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CFA Institute Research Challenge - CFA Society Sydney Griffith University Hosted by - Transtutors
CFA Institute Research Challenge
             Hosted by
        CFA Society Sydney
         Griffith University
CFA Institute Research Challenge - CFA Society Sydney Griffith University Hosted by - Transtutors
2016 | CFA Institute Research Challenge
Flight Centre Travel Group Limited
FLT: AU/ FLT.AX                                                                                                           Recommendation
Industry: Consumer Discretionary
                                                                                    Current                    $36.85
                                                                                      At 31/8/2016
 è Market Cap               è Avg Daily Volume              è Free Float            Target                     $31.93
 AU$3.6B                    820,640M                        50.49%
                                                            100.93M Shares          Potential Downside           13%

                                             Executive Summary
 Key Stock Data Sep16
                                             As per our valuation, we issue a sell recommendation for Flight Centre (herein ‘FLT’ or the
 52 Week Range              45.37 - 29.38    ‘Company’). Our 12-month target price is $31.93AUD, with a projected downside of 13%. This
 Institutional Ownership         62.45%      has been calculated using a combination of (1) The Dividend Discount Model, (2) Discounted
                                             Free Cash Flows to the Firm, and (3) several Relative Valuation techniques.
 ROE                                 18.67
 Current P/E                         12.93
                                             Investment Thesis and Outline
 Est. International P/E              10.21   Industry volatility, lowered necessity for travel agency intermediation and little international room
 Est. Domestic P/E                   14.08   for expansion all collectively suggest that FLT will face future struggle. Declines in financial
                                             performance of the Company in 2016 have resulted in weaker competitive positioning. We
 EPS                                  2.42
                                             believe this is paving the way to eventual stagnation of income, and hence loss of investor returns.
 Est. EPS                             2.69   A summary of our fundamental top-down analysis is as follows:
 Price/Book                           2.37   • High International Competition: Many key international players already dominate worldwide
                                                                1
 Price/Sales                          1.21     market share. We forecast eventual online market saturation, leaving little room for global
                                               development unless FLT can steal revenue from its existing competitors.
 Dividend
                                             • Lowered Industry Commission Potential: Increased sales demand from price wars between
 Div. Yield                       4.30%        domestic budget airlines cannot offset lowered commission revenues. Further, demand for
 DPS                                  1.52     agency intermediation is decreasing as online platforms are making it easier for consumers to
 5 year Dividend                               bypass the middleman, and compare the competition.
                                 12.59%
 Growth
                                             • Shifts in consumer preferences: Consumer preferences have shifted and now favour
                                               localised travel due to the weak AUD/USD primary pairing. This form of travel is simple and
 Relative Performance                          does not usually require agency intermediation. Further, corresponding growth in inbound
 S&P/ASX200                                    travel does not form revenue for FLT.
 Ticker: AS51                                • Expensive Capital Structure: FLT currently has the most expensive WACC of all peers as
                                                                                             2
 1m                                   3.73     CAPEX is funded entirely through equity. As the Company is focusing on future expansion,
 6m                               -25.46       this will reduce the profitability of such ventures.
 12m                              -19.81
                                             • High Expenses and Low Net Profit Margins: For the previous 3 financial years, operating
                                               expenses have grown at a higher rate than revenues, leaving low and unimproved net profit
 S&PASX 200 Consumer Discretionary             margins. This has led to a ROA below peer average, and an ROE at a second all time low,
 Ticker: S5COND                                causing concerns for shareholders.
 1m                                   5.76   • Low Potential for International Profits: As FLT have shifted their focus onto claiming
 6m                               -16.68       international market share, expenses incurred do not benefit from FLT’s economies of scale
                                               within Australia. Consequently the bottom line for these segments is not as profitable as it could
 12m                              -13.58
                                               be if revenues were incurred domestically.
                                             • Many investment risks are faced and inherently volatile: Operation within 14 countries
      Source: Bloomberg & Team Estimates       naturally causes high amounts of foreign exchange and economic risk. Further, FLT’s large
                                               fixed expenses combined with commissions fluctuating due to price wars cause high operating
                                               risk.

                                                Income Statement
                                                                                    2016              2017F      2018F     2019F      2020F
                                                ($'000,000)
                                                TTV                               19305               20608      21879     23095      24234
                                                Revenue                             2640                2878       3058      3222       3372
                                                EBITDA                               409                 456        459       473        482
                                                     EBITDA Margin               15.49%              15.86%     15.01%    14.67%     14.29%
                                                Net Income                           245                 272        265       265        265
                                                     Net profit Margin           9.264%              9.466%     8.683%    8.240%     7.868%
                                                Balance Sheet ($'000,000)
                                                Total Assets                        3001               3285       3596       3936       4308
                                                Total Liabilities                   1655               1812       1983       2171       2376
                                                Total Equity                        1346               1473       1612       1765       1932
                                                Ratios
                                                FCFF/Share                          2.80                2.77       2.72      2.65       2.56
                                                EPS                                 2.42                2.70       2.63      2.63       2.63
                                                DPS                                 1.52                1.61       1.55      1.54       1.53
                                                ROE                              18.70%              19.33%     17.21%    15.72%     14.35%
                                                ROIC                             18.18%              18.30%     16.36%    15.03%     13.61%
  1
  Priceline (PCLN:US) $1,418.59, Expedia (EXPE:US) $113.13, CTrip.com (CTRP:US) $48.96
  2
  Above, also including Webjet (WEB:AU) $9.64, HelloWorld (HLO:AU) $4.30, Corporate Travel Management (CTD:AU) $18.14

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Figure 2: Corporate Structure           Business Description
                                        Company Overview
                                        Founded in 1981, FLT is an Australian based travel agency headquartered in Brisbane, Queensland.
                                        The Company had its IPO in 1995, and boasts 2.64B in revenue and 3000 stores in 14 countries as
                                        of FY16. Despite their name, FLT is not limited to revenues from airline ticket sales, and actually
                                        provides a number of services within the travel industry, such as cruise lines, car hires, and hotel
                                        accommodation.

                                        Business Structure
   Source: Flight Centre Travel Group   Previously known as Flight Centre Limited, FLT changed their name to Flight Centre Travel Group
                        Annual Report   Limited in 2013. Majority of the Company’s revenues are derived from the travel industry, where
                                        they operate within leisure, corporate and wholesale sectors. Of the 40 brands under FLT, leisure
Figure 3: Recent Acquisitions           has consistently remained the strongest sector, while the corporate division has grown to 33% of
                                        revenues for FY16 under 6 dedicated brands. The Company are targeting consumers at many
                                        different stages of travel: expanding their products to include tourist activity packages (Cruise About)
                                        and currency exchange services (Travel Money).

