Trip.com

Trip.com's revenue rose 6% in the second quarter to CNY 15.7 billion, while net loss was CNY 18.2 billion, due to the antimonopoly penalty fine levied by the government.

Why it matters: Revenue was in line with our estimates as we expected a growth slowdown in the second half of the year due to a change in how Trip.com collects revenue from antimonopoly rules. We expect third-quarter revenue to increase 4% year on year as the slowdown is likely to persist. While we expect hotel booking volumes to increase modestly in the second half, Trip.com is still adjusting to new operational practices to align with compliance—which suggests that the commission rates are still uncertain, but likely to lower revenue growth long-term. Transportation revenue fell 1% year on year. We expect near-term challenges to continue, as airline and ground ticketing revenue dropped by 20% year on year after changes to Trip.com's monetization policies.

The bottom line: We keep our USD 63 (HKD 504) fair value estimate for narrow-moat Trip.com as we already made revisions to reflect slower growth. Despite near-term headwinds, we believe Trip.com is undervalued, highlighted by a long-term 20% operating margin and strong network effect. While Trip.com's growth is slowing, overseas business revenue still rose 50% in the quarter, and remains an incremental long-term driver of valuation. We still expect the overseas platform to grow to 15% of total revenue by 2028. We expect overall macro weakness in the near term as outbound flights are still down by double digits compared with 2019, while revenue per average room is flattish year on year. Trip.com has already lowered operating expenses this quarter to offset the slowdown.

Between the lines: Recently, China imposed restrictions on civilians in specific sectors traveling outbound of China. We believe that this affects a very small portion of the population and is mostly directed at US travel, which only consists of only 10% of revenue.

Our fair value estimate is USD 63 or HKD 504. Valuation will be largely determined by the level of recovery, especially in international air ticketing and hotels in 2024, and whether it is able to successfully expand its overseas platform without sacrificing profitability. The company wants its overseas platform to contribute 15%-20% of total revenue, from 6% currently. While we are encouraged that the expansion will raise revenue growth to mid-20% levels during 2023-28, we would like to see it expand without heavily diluting operating margin. There are some policy tailwinds as visa restrictions are being lifted, but whether demand can continue its rapid pace remains to be seen.

Domestic business and accommodation have recovered much faster than the international business. We expect 2024 international revenue to recover to 80% of 2019 levels. Operating margins from the international air and hotel businesses should also drive margin expansion.

Other businesses such as Skyscanner, packaged tours, and corporate travel are smaller factors in determining Trip.com’s fair value, but we assume that they recover to 2019 levels as well. The business already recovered beyond 2019 levels in the first quarter of 2023. Regardless, the main determinant of Trip.com’s fair value will be its operating margins, which are dictated by the number of bookings of its higher monetization rate products: international air, international hotels, and high-star hotels.

We do not believe that a recovery in domestic travel or activity will necessarily represent greater valuation for Trip.com, as monetization is minimal for the domestic travel business. Domestic air ticketing has a take-rate of 1%-2%, and most ground transportation have close to 0 take-rate.

We assign a narrow moat rating to Trip.com due to its strong network effect in China’s online travel agent industry. The network effect for Trip.com is its massive number of hotels on the platform relative to its competitors, which drives consumers toward its platform as a one-stop shop for travel needs. Trip.com was the largest OTA platform worldwide from 2018 to 2020 and the largest in China for the last 10 years in terms of gross transaction value. The platform provides the widest hotel accommodation options in China with 1.4 million hotels listed compared with its closest competitors Meituan at 360,000 and Fliggy at 200,000 hotels, as of 2019. The strength of its network effect has been evident during the pandemic. While covid-19 has decimated the OTA industry, Trip.com has been able to outperform the OTA industry as accommodation bookings and air tickets have outperformed the domestic average by 15%-20% and 5%-10%, respectively. We believe the outperformance is due to its massive hotel options and network effect relative to its competitors, which would take time to replicate.

Despite many competitors in the industry, acquisition channels and demographics are different for each platform, which also contributes to Trip.com’s business moat. Trip.com’s strategy is fundamentally different from other competitors, as low-star hotels are viewed as traffic acquisition channels on Trip.com’s platform for its high-star hotels, where monetization and margins are higher. We believe that this contributes to its network effect, where consumers view Trip.com as the platform for high-quality travel accommodations and a one-stop shop in the long term. The market for low-star hotels is highly competitive, and while other platforms are looking to make a profit, Trip.com hopes to only break even so that it can drive traffic toward its high-star offerings, according to management.

