On The Beach - why its shares are ready for take off

Investment Case

• As an online travel agent, On The Beach (OTB) was hit hard by covid-19 but has fully recovered and is growing at a double-digit rate  
• The company acts as an agent - so it does not have any inventory risk from unsold holidays. It is also capital-light - it does not own capex-hungry hotels or aircraft 
• OTB offers increasing returns to scale as an online business and is inherently cash generative
• The stock has been significantly de-rated. It sells on a prospective 8.5x p/e (Sep ‘25), compared to a p/e multiple of 15-20x prior to the pandemic. With c.15% EPS growth this gives an attractive PEG ratio of 0.6x
• Dividends have been restored and forecast Sep ’25 net cash of £100m is 40% of the market cap

The business

On the Beach (OTB) is a leading online travel agent focused on dynamically packaged holidays. The traditional package holiday business model involves the tour operator leasing planes and owning hotels or contracting to take rooms in them. It will then sell air-and-hotel inclusive holidays to customers either directly or through travel agents. Customer choice is limited by the tour operator’s flight times and hotel combinations, while the tour company carries the risk of unsold inventory - an empty seat or hotel room is a cost that can not be recovered. 

In contrast OTB’s online platform allows a holidaymaker to select a hotel and choose a suitable departure airport served by a low-cost airline. Extras like transfers and insurance can be added, with the customer assembling their own bespoke package holiday. OTB passes through the cost of the flight and makes most of its revenue from the commission paid on the hotel booking. In the early days of the business the company used hotel ‘room bank’ intermediaries to secure accommodation, but now 91% of bookings are in rooms where OTB has directly contracted with the hotel to maximise its commission rate.

OTB has built a 22% market share in its core value segment of 3* short-haul beach holidays. This is a 5m passenger market worth £2bn, implying an average value of £400 per passenger. Out of this total transaction value OTB will earn a revenue margin (its ‘take rate’) of ca 10% or £40. A strategic objective of management has been to extend the offer beyond the value segment into premium and long-haul holidays. Premium stays are in mainstream 5* hotels with an average value of £1,000 per person per booking. This is a similar size market to the 3* segment by passenger volume, therefore its value is 2.5x larger. OTB’s share in premium is only 5%; so, the opportunity is clear with each extra premium holidaymaker bringing £100 of incremental revenue.

The other big growth opportunity is in long-haul holidays. This is a significant market segment of 3m passengers per annum with OTB currently having a mere 2% share. The main destinations currently served are Dubai, Mexico, and Dominica, with new routes such as the USA, Thailand, and the Maldives being added. Given the higher value of long-haul flights (passed through to the customer at cost), the percentage take-rate will be lower, but the cash contribution should be higher per booking than in the value segment. 

Marketing is a major expense for online businesses, with OTB investing ca 40% of its revenue. This is split between brand awareness advertising and customer acquisition. A key strategy in brand building and product differentiation has been the offering of ‘perks.’ Adding valuable benefits like free airport lounge access, fast track security and e-sims, differentiates the product by adding value and improving the quality of the experience. The trick is to ensure the perceived value is higher than the cost of providing it, which is where OTB’s buying power of airport lounge passes comes into play. Management sees perks as a long-term investment in the brand, but their introduction also saw a boost in volumes as well as revenue per booking. Perks should increase customer loyalty and make the purchase decision less price driven.    

Supply of flight seats is an important variable outside the company’s control. So, the recent accord reached with Ryanair is a significant positive - probably more significant than the stock market realises if the enthusiasm expressed by management (‘a brilliant outcome’) when we spoke is anything to go by. Ryanair has a ca 50% share of the available seats to OTB’s destinations, and the previous awkward relationship meant a lot of investment and complexity on behalf of OTB to keep this supply of seats on its platform and maintain a positive customer experience. The agreement will see smooth integration between the two booking platforms and remove what management had seen as a risk to its growth prospects.

The acquisition of Classic Collection Holidays (CCH) in 2018 saw the company enter the ‘offline’ B2B sector which is estimated to consist of 4m annual passengers. OTB had been a pure online B2C business, while CCH provides high street travel agents with premium holidays. It reports revenue as principal rather than agent due to the nature of its contracts, though management confirmed to us that it has minimal inventory or guaranteed volume risk. Classic Package Holidays was launched in 2019, allowing travel agents to offer dynamically packaged holidays. 

The CCH deal opened up a new sales channel but has been slower to recover post covid-19, with the B2B segment seeing increased competition. Action has been taken to simplify the business, cutting costs by ensuring it is more closely integrated with the group. The division will also move to agent rather than principal accounting (see Finances section below). 