                                        Excluding the travel industry, in 2016 only 9.92% of total revenue was attributed to FLT’s other
                                        companies. Evidently, FLT’s business structure is hardly diversified. This is due to the fact that
                                        management are aiming to use such expansion into other areas to support FLT travel segment
                                        growth simultaneously. For example, products from Buffalo Tours are sold within FLT’s travel
                                        package bundles, and courses offered First Class Education Group include travel agency training
                                        for employees.

                                        Though originally a brick and mortar store based company, new technology developments are
                                        forcing FLT to expand online to continue sustainable growth. The Company has shifted its business
                                        structure by investing in online booking platforms, either by developing its own websites and online
                                        brands such as Aunt Betty, or acquiring businesses who already have a foot in the door such as
                                        BYOjet and Student Universe (Figure 3).

     Source: Bloomberg &FLT annual
                                        Company Strategy
                            Report      FLT is undertaking a transition from traditional travel agency to a ‘person-to-person’ travel service
                                        provider. This includes less reliance on physical stores and increased presence online. Further, the
Figure 4: FLT Revenue Break-            company also wants to further personalise customer experiences, by giving agents the ability to
down                                    work from home and build a selective customer base.

                                        The Company is undertaking large geographical expansion, and does so primarily through
                                        acquisitions. Within the last two financial years FLT have acquired several profitable companies,
                                        such as StudentUniverse.com. It is expected that they will continue to capture market share through
                                        this method.

                                        Revenue and Expenses
                                        FLT’s main source of income is on a commission basis with individual airlines. As these contracts
                                        are largely discretionary, FLT’s revenue streams can fluctuate, particularly if high competition is
                                        shrinking retail prices. These contracts include different commission streams, such as a flat dollar
                                        amount per ticket sold, a percentage, and even overrides if FLT is successful in selling all their
                                        holdings. FLT’s revenues are hence a percentage of their total transaction value (TTV); an unaudited
                                        Figure representing the total price of transactions they have undertaken as an agent.
        Source: FLT Annual Report &
                                        FLT suffers from high operating costs, particularly through wage and rent expenses necessary to
                        Bloomberg
                                        maintain their dominant brick and mortar stores. Management is making efforts to combine several
                                        smaller stores into a few large ones to maximise efficiency. Further, as the Company is planning
Figure 5: Industry Sentiment
                                        further expansion into digital platforms, this may also then cut these expenses.
Survey: Factors Essential to
tourism
                                        Geographical Performance
                                        FLT has operations across 14 countries, among which Australia comprises of 49% revenue. This
                                        should come as no surprise as FLT have built themselves to a bellwether status within the domestic
                                        market; with a total of 20,000 employees within Australia and 79% of the domestic industry revenue.
                                        Following Australia are both the Europe and North America segments, at 15.6% and 11.2%
                                        respectively. In FY16, South Africa hit a record first-half year result, becoming the third most
                                        profitable country by TTV to EBIT margin.

                                        FLT’s success however, is not consistent across the board. The INDUASIA segment contains India,
                                        Singapore & Malaysia, Greater China and United Arab Emirates. FLT have had increasing issues
                                        within this area and closed losses in FY16. However in order to compensate, management have
                    Source: Austrade    made acquisitions within the area to capture increased market share. In particular, the Company
                                        may expand into mainland China to add to their geographical diversity.

                                                                                                                                           2
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 Figure 6: Terrorism Incidents          Industry Overview and Competitive Positioning
                                        FLT operates under the Travel and Tourism subsector of the ICB; an industry that currently has
                                        an adjusted market value of $7.05B AUD and an adjusted 5-year CAGR of 11.16%. This growth
                                        rate is dependent on macro-economic factors which highly influence the expected travel
                                        expenditure of both corporate and leisure consumers. In particular, business and consumer
                                        confidence levels, exchange rates, and discretionary income Figures all remain key drivers in the
                                        revenue potential of travel intermediaries (Figure 5). Additionally, the industry is also subject to a
                                        large amount of social and environmental challenges, such as Brexit, the Zika Virus and increased
    Source: Global Terrorism Database   threats of terrorism (Figure 6). These effects are further described in Appendix 2. These issues
                                        pose great threats to consumer confidence levels; a crucial element to success within an industry
 Figure 7: YOY International            that survives on discretionary spending.
 Travel Growth
                                        Decreases in Outbound Travel Reduce Industry Sales
                                        Currently, growth of total Australian overseas departures is below the 10 year YOY growth
                                        average (Figure 7). This slow in outbound growth can be attributed to the weak AUD, as
                                        international travel for Australian residents is obviously becoming more expensive. While this is
                                        matched with a higher amount of incoming foreign travellers who wish to reap the benefits of a
                                        cheaper exchange rate, Australian travel agencies such as FLT will not profit. This is because
                                        bookings will likely be made from a foreigner’s local travel agency, or online platforms. We expect
                                        this situation to continue and hence FLT’s revenue streams to struggle, as NAB economist
                                        predictions favour a further weakening of the AUD (Figure 8).

                                        Emerging Budget Airlines and Increased Aeroplane Capacity Reduce
                                        Agent Commissions
                                        The previous 10 years have seen the emergence of budget airlines revolutionise the travel
           Source: bitre.gov.au;        industry. This increased demand for cost-effective travel is being driven by shifts in consumer
      IBISWorld; Team Estimates         preferences (Figure 9), a large driver of Australian tourism. Combined with falling international
                                        airfare prices (Figure 10) demand has increased significantly for FLT products.
 Figure 8: Currency Forecast ($)
                                        Yet this is not matched with corresponding profit growth, as commissions are also cut with retail
                                        price. While the decision to offer these bookings is necessary to retain market share, it is expected
                                        FLT’s profit margins will suffer considerably.

                                        Increasing aeroplane capacity also has a similar effect. The enhanced supply of tickets is
                                        expected to act as an incentive for airlines to offer overrides within their contracts. Yet inherently
                                        with such over-supply, prices must be decreased to also increase demand. Combined with the
                                        slow down of international travel, these increased capacities are eroding commission potential. It
                                        is expected that this will adversely affect FLT, and that their profit margins will lower
                                        correspondingly.

                                        The Need for Travel Agency Intermediation is Greatly Lowered Due To 4
        Source: NAB & Bloomberg L.P
                                        Key Factors
                                        1. Consumer Preferences Favour Simple Localised Travel: Increased consumer preference
 Figure 9: Passenger Count              for localised travel within Australia is evident by high passenger growth to domestic destinations
 (Budget Vs Full Service)               (Figure 11). While increases in discretionary spending would normally plant the perfect seeds for
                                        growth within the travel industry, agencies cannot derive revenue from localised travel due to it’s
                                        inherent simplicity. Consequently, this effect is expected to be disastrous for FLT revenues as
                                        excess consumer income is spent on travel that does not usually require agency intermediation.

