash flow has grown nearly 70% since 2007.
Owner Earnings
Owner Earnings is a better measure for valuation purposes than free cash flow. Warren Buffett defines Owner Earnings as follows:
These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.
I'll calculate Owner earnings by taking the Net Income and adding back various non-cash items, such as depreciation, and then subtracting the 5-year average Capital Expeditures. I'll also add interest payments adjusted for taxes since interest is tax deductible.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Net income | $-85 | $-299 | $-337 | $-59 | $-38 |
| Depreciation & amortization | $57 | $66 | $69 | $72 | $60 |
| Investment/asset impairment charges | $0 | $297 | $331 | $81 | $49 |
| Stock based compensation | $0 | $15 | $14 | $12 | $8 |
| Other non-cash items | $12 | $15 | $13 | $15 | $15 |
| Interest Payments | $83 | $63 | $57 | $44 | $40 |
| Avg Capital Expenditure | $-48 | $-48 | $-48 | $-48 | $-48 |
| Owner Earnings | $19 | $108 | $100 | $120 | $89 |
Owner earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the Owner Earnings figures to determine Orbitz's Cash Return on Invested Capital, or CROIC. This is the cash return generated by the company on invested capital, and is simply the Owner Earnings divided by the total invested capital. This is a better measure than ROIC because ROIC relies on earnings, which is a poor measure of profitability.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Owner Earnings | $19 | $108 | $100 | $120 | $89 |
| Invested Capital | $1,925 | $1,590 | $1,294 | $1,216 | $1,145 |
| CROIC | 0.99% | 6.83% | 7.8% | 9.88% | 7.78% |
Orbitz's CROIC has been roughly 7-8% over the last four years. This means that every $100 of retained earnings invested back into the company will yield $7-8 in increased earnings. One thing to note is that through the recession Orbitz was able to remain profitable, something that can't be said for all companies.
Let's take a look at the most recent balance sheet.
| Cash and Cash Equivalents | $187 |
|---|---|
| Investments | $0 |
| Debt | $440 |
| Pension Obligations | $0 |
| Minority Interest | $0 |
| Net Cash (Debt) | $-253 |
| Diluted Float | 105 |
| Cash/Share | $-2.39 |
Orbitz has $187 million in cash and $440 million, leaving $2.39 per share of net debt. The interest payments have been decreasing, from $83 million in 2007 to just $40 million in 2011. Although this interest payment is a significant fraction of the cash flow, Orbitz has enough cash on the balance sheet and consistent cash flow to handle it.
Valuation
I use a discounted cash flow analysis to estimate the fair value of a company. I'll assume that owner earnings will grow at just 3% annually, or no growth after inflation, a fairly conservative projection. I will use a discount rate of both 12% and 15% to define a fair value range. Using these parameters I arrive at a fair value range of $4.86 - $7.28. Below is a table of buy targets for various margins of safety.
| Margin of Safety | Buy Target |
|---|---|
| 10% | $4.38 |
| 15% | $4.13 |
| 20% | $3.89 |
| 25% | $3.65 |
Conclusion
Orbitz is currently trading at a whopping 41% discount to the lower bound of my fair value range. While the company faces challenges in the near-term, I see no real reason why the stock is trading at such low levels. The long term prospects for the company seem fine, and my extremely conservative projections assume no real growth at all. At these prices, Orbitz looks like a bargain.
TheBargainBin has no positions in the stocks mentioned above. The Motley Fool owns shares of Priceline.com. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.
