Description

Summary: China is coming out of a deep recession and recovery has been uneven. One of the bright spots is travel, which should not be surprising as this has been a global trend post Covid – as people prioritize experience over goods consumption. Arguably this trend should be even stronger in China over the next two years, as there will be more pent-up demand for travel given the extensive lockdown much of the country has experienced on and off for nearly three years. HTHT (hotels) and TCOM (OTA) have been consensus longs to play this theme. TravelSky Technology (696.HK) will be a direct beneficiary of air travel recovering/surpassing prior peak, as the monopoly GDS player in China. Already in Q1, domestic flights have recovered to 90%+ of 2019 volume, while ticket volume is at 75%+, and we will likely get more positive data points coming out of the May 1 national holiday long weekend. Going into 2H and 2024, international flights should also continue to ramp – people are DYING to travel overseas, and it is only logistics issues that are putting a damper on the recovery trajectory. This will benefit TravelSky disproportionately as the company makes 26-27 RMB per international ticket vs. 5 RMB per domestic ticket. There may even be some opportunity for the company to raise prices given the rapid increase of airline tickets both domestically and internationally. I don’t need heroic assumptions to get the company to generate 10B RMB revenue in 2024 at 25-30% op margin, putting the stock at under 9x ’24 EV/EBIT, a significant discount to global peers like Amadeus. One of the knocks on the company is poor corporate governance as an inefficiently run SOE, and capital allocation is poor with 25% of market cap in cash even though the company should be relatively asset light and generates good FCF. I am willing to overlook this negative for the time being, as 1) near term fundamental recovery should be the dominant theme, and 2) the company may enact more favorable corporate action given the backdrop of SOE reform.

Company Background: Travelsky is THE software IT system vendor for the Chinese airline industry, including GDS (Global Distribution System), inventory management system, airport IT systems, and passenger management systems. These services are accounted for in the Aviation Information Technology Services segment and make up over 50% of total revenue.  It is essentially a government mandated monopoly. For example, the GDS product has 98% of market share, with only the low cost airline Spring Airline using an in-house product. Some of its biggest customers (the Big four airlines) are also sizable shareholders, a common theme in many SOEs (China Tower and the mobile phone operators for example). This is a double edged sword – relationship is very sticky and customers have little incentive to switch, but the “monopoly” does not really have any pricing power. Travelsky has charged a fixed fee per domestic booking around 5 rmb for years now (vs. a typical one way ticket from Shanghai to Beijing at 1200rmb), much lower than the fee charged by global peers. Still, the company historically earned a very respectable 30% EBIT margin before 2020, and FCF has been fairly similar to net income.

V-shaped Recovery: Travelsky was hit hard by Covid for obvious reasons, as the AIT segment saw revenue plummet from 4.5B rmb in 2019 to 1.5B in 2022. Still, the company is able to stay marginally profitable through the downturn, while its customers incurred heavy losses and only avoided bankruptcies with government help. The company did have to offer some subsidy and discounts and offered working capital relief (account receivable went up in 2022 despite down revenue), but credit impairment was manageable (59m rmb in 2022), a testament of customers being SOEs with essentially unlimited line of credit. The key development is the 180 degree pivot of the government away from Zero Covid. After the major outbreak essentially generating herd immunity in a span of two months, the country sprang back to life after the Chinese New Year. Airports and rail stations have become packed again, first driven by pent-up business travel needs, and now increasingly leisure travel. China will experience the first national long weekend post Covid around May 1st, and social media is already buzzing with all the sold out tourist spots and sky high hotel and flight tickets. Sales of big ticket items like houses and cars remain tepid, but people are not shy about shelling out for travel. As I am typing this write-up, Travelsky just released its monthly data through March. Numbers are fairly self explanatory.

It is worth pointing out that international flights recovery has badly lagged domestic flights. But this boils down to supply rather than supply (just look at the latest quarterly results of test prep segment from EDU as a gauge of demand). In particular, China and US are engaged in a pissing match negotiating the number of commercial flights (still down 90% from 2019). Most Chinese nationals have also seen their passports/visas expire over the last three years, and there is a major backlog in issuing new ones. But these bottlenecks should resolve themselves as the year goes on, and it is widely expected that the industry should approach 2019 run-rate exiting 2023, and 2024 and 2025 should both be bumper years for both outbound and inbound travel (tourists, Chinese expats visiting relatives, etc). As noted previously, Travelsky is super levered to international tickets with ASP over 26 RMB vs. 5RMB domestically. Given how much ticket prices have risen over the last few years, I wouldn’t be surprised to see Travelsky get even a higher fee per ticket.

Current sell-side models have Travelsky hit 10B RMB revenue in 2024 @ 25-27% op margin, vs. prior peak revenue of 8B in 2019 and op margin over 30% in 2018 and 2019. Given how long and depressed the down cycle was, I think it is likely that the recovery would be both stronger and longer, leading to double digit growth in ’25 and beyond. 9x ’24 EV/EBIT feels on the low side.

The elephant in the room is corporate governance. I have followed the company on and off since Nails wrote this up in 2018, and have met mgmt. several times. I have no illusion about the company suddenly finding religion on capital allocation, in addition to the various vanity projects (some at the request of their customers). However, I do believe we could see some improvement on that front, as the governing body of SOEs (SASAC) has changed KPIs on how these SOEs get measured, including total shareholder return and ROE. There are more and more examples of SOEs across industries boosting shareholder returns, with the best examples being China Mobile, China Telelcom and CNOOC, raising their dividend payout to 70%+. For Travelsky, boosting ROE could be easily achieved via more aggressive dividends and buybacks. During a recent roadshow meeting, mgmt. hinted that they are implementing a new share incentive scheme, which could include boosting dividend payout ratio beyond 40%.

Catalyst

1. continued recovery in domestic and international flights

2. New employee share incentive plan, higher dividend.