                                        2. Online Platforms Create Higher Competition and Increase Direct Online Supplier Sales:
                                        The online industry is highly concentrated by direct suppliers and major online agents, who
                                        collectively hold 72% of revenues (Figure 12). Many of these well established travel companies,
                                        such as airlines, hotels and other direct service providers face little difficulty in expanding online.
                                        Due to the cost-effective nature of such a platform, these businesses are rapidly increasing their
                                        direct online sales by directly marketing to consumers, cutting out the middleman (Appendix 4).
          Source: QAN Annual Report     Consequently there is a lowered necessity for travel agency intermediation.

 Figure 10: CPI Adjusted Best           Such a conclusion is supported by a study conducted by the European Journal of Tourism
 Discount Rate Airfare ($AUD)           Research in 2015 (Appendix 4). Particularly for frequent traveller, consumers prefer booking
                                        directly online. This is due to the quick and easy nature of the platform, user desire to save
                                        intermediation costs and the ability to effortlessly compare competitors at the click of a button:
                                        increasing the risk of stolen market share.

                                        Further, the study also concludes that online travel research has transformed into an
                                        entertainment platform for consumers, who can come home after a long day at the office and plan
                                        their dream holiday. While these persons are typically low-frequency travellers, and the study
                                        suggests that they are more likely to require intermediation, they are inherently less profitable
                                        than those who travel regularly. Hence the increased presence of direct online booking systems
                                        pose a great threat to travel agency revenues.

             Source: bitre.gov.au

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Figure 11: Passenger Growth
(%) To Leisure Destinations             As this technological expansion favours the easiest methods for consumers, it is likely that agency
                                        presence online could become redundant. Companies such as Google, Facebook and travel
                                        information websites like Tripadvisor are seeing exponential growth in their travel advertising
                                        revenues. This is due to an increase in suppliers expanding their direct online marketing strategies
                                        (Appendix 5). As a result it is likely that these large web conglomerates may look at directing online
                                        traffic more efficiently, causing further disintermediation.

                                        3. Airlines Directly Winning Corporate Contracts Cut Out the Middle Man: Another factor
                                        responsible for agency disintermediation is an increased amount of exclusive contracts won by
                                        airlines directly. Loss of large contracts with these corporate clients is resulting in further agency
                                        struggles. Further, those clients that have been maintained are no longer as profitable, and likely
                                        not to be renewed. This is because enhanced connection speeds have increased teleconferencing
                                        capabilities, hence reducing demand for business travel (Figure 13).

                                        4. Increased Technological Competition Challenge Agency Revenue At All Stages of Travel:
                                        The rises of peer-to-peer travel services is causing further competition and further potential
                                        intermediary redundancy. Agencies strive to target consumers at all stages of their travel, such as
                 Source: bitre.gov.au
                                        hotel and vehicle hire, where corresponding commissions and packages can be made. However
                                        low-cost alternatives like Uber and Airbnb are now also threatening these revenue streams
Figure 12: Australian Online            (Appendix 3). Consequently FLT’s entire service revenue chain is being threatened due to micro-
Travel Agents (OTA)                     entrepreneurs.

                                        All of these factors are expected to cause future revenue struggles for FLT as a travel intermediary.
                                        Consumer preferences clearly favour online direct bookings without agency involvement. As agency
                                        online sales are expected to continue stagnating, FLT cannot expect any further growth within the
                                        industry from their online platform. Additionally, struggles to maintain corporate contracts, a segment
                                        that accounts for 33% of FLT’s total revenues, are expected to be detrimental to sales.

                                        FLT’s Online Expansion Lags Behind the Industry
                                        Revenue streams within the industry saw massive growth within the 2012-2013 financial year due
                                        to the weak AUD and resulting increased demand for international travel. These excess profits saw
                                        many companies within the industry focus on a cost-effective online expansion. FLT however, was
                                        not one of them. As a result the Company is expected to face struggles within this platform,
                  Source: IBISWorld
                                        particularly as they face enhanced international competition and are falling behind competitors. This
                                        is further elaborated in the Porter’s Five Forces model in Appendix 1.
Figure 13: Enhanced
Teleconferencing Ability on
                                        Currently, Australia maintains a dominant online presence, with an Internet retention rate of 93.1%
Industry Corporate Travel
                                        (United Nations, ITU, 2015). Naturally then, consumer preferences highly favour online platforms
                                        due to their ease and efficiency, and so these have seen large success within the industry since
                                        introduction. Consequently, there is little market share left to be won by those who did not originally
                                        expand into the platform, such as FLT. While management aims to grow online TTV to $1B in 2017,
                                        this is not feasible with the industry supply chain rapidly transforming. Further, FLT now face
                                        competitors who solely exist online and hence have lower costs and higher profit margins. As half
                                        of the world's population will have access to the Internet by 2020 (United Nations ITU, 2015), and
                                        FLT is lagging behind in an industry expansion that will soon see their current brick and mortar stores
                                        become obsolete, it is expected that they will struggle immensely.

                                        Fierce International Competition Limits Organic Revenue Growth
                                        FLT has attempted a global expansion over the previous decade, however competition is undeniably
   Source: Bloomberg; United Nations    high with Expedia.US and Priceline.US dominating the online market as a duopoly. The low
                                        likelihood of FLT stealing market share from these dominant players coupled with the eventual
                                        industry approach to market saturation both pose large barriers for FLT to gain online revenues.

Figure 14: Market Share of Total        Admittedly, the Company has taken a dynamic approach to obtain market share by undertaking a
Rides (US)                              large amount of acquisitions and divestitures, particularly within demographic specific service
                                        companies. An example is their acquirement of StudentUniverse (a total overview of all acquisition
                                        activities can be found in Appendix 20. However the Company is struggling to transfer its domestic
                                        success and economies of scale onto an international platform. Global competitors already hold a
                                        large market share that FLT is struggling to steal (Figure 20). As a result the company’s continued
                                        acquisitions are expected to be stagnant to revenues and are in fact distracting management from
                                        further domestic profits. This is magnified as FLTs decreasing market share in Australia is corroding
                                        their economies of scale advantage (Figure 17).

                                        Online Expansion Will Cannibalise Sales and Increase Competition
                                        Switching to a multi-channel agency also poses threats for FLT as this will cannibalize their revenue
                                        streams. Majority of the Company’s traditional customer base originate from brick and mortar stores.
             Source: Certify Report     By moving online, this opens up an easy platform to compare competitor pricing. Consequently FLT
                                        are providing their loyal, store-based customers a method to reconsider their agency options. As a

                                                                                                                                          4
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                                     result, it is expected that FLT will struggle to retain their in-store customer base through this
Figure 15: Airbnb Number of          transition, and so sales will suffer accordingly.
Nights Booked
                                     The Industry Life Cycle Favours High Growth for Competitors
                                     FLT currently resides within the mature stage of the industry life cycle. This is resultant from
                                     management's strategy to protect its currently dominating market share and secure stable revenues.
                                     The company’s competitors however, are all estimated to have a strong growth outlook, and hence
                                     in a position to retain market share and greater benefit from industry success. Online competitors
                                     Webjet and Helloworld have strong forecasted growth for FY17, largely due to strategic M&A
                                     Activity. Although the online market is reaching saturation, these competitors are all stealing
                                     proportions of FLTs market share, and so are within the shakeout stage of the industry life cycle
                                     (Figure 18).