Trip.com’s dominance with high-star hotels appears to be paying off. While Meituan indicated that it has become the leader in the hotel booking industry in terms of the number of rooms booked and implied that it has taken market share, we believe that Meituan’s metric is based on low-star hotels and hourly rooms where the monetization rate is much lower than that at Trip.com. We estimate that Trip.com has 50%-plus the market share for high-star hotels, where the take rate is 9%-10% compared with 5%-6% for low-star hotels. As a result, we estimate that Trip.com’s room nights booked were about 300 million-320 million compared with Meituan’s 392.4 million, but domestic accommodation revenue was CNY 10.5 billion versus Meituan’s CNY 5.5 billion estimate in 2019 despite having more room nights booked. Trip.com remains the postpandemic leader in high-star and international hotel bookings in 2024.

How consumers view Trip.com’s platform can also be seen through its transportation ticketing business. The transportation business, excluding Skyscanner and international flights, is essentially domestic airlines and ground transportation (that is, high-speed rail, trains, buses) that is accessible to other OTA platforms and identical substitutes. Government regulations prevent OTAs from taking a commission from state-owned enterprise ground transportation, and for domestic airline ticketing, only fixed booking fees of CNY 5-CNY 10 are allowed after the industry revamped the amount of commission allotted for OTAs, which implies that revenue is directly correlated with transaction volume. Given identical substitutes and differences in revenue, we believe that this is illustrative of the mindshare and popularity of Trip.com as a platform relative to competitors who can offer the same service.

We assign Trip.com a narrow moat rating, rather than wide, as ROIC has been declining in recent years due to lower take rates and increasing competition from direct channels and relatively low barriers to entry. Since late 2015, larger airlines in China have decided to increase their direct sales portions and lower the commissions to online travel agents. By 2017, the three largest Chinese airlines had reduced commissions to agencies by 50% after two years, and now, according to management, the platforms are only taking CNY 5 per transaction for booking fees. The airlines are also expanding to accommodation-reservation services, with the goal of cross-selling with air tickets. Despite greater options in hotel selection and international flights, there are no patents or nonreplicable barriers to Trip.com’s success, although it will take time and resources to forge the same relationships and network effect. Fliggy remains an Alibaba service, and Tongcheng is partially backed by Tencent as well, which means that other existing peers have the resources.

The major competition is from Meituan, Tongcheng, Fliggy, Tuniu, and Mafengwo, which are still much smaller. There is potential that Trip.com will lose market share in the long term, given that smaller companies will likely grow faster, but its greater high-star hotel and international options, which have higher margins and monetization rates, should retain customers for Trip.com and increase ROIC again once covid-19 wanes.

We can also look to the US OTA industry as an example of how certain companies have been able to ward off competitors. The network effects for Booking Holdings, Airbnb, and Expedia are driven by the large amount of travel supply content on their platforms that incentivizes travelers to visit and book. As these platforms get more visitors, it motivates suppliers to list more content, and as more content is available, it drives more use. This traffic allows these operators to improve the user experience quicker than smaller peers, which also improves the network and is tough to replicate. The supplier relationships also require sales and servicing, which is another hurdle to replicate. We believe that given Trip.com’s scale and size, it is better positioned to maintain these relationships with its suppliers as well.

The number of Chinese passport holders is only about 10%-15% of the population, which should provide Trip.com with secular demand given the low saturation.

International and outbound business will eventually recover and drive margins upwards. Margin expansion will be dictated by its higher-margin businesses, including international air and hotels.

The industry will see less competition in the future than before due to current headwinds faced, and thus fewer disruptions to its long-term business plan.

International expansion may fall flat given greater competition beyond China's borders and could pressure margins as it prioritizes growth.

Competition intensifies, and new entrants squeeze long-term margins in the industry. Competitors such as Meituan and Alibaba-owned Fliggy in China will lead to price wars in the online travel market.

Travel demand in general has shifted to more domestic consumption rather than international business, which means a lower margin outlook in the long term.