Finances 

OTB’s financial trends were upset by covid-19 travel restrictions which saw revenue collapse from £140m in FY '19 to £21m in FY ‘21. Two share placings in 2020 and 2021 raised a total of £92m, ensuring the company emerged from this period in good shape. Revenue is forecast to be 35% above pre-pandemic levels this year and EPS should be 11% ahead, despite the dilution.

Margin trends have been muddied by the CCH acquisition reporting as a principal. CCH books the total transaction value as revenue rather than the commission income that the rest of the group reports. So, in FY '23 CCH added £58m to the top line but post the accounting change this will drop to ca £5m which the unit should contribute to commission from its travel agent customers. 

Prior to this deal in 2018, OTB reported an ebitda margin of 37% for FY ‘17; last year’s margin of 18% reflects the inflated CCH revenue (and the fact that CCH lost £1m). The change in accounting treatment suggests FY ‘24 revenue will be ca £140m on an agency basis (consensus on the old basis is £190m), implying a margin of 30%. There have been a few adverse changes weighing on the margin: credit card fees (companies are no longer allowed to charge for credit card bookings), compliance costs, and the lower percentage margin of premium holidays. However, action on costs at CCH and growth in the business suggests plenty of scope to see margins move in the right direction in future.      

The company is naturally cash generative. There is capex spend of around £12m on the platform. The largest cost item is marketing with £40.6m spent last year - while this is not a fixed cost, it is necessary to maintain the brand and acquire customers so there is limited discretion. However, there ought to be operational gearing from leveraging the overhead base and the brand element of marketing spend. 

OTB sees a cash outflow in the first half of the year. Marketing spend is incurred in the winter and spring booking season for holidays taken later in the year. Similarly, OTB pays airlines for the flight element but only takes a £30 deposit at the booking stage. Customer monies sit in a ring-fenced trust account. 

There is an RCF facility of £85m to cover this seasonal outflow and £55m was drawn at March, which is the low point of the cycle. By the September year end net cash is expected to stand at £90m, rising to £100m in FY ‘25 and £130m in FY ‘26. Dividend payments were restored with the recent interims and management indicates a 25% payout ratio (suggesting broker forecasts are conservative). Material M&A seems unlikely, and the board is aware of the need to return surplus cash to shareholders. However, a reasonable cash buffer is prudent given the seasonal working capital flows; so, we await more clarity on what constitutes ‘surplus cash’ - suffice to say the growing cash position looks anomalous in the context of the market cap. 

Management

OTB was founded in 2004 by Simon Cooper who retains a 7.5% stake. He has been a buyer of the stock over the last couple of years with his largest purchase of 2.8m shares at 88p last August marking the low. Cooper stepped down from the CEO role to become a non-exec in June 2023 with Shaun Morton (42) moving up from the CFO position. He was replaced as CFO by Jon Wormald (46) who joined from The Hut Group. The board is chaired by the experienced Richard Pennycook who was chair of Howden Joinery and of The Hut Group, as well as CEO of the Co-Op during 2013-17. Institutional holders include Fidelity (7%), Liontrust (6%) and Lombard Odier (5%).

Valuation and Outlook

While the industry is economically sensitive, almost everyone regards an overseas holiday as a necessity and something they are very reluctant to go without. Forecasts have the industry growing 5-8% pa by volume which is supported by airline seat growth and ATOL licences. Management believes industry competition is rational currently, with plenty of growth to go around. The May interim statement said that OTB was growing ahead of the 7% market rate with premium doing particularly well, up 41% by transaction value. ‘Trading momentum has continued since the half year date.’ [RNS 14 May] 

The shares spiked up to 168p on this upbeat statement, back to the 2024 high. However, they fell back almost as quickly and today trade below the levels which prevailed prior to February’s announcement of the Ryanair accord. Broker forecasts have been stable, and it is hard to see why the shares, which trade just above their 200-day moving average of 136p, have remained unloved. The valuation looks compelling for a capital-light, cash generative business growing EPS at 15%, and which also has a large and growing chunk of its market cap represented by cash. A return to the mid-teens multiple enjoyed pre covid-19, justified by the growth rate and business model, would see the shares double.  

Ticker: OTB

Sector: Leisure

Mid-price: 142p

Spread: 141.6p - 142.4p

12 months high/low: 178p / 83p

Market cap: £242m

Notes: We interviewed CEO Shaun Morton and CFO Jon Wormald on 7/6/24. The writer owns shares in On the Beach.