    Source: Cowen &Company; Team
                       Estimates.
                                     Investment Summary
Figure 16: Porters 5 Forces          We issue a sell recommendation for FLT with a 12-month target price of $31.93AUD, representing
                                     a 13% downside potential from it’s current stock price of $36.85 on August 31st, 2016. The three
                                     valuation techniques used to derive our target price were the Dividend Discount Model (DDM), the
                                     Discounted Cash Flow Model (DCF) and Relative Valuation techniques (RV). This downside is
                                     driven by:
                                     • Lowered agent commissions due to decreases in outbound travel and price wars;
                                     • The high costs and little profit potential of international expansion both in store and online due
                                        to existing competitors and forecasted online market saturation;
                                     • Reduced necessity for agency intermediation within the industry;
                                     • FLT’s below average capital structure; and
                                     • The Company’s high and inefficient operating expenses and resulting inability to improve low
            Source: Team Estimates      margins.

Figure 17: Industry Market Share     Investment Drivers
(Australia)                          Decreased Domestic Agency Commissions: High competition within the industry is resulting in
                                     exceedingly low airfares, reducing commission margins for FLT. Despite increased demand due to
                                     over-supply; revenues are still expected to decrease accordingly. Further, the weak AUD is resulting
                                     in lower outbound travel rates, and so discretionary income is being spent on localised travel, which
                                     has comparatively lower profits. While Australia’s cheap currency is increasing foreign travellers,
                                     these consumers are likely to use their own respective travel agencies and so such an influx does
                                     not lead to profits.

                                     Low Potential for Profitable International Expansion: The online travel industry is highly
                                     competitive as it combines direct suppliers and other agency competitors onto one easily
                                     comparable platform. Many existing competitors, particularly the dominating international duopoly
                                     of Expedia.US and Priceline.US, broke into online platforms earlier than FLT, hence securing a
                                     competitive advantage (Figure 20). Consequently, the Company will need to steal existing market
                                     share in order to break through within these markets. This is supported by our prediction that the
                 Source: Bloomberg   market will reach saturation. The result is an increased price competition placing further downwards
                                     pressure on revenue forecasts.
Figure 18: Stages in the Industry
Life Cycle                           FLT’s management is currently undertaking expansions through the costly acquisitions of
                                     businesses within niche markets. However, this strategy is not permanently sustainable, and does
                                     not improve the Company’s organic growth nor steal market share from other existing competitors.

                                     Profit margins of international segments are also significantly lower than those within Australia, as
                                     overseas expense structures do not benefit from FLT’s domestic economies of scale (Figure 23;
                                     Figure 24). Consequently, management’s focus on international expansion will not result in
                                     corresponding shareholder gains.

                                     Lowered Necessity for Travel Agency Intermediation: Four key industry factors are adversely
                                     affecting demand for FLT services. Firstly, consumer preferences have shifted to favour local travel:
            Source: Team Estimates
                                     an inherently simpler task generally not requiring intermediation. The industry’s expansion online,
Figure 19: FLT SWOT- Analysis        secondly, has resulted in higher competition and increased sales between suppliers and consumers
                                     directly. FLT is consequently cut out. Airlines are now also targeting large corporate clients,
                                     contracts that FLT used to win. These corporate sales account for 33% of FLT revenues. Finally,
                                     sales are being challenged at all platforms due to the rise of peer-to-peer travel services. This
                                     include companies such as AirBnB and Uber, who are capturing market share from FLT’s car hiring
                                     and hotel packages (Appendix 3).

                                     Expensive and Below Average Capital Structure: FLT has the lowest amount of debt financing
                                     among key industry players. While this might give reason for upside potential, FLT have confirmed
                                     they will not take on any debt capital. Consequently they will continue undertaking much more
                                     expensive investments than necessary, falling further behind competitors.
            Source: Team Estimates

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 Figure 20: Revenue Comparison         High Operating Expenses Drive Down Profits and Shareholder Returns: While FLT’s TTV
 (US$ Million) (International)         grew consistently over the last five years, this does not translate to their bottom line. This is
                                       because expenses are growing at a higher rate than revenue streams, jeopardising profits.
                                       Correspondingly, net profit margins have remained consistently low. Majority of the Company’s
                                       high operating expenses are derived from rent and salaries, as they heavily rely on their bricks
                                       and mortar stores for revenue. Consequently, these low profits are forecasted to continue, and
                                       as revenue streams will be declining while expenses maintain steady growth, profit margins will
                                       be squeezed (Figure 27).

                                       Dividend Policy
                                       FLT's payout ratios over the last five years have been in line with their dividend policy of returning
                                       50-60% of NPAT to shareholders, with the only exception being FY14 when a fully franked
                  Source: Bloomberg    dividend of $1.52 led to a payout ratio of 74%. This particular outlier was due to the directors
                                       desire to share their strong cash reserves despite a low NPAT for the year. FLT’s current payout
 Figure 21: Dividends & Payout         ratio of 61% also sits slightly higher than usual, with the ten-year average being 55%. Our
 (%)                                   forecasts expect the Company to pay flat dividends of $1.61 per annum until FY20, as we believe
                                       they will maintain a payout ratio of 60% while NPAT stagnates (Figure 21).

                                       Investment Risks
                                       The key risks that pertain to FLT include foreign exchange risk, economic risk, operational risk
                                       and credit risk. The former risk includes translation and exchange risk due to their multicurrency
                                       debt facility. Economic risk includes the high sensitivity global shocks may have on travel
                                       behaviours and discretionary spending. The Company faces operational risk through decreasing
                                       airfare prices, which lower commission streams, as well as the increasing threat of online
                                       competitors.

 Source: Bloomberg & Team Estimates

 Figure 22: P/E Ratio forecast for
 FLT, domestic and international
 peers

                                       Financial Analysis
                                       Expensive Capital Structure with No Plans of Changing
                                       Comparative to the chosen peer group, FLT now remains the only major company within the travel
             Source: Team Estimates    industry that is not taking advantage of debt financing. (Figure 26). While this may immediately
                                       seem like a good reason for upside potential, FLT have never once taken on long-term debt nor
 Figure 23: International              have any plans to. Although in FY16 both ROE and ROIC (18.7% and 18.17% respectively)
 Segments                              remain higher than 5 year historical WACC (12%), ROE sits at a second all time low for the
                                       company, suggesting future shareholder returns are limited (Figure 25).

                                       High Operating Expenses Limit Equity Returns
                                       FLT has continuously boasted a high and consistent ROE, largely as a result of their strong
                                       revenue streams. The lack of debt capital creates a small book value size of the company, thus
                                       creating an outstanding total asset turnover (Appendix 9). Such efficiency, however, is limited to
                                       the books. FLT have an outstanding amount of fixed operating expenses, resulting in a
                                       consistently low net profit margin (Figure 27). This has then resulted in an average return on
                                       assets comparative to peers. (Figure 28) This translates into their ROE.

                                       Erratic Capital Expenditure and High Lease Commitments Further
                                       Decrease Profit Margins
           Source: FLT Annual Report   The Company’s major downfall lies in its large underlying expenses. Capital expenditure has been
                                       volatile and hence not accurately predictable, leading to fluctuating profit margins (Figure 29).
 Figure 24: Segment Summaries          FLT currently utilize straight-line depreciation, which is incremental at 10% of yearly capital
                                       expenditure; this expense alone grew 22.2% in FY16. For the previous 2 financial years expenses
                                       have grown at a faster rate than revenues (2015: 10.6% to 7.0%, 2016: 13.4% to 11.2%). Further,
                                       FLT operate their stores entirely through lease commitments, and so considerable cash flows
                                       also go toward paying these rental expenses. FLT have a total of $654M of lease commitments
                                       over the next 7 years, with an estimated present value of $529M (Appendix 8). Consequently the
           Source: FLT Annual Report   lack of any clear management strategy between capital expenditure and free cash flow, combined
                                       with large amounts of short-term lease commitments, will greatly decrease shareholder value as
                                       dividend payouts are hence derived from NPAT.

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Figure 25: ROE and ROA                International Expansion Will Jeopardize Net Income Due To Higher
                                      Expenses and No Economies of Scale
                                      FLT are quick to boast their international income diversity, with Australia comprising 55.4% of total
                                      FY16 revenues (Figure 23). However differences in geographical expenses result in drastically
                                      different statutory EBIT values, as Australia rose to 74% due to the clear presence of economies of
                                      scale within domestic expense structure. Further, the segment’s profit margin stood at an astounding
                                      21.15%, with the Rest of the World and US regions causing concern at 8.32% and
                                      2.7% respectively (Figure 24). As discussed above, management is targeting strong international
                                      expansion. In doing so however, the larger expenses faced in non-domestic regions will result in
                                      lower profits than if such revenues were made locally. Also, the required capital expenditure to then
                                      set up such income streams in these new segments will then further decrease profitability and
 Source: Bloomberg & Team Estimates
                                      efficiency, drastically affecting shareholder value.

Figure 26: WACC Peer                  Revenues Internationally Are Not Justifying Costs
Comparison                            The company is adamant regarding their strong TTV growth as a major driver of their success,
                                      however increased sales volume does not result in corresponding revenue growth. (Appendix 8).
                                      When the margin between TTV and revenue is broken down per segment, they severely differentiate,
                                      likely due to differentiating commission laws and standards.

                                      Though overall revenue grew 11.2% in FY16, expenses grew 14.61% (13.4% excluding the one off
                                      impairment charge), resulting in a 5.8% decrease in EBIT. When broken down into segments, all
                                      regions had decreased profit margins in comparison to FY15 (Appendix 6).

                                      As discussed above, FLT is losing market share due to its main competitors deriving online revenue.
                                      While this area is one that FLT are looking to explore further, these trends will continue as younger
 Source: Bloomberg & Team Estimates   generations favor a technological approach. Despite the Company addressing this, they are still
                                      undertaking large investments into physical assets and employees. This alone increased their wages,
Figure 27: Profitability Analysis     rental and depreciation expenses by 11.91% in FY16.

                                      The current management plan clearly favours long-term growth however financially this will not result
                                      in increased shareholder value in the forecasted period. Instead it is expected that expense growth
                                      will continue to surpass sales growth within the next four years, and so any eventual benefits to net
                                      income will not fall within the forecasting period. Consequently, as the dividend policy sits at 50-60%
                                      of NPAT, these growing expenses will be detrimental to shareholder profit.

                                      Valuation
                                      We have used a combination of three valuation approaches: the Dividend Discount Model (DDM),
 Source: Bloomberg & Team Estimates   the Discounted Cash Flow Model (DCF) and Relative Valuation techniques (RV). These have led us
                                      to our weighted average target price of $31.93AUD indicating 13% downside potential. Each of
Figure 28: Peer ROA                   these methods have weightings of 20%, 40% and 40% respectively. These were chosen to reflect
Comparison                            that free cash flows are a better indicator of FLT’s future cash flows opposed to dividends, and also
                                      to reflect our opinion that multiples are the key driver behind making a stock converge to it’s intrinsic
                                      value.
                                                                                                                             DDM

                                      Dividend Discount Model                                                               (20%)

                                                                                                                            $27.33

                                      FLT has maintained relatively stable dividend payments over the
                                      past 10 years, hence making the DDM an ideal valuation                               Weighted
                                                                                                                            Value
                                      technique. The Company has maintained their policy of returning                       $31.93
                                      50% to 60% of NPAT. Therefore, future dividends are predicted             RV (40%)
                                                                                                                                       DCF
                                                                                                                                      (40%)
                                      based on this policy being maintained with forecasted earnings.            $33.10
                                                                                                                                      $33.07

                 Source: Bloomberg
                                      CAPM: The capital asset pricing model was used to determine
                                      FLT's required rate of return at 8.51%.(Figure 31)
Figure 29: Operating Margin
                                      Dividend Forecasts: We have assumed the Company will maintain a consistent 60% payout ratio
Analysis
                                      of NPAT, and hence calculated future dividend payments based on our bearish net income forecasts.

                                      Terminal Growth Rate: The Company’s terminal growth rate was estimated at 3% (Figure 35).
                                      Notably, nearly half of FLT’s total revenues are generated from international markets. Therefore we
                                      have incorporated the GDP growth rate of domestic and international markets to reach a suitable
                                      terminal growth rate. We assigned a weighting of 75% to the average GDP growth rate of the three
                                      most dominant markets (Australia, UK and US), consistent with revenue breakdown per segment.
                                      The remainder is attributed to an average of Asia and South Africa (Appendix 11).

                                      Two Stage Model: Currently our projected dividends indicate a decreasing trend due to our
                 Source: Bloomberg    prediction that net income growth stagnate. However in times of struggling profits, FLT have
                                      historically raised the payout ratio to avoid negative dividend signals. As the last three years’ d
                                      ividends were paid at flat level, we assume that FLT will undertake a similar strategy on the basis of
                                      our forecasted 2017 dividend ($1.61AUD) until 2020. After this, we assume the dividend growth rate
                                      will be constant.

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Figure 30:
                                      Based on the above information and Appendix 12, we have reached an intrinsic value of $27.33AUD.
                                      Additional sensitivity analysis has been conducted with two pairs of variables: payout ratio versus
                                      cost of equity and terminal growth rate versus cost of equity.

                                      Discount Cash Flow Model
                                      We have also used free cash flows to firm (FCFF) as alternative future cash flow to estimate FLT’s
                                      intrinsic value.

Source: Bloomberg. & Team Estimates   WACC: We have considered two major uncertainties to estimate the cost of capital:
                                      1.  Historically low interest rates could entice FLT to take on more debt; and
Figure 31:                            2.  High volatilities in stock price and pressures upon future earnings create higher risk.
                                      Consequently, we used a combination of current WACC (8.3%) and the 10-year historical average
                                      WACC (12%) to reach our long-term estimated cost of capital at 10.15% (Appendix 11).

                                      FCFF: We have computed FCFF from Cash Flows from Operations (CFO), which has been
                                      projected by directly forecasting its components. Two essential components are receipts from
                                      customers and payments to suppliers and employees.
                                      1.    We have set the growth rate of receipts at 6.3%, equal to forecasted compounded revenue
Source: Bloomberg. & Team Estimates   growth from 2017-2020. Historically, these two factors have shown high correlation with minimal
                                      spread.
Figure 32:                            2.    Similarly, we set the growth rate of payments equal to the compounded operating cost growth
                                      rate for the forecasted period, at 6.7%.

                                      CapEx Growth Rate: FLT has undertaken aggressive expansion in the past five years, and so we
                                      assume they will continue to invest in fixed assets in accordance with the historic five-year average
                                      CapEx growth rate of 11.5% (Appendix 11).

                                      By applying the same LGR as above, we reached an intrinsic of $33.10AUD. The three key
                                      variables used in sensitivity analysis are WACC, CapEx growth rate and LGR (Appendix 13 & 15).

                                      Relative Valuation
      Source: Bloomberg & Team        Through our relative valuation model, we derived a target price of $33.07AUD using three key
                      Estimates       multipliers: Price/Earnings (P/E), Enterprise Value/Earnings before Interest Tax, Depreciation and
Figure 33:                            Amortisation (EV/EBITDA), and Price/Sales (P/S).

                                      This model is then further split into domestic and international to provide insight into differentiating
                                      Company expectations within different playing fields. (Appendix:14).

                                      Within the domestic comparable pool we have included HLO:AU, CTD:AU, WEB:AU and also the
                                      S&P/ASX Consumer Discretionary Index. International peers consist CTRIP:US, PCLN:US,
      Source: Bloomberg & Team        EXPE:US and the MSCI World Consumer Discretionary Index. All chosen comparables are subject
                      Estimates       to similar risks and growth potential. To derive our final intrinsic value, we have combined both
Figure 34:                            target prices, weighting domestic and international target prices based on their forecasted
                                      proportions of total revenue as illustrated in Figure 34.

                                      P/E and EV/EBITDA: These multiplies provide an insight into FLT financial health by taking into
                                      account both the Company’s capital structure and earnings. Historically, both international and
                                      domestic multiples have sat above FLT by the same margin.

                                      Price/Sales: This multiple however, serves as an alternative and is useful for identifying how much
                                      revenue the company generates in isolation, with less chance of accounting manipulation. However
                                      as the multiple shows a limited picture by only capturing sales, we have assigned a weighting of
                                      20%. P/S has also traded as a discount, with the international pool sitting significantly higher than
                                      domestic (Appendix 14).

                                      FLT has maintained a dominant presence in the Australian travel industry, hence explaining the
                                      higher target prices in comparison to international for P/E and P/Sales. This further illustrates the
                                      risk FLT will face as they expand internationally and compete with the international comparable.

                                      Additional Sensitivity Analysis
                                      Both the DDM and DCF methods highly depend on terminal value, in order to neutralise this
                                      drawback, we conduct the following analyses to gain further confidence in our recommendation.

                                      Residual Income: One of the key advantages to RI model is the reduced reliance on terminal value
Source: Bloomberg & Team Estimates
                                      for the determination of intrinsic value. Applying the same variables as the DDM, and taking current
                                      book value into consideration, we obtained an intrinsic value of $32.25AUD. This is consistent with
                                      the DCF results. Consequently while residual income was not taken into the final weighting
                                      arrangement, the RI results confirm the results of our DCF model (Appendix 16).

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Figure 35: Terminal Growth            Monte Carlo: In addition to the sensitivity analyses conducted for each method, we have also
                                      completed a Monte Carlo simulation on the basis of the DCF. In the simulation, we defined
                                      assumptions for five major variables (receipts, payments, CapEx growth, WACC and LGR) and
                                      applied reasonable standard deviations. After running 20,000 trials, the simulation results suggest
                                      that more than 60% of total possibilities estimate a target price below FLT’s current market price
                                      (Appendix 17).

      Source: IMF & Team Estimates    Scenario: To gain further robustness, a scenario analysis was also conducted based on all three-
                                      valuation models, and has been explained with Monte Carlo distribution. The following table
Figure 36: Scenario Prices            illustrates our forecasts for the decisive variables within the three valuation models for each case:
                                      bearish, base, and bullish.

                                      Bearish Assumptions: We assume that FLT’s revenue growth will be below the Australian
                                      outbound travel growth rate of 5.5% (Appendix 19). This is then expected to lead to even worse net
                                      income growth, and a lowered dividend payout ratio. In this situation, the Company will strive for
                                      survival by maintaining a relatively high CapEx growth rate. Further, cost of equity and hence WACC
                                      could rise due to higher risk.

                                      Bullish Assumption: Here, we have assumed FLT’s revenue growth rate will outperform their 5Y
Source: Bloomberg & Team Estimates
                                      average, and stay in line with their historical 10Y long-term growth average by increasing
                                      investments. Net profit margin will be improved, which will boost investor confidence and hence
                                      decrease WACC.
Figure 37: Monte Carlo

                                         Scenario Analysis
                                         Key Variables                          Bearish                 Base                         Bullish
                                         Receipts                                 5.00%                6.30%                          9.00%
                                         Payment                                  6.00%                6.70%                          9.00%
                                         CapEx                                   11.15%               11.50%                         15.00%
            Source: Team Estimates
                                         WACC                                    10.89%               10.15%                          9.40%
                                         Cost of Equity                           9.13%                8.51%                          7.89%
                                         Payout Ratio                            50.00%               60.00%                         60.00%
Figure 38: Risk Matrix                   Net profit                               1.50%                2.00%                         12.50%
                                         Target Price                             $23.45               $31.61                         $40.71
                                         Up/Downside Potential                  -36.36%              -14.21%                         10.46%
                                         Probability                              0.2455               0.4551                         0.2994
                                         Probability Weighted Target Price                                                            $32.33
                                         Potential Downside                                                                         -12.26%

                                      Investment Risk
            Source: Team Estimates
                                      By regressing FLTs monthly returns against the S&P/ASX200 and observing the coefficient of
                                      determination, it is evident that FLT’s risk profile is relatively independent from the market.
Figure 39: Trade & Other              Consequently, approximately 71% of total risk faced by FLT is unsystematic (See Appendix 19 for
Payables ($'000)                      time-varying volatility modelling) This can be attributed to the outlined risks below.

                                      Foreign Exchange Risk
                                      FLT plans to expand their international operations (Figure 42), increasing their exposure to foreign
                                      exchange rate risk. As illustrated in Figure 39, FLT dramatically increased its foreign trade payables
                                      by 118% between 2014 and 2016 (Appendix 22).

                                      FX1 - Translation Risk: For functional and presentation purposes, FLT’s financial statements are
                                      recorded in AUD. Transactions occurring overseas are transformed to Australian currency at the
                                      time of the transaction. Conversely, Asset and liability translations occur on the date of the statement
                                      using the closing rate. Any spreads arising from the translations are then reclassified to profit and
                                      loss, which have a history of being highly volatile (Figure 40).
          Source: FLT Annual Report
                                      FX2 - Cash Flow: While forecasted cash flows are highly probable, they can be subject to
Figure 40: Net exchange               forecasting error as the contracts are re-priced every 12 months. Over the previous 5 years,
differences on translation of         variations in gains and losses from cash flow hedges have remained relatively low (Figure 41).
foreign operations ($'000)            Mitigation: FLT is risk adverse in their hedging strategy. The Company aims to minimize exposure
                                      and achieve a 1:1 hedging ratio. FLT treasury only enter into forward foreign exchange when
                                      exchange forecasts become highly probable. Thus, speculation is not FLT’s hedging strategy.

                                      Economic Risks
                                      ER1– Consumer Confidence and travel patterns: Global shocks such as terrorism, political unrest,
                                      natural disasters and social pandemics can have an adverse effect on consumer travel confidence,
                                      potentially decreasing TTV. Furthermore, changes in discretionary income and exchanges rates can
                                      alter consumer travel patterns.
          Source: FLT Annual Report   Mitigation: FLT’s strategy involves increasing their brand and geographic diversification to avoid
                                      relying on a single segment.

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2016 | CFA Institute Research Challenge

Figure 41: Changes in Fair Value               Operational Risk
of Cash Flow Hedge ($'000)                     OR1 - Budget Airlines and Price Wars: While lowered airfares result in increased demand, benefits
                                               are likely offset as cuts in retail prices also erode commissions and overrides. Individual agreements
                                               between each individual airline carrier outline guaranteed payments and volume incentives. Hence
                                               if budget airfares continue to trend downwards, commission incentives and margins offered by
                                               carriers may decrease to compensate.
                                               Mitigation: FLT consultants have lowered their commissions in a bid to increase demand.

                                               OR2 - Technology Disruptions: Rapid and continuous technology expansion of online booking
                                               platforms is likely to constrain industry growth and impact FLT market share. Online industry players
              Source: FLT Annual Report        such as Webjet are able to enter the market with little capital and provide heightened price
                                               competition. Consumers will then be able to bypass travel agencies and book directly with the travel
Figure: 42: FLT Australian                     provider.
Revenue Proportion                             Mitigation: FLT has acquired a number of brands such as StudentUniverse and BYOjet.com to
                                               ensure they maintain significant market share.

                                               Credit Risk
                                               CR1 – Credit ratings: FLT is exposed to credit risk through their forward foreign exchange contracts,
                                               their cash equivalent and available for sale assets.
                                               Mitigation: All FFX contracts and 87% of liquid assets are equivalent to S&P rating AA to A-
                                               (Appendix 21).

Figure 43: Board of Directors                  Corporate Social Responsibility
 Board of          Remuneration   Ordinary
 Directors         FY16 ($)       shares       Governance
 Graham            675,000        15,244,487   As an ASX listed company, FLT utilizes the corresponding corporate governance principles. While
 Turner
 Managing
                                               most principles are implemented, the company does not separate the remuneration and nomination
 Director/CEO                                  committees as per Principle 2: ‘structure the board to add value’. Consequently, FLT has a rating of
 Gary Smith        201,218        15,000       4.49 out of 5 based on our estimations, so is bested by some competitors such as Corporate Travel
 N.E. Director                                 Management, who have implemented all principles (Appendix 27). FLT meets all six OECD
 Chairman
 John Eales        150,848        3,000        Corporate Governance Principles. Further, the Company shows growth in their environmental and
 N.E. Director                                 social scores yet a decline in corporate governance as provided by the Thomson Reuters Asset4
 Robert Baker      150,503        2,500        database (Figure 45; Appendix 25).
 N.E. Director

                                               Board of Directors
             Source: FLT Annual Report         FLT’s independent directors only hold small amounts of shares, which could lead to a moral hazard,
                                               as they may not act in the shareholder’s best interest but rather in their own (Figure 43). Further,
Figure 44: Board Members                       FLT has the smallest board of directors’ comparative to all peers worldwide, with only four members
                                               opposed to the international average of eight (Figure 44). Consequently, the Company does not
                                               have a separate audit and remuneration committee. Also, FLT does not have a female director. This
                                               has been historically proven as suboptimal, as females improve company performance, risk
                                               management and the quality of the decision making process. The absence of such diversification
                                               and gender equality can lead to one-sided decisions (Appendix 26).

                                               Corporate Social and Environmental Responsibility
                                               The Company founded the Flight Centre Foundation in 2008, supporting organisations engaged in
                                               movements for the environment, children, education and cancer support (Appendix 23). FLT
                                               provides employees the opportunity to volunteer their time to charities and community organisations
                                               while still being paid, and matches their donations dollar for dollar. The Company was recently
                      Source: Bloomberg        appointed to the top ten ASX listed charity givers (Australian Charities Fund, 2016). The
                                               Foundation's charity partners are non-political and receive limited or no support from any
Figure 45. FLT ESG-Scores                      government entity. Overall, donations to communities since its foundation amounted to $7.7 million
Asset4                                         at the end of the 2016 financial year.

  Source: Thomson Reuters Database

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tg2016 | CFA Institute Research Challenge

Appendix: 1
 Force 1: Threat of New Entrants
     1) Strict Regulatory and financial monitoring pressures on new
         agents                                                                                   Supplier Power
     2) Existence of Economies of Scale and incumbent exclusive
         partnerships makes entry difficult and/or unprofitable
     3) Rise of technology based travel advice allows low cost and                 Threat of                         Threat of New
         innovative myriad micro-entrepreneurs to quickly gain market             Substitution                             Entry
         share. However online market heavily dominated.
     4) Higher comparable Profit Margins for Online Travel Booking
         services
     5) Large Network effect of current market leader (FLT) provides                 Buyer Power
                                                                                                                 Competitive
         more tailored and cost effective service to clients.                                                      Rivalry
 Force 2: Threat of Substitute Products
     1) Holds largest market share, however there are highly
         substitutable branch and online travel booking services.
     2) Other Flight Planning Services, particularly low-cost online travel booking services. However, buyers are still
         dependent on a quality face-to-face tailored servicing.
     3) Brandjacking: illegal use of popular brands by brandjackers to drive traffic to their sites without the permission of
         brand owners. Potentially drawing away revenue and reputation of FLT.
     4) Disintermediation: Especially on a domestic level, as Australian’s typically avoid travel agents when travelling
         domestically. Additionally airlines are now directly approaching customers reducing potential commissions for FLT.
 Force 3: Bargaining Power of Buyers
     1) Easily substitutable for other agents, and thus can negotiate price wars between agents.
     2) Information Asymmetry: Lack of pricing information, especially on grounded services (hotels) between customers
         and suppliers creates dependency of buyers. This due to the complexities of travel.
 Force 4: Bargaining Power of Suppliers/Sellers
     1) High Threat of backward integration from Airline suppliers due to online pricing
     2) Grounded travel Services (hotels) have little influence of FLT, as their revenues are highly dependent on the agency
         relationship.
     3) High Competition between suppliers, creates higher commission potential, and low bargaining power.
     4) Enhanced Capacity and supply of available airline seats has enhanced the negotiating power for agents to receive
         more commissions in order to fill the excess supply.

 Force 5: Competition in the Industry
     1) The Innovative Deployment of online travel agency models are showing higher levels of profitability than store-
         based agents.
     2) Enhanced online competition has forced FLT to enhance their online presence to keep market share. But, this has
         cannibalised their store sales.
     3) Still the market leader with economies of scale advantage.
     4) Competition is fierce for offering low-cost travel services, hence marketing, brand awareness and online strategy
         will give the competitive advantage.

Appendix 2: Current Issues affecting Travel
Spread of the Zika Virus

                                                                                    Most Popular Travel Destinations for
                                                                                    Australian Travellers (ABS Data)

                                                                                    New Zealand
                                                                                    Indonesia
                                                                                    USA
                                                                                    UK
                                                                                    Thailand
                                                                                    China
                                                                                    Singapore
                                                                                    Fiji
                                                                                    Japan
                                                                                    India

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tg2016 | CFA Institute Research Challenge

Zika Virus
The top 10 international destinations for Australian Travellers are shown in the above table. The transmission of the
deadly Zika virus has been reported in 50% of the most popular travel destinations. Thus, it is expected that international
travel demand will decrease through fear of contraction when travelling. Although it could be argued that the Zika virus
would simply cause travellers to change their travel destination, this is not so easy. A key reason for these travel locations
is their low-cost, and short distance from Australian Airports. The majority of south-east Asia has been infected by the
Zika Virus, and thus the closest alternative is the European region or the northern parts of Asia. However, these are
generally more expensive alternatives and thus may not be of adequate substitution for Australian Travellers. There is
also the alternative for the Middle East, but travel to these countries has decreased by the effect of terrorist associations
which are discussed next.

Terrorism
Since 2000, there has been a nine-fold increase in the
number of deaths from terrorism. More recently the events in                                          Global Terrorism Threat
France, Bangladesh, turkey, United States as well as
Australia highlight the increased threat at high-target areas.              50,000
The Australian Government has listed mass gathering places                                           Number of
such as hotels, markets, public transport, airports and tourist             40,000                   Incidents
sites are a common target for terrorism activities. Australian’s                                     Deaths
are viewed by the levant (ISIL) as a key target for terrorist               30,000
attacks.     Even in cases where Australian’s weren’t                                                Injuries
necessarily the target, Australian citizens are still harmed by             20,000
indiscriminate attacks. The immense fear from Australian
Travellers particularly after events in 2016 has created a                  10,000
culture that hesitates to travel. A common trait is to cancel
flights and travel after a major terrorism event, even if it is in                 0
                                                                                       1970

                                                                                              1975

                                                                                                     1980

                                                                                                            1985

                                                                                                                   1990

                                                                                                                          1995

                                                                                                                                 2000

                                                                                                                                        2005

                                                                                                                                               2010

                                                                                                                                                      2015
another country. A survey in 2015 compiled by YouGov has
shown that 10% of American travellers have cancelled their
trip in response to terror, and 18% have delayed their travels.
The world is now on red alert (figure 3), and we expect this                                                       Source: Global Terrorism Database
adjustment to consumer preferences will cost the travel
industry, and thus the travel agent industry.

Brexit
The effect on the UK leaving the European Union caused an immediate downturn on the world travel market. However
the effects on airline share price, exchange rates and consumer confidence have already started to adjust from June.
However the long-term effects are not fully realised yet. We expect the travel industry in Australia to have limited effect
from the Brexit other than a decrease of UK tourists in Australia, which would be offset by an increase of Australian
passengers to the UK. Although, once the Brexit is fully undertaken there may be a change in visa protocol which overrides
the current no-visa policy for Australians holidaying in the UK and EU.
Ultimately the Brexit has the biggest effect on the UK and European travel market. Thus with FLT deriving 13% of their
profits and revenues from this continent, they are at risk of long-term revenue slowdowns. The International Air Transport
Association has predicted
by 2020 UK air passengers could be 3-5% lower due to a downturn in economic activity and fall in sterling.

The Insurance Industry
The insurance industry has faced rising costs in the form of reinsurance expenses over the past five years. An unusually
high incidence of natural disasters and terrorist encounters around the world has led to a rise in the volume and value of
insurance claims, forcing reinsurers to increase premiums (Wu, 2016). Ultimately, indirect costs of travel are increasing
and this correlates with a decreased consumer confidence in travel due to the current aforementioned global risks. What
was once seen as a safe and reliable place to travel, is now sacrificed due to the increasing threat of terrorism. Which
has forced insurance companies to raise their risk-adjusted premiums. This problem also relates to FLT’s Travel insurance
revenue stream. Thus enhanced insurance premiums are reducing the total Passenger outflow as well as the profit
margins of Flight Centres Insurance Products.
Source: Wu. T. (2016). IBISWorld Industry Report OD4216. Travel Insurance in Australia. Retrieved from http://www.ibisworld.com.au

Appendix 3: The Sharing Economy
The Travel industry like most industries are rapidly expanding into peer-to-peer services. The low-cost options as well as
direct exposure to locals is providing a more authentic and cost-saving experience compared to traditional Travel
operations. Micro-entrepreneurs are offering alternatives in an array of travel sectors such as hotels (Airbnb),
transportation (Uber, Lyft), dining (Eatwith, Feastly) and tours (Viator, Vayable). This growth is not just left for leisure
travel, business travellers are increasingly adapting their Travel & Expenses (T&E) budget for more cost-effective sharing
economy services.

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