The Travel Stock I Left Behind

02/04/2011 4:04 pm EST


Jim Jubak

Founder and Editor,

I dropped International (Nasdaq: CTRP) from the Jubak Picks 50 long-term portfolio on January 18, but this the first time I’ve had the chance to explain why in detail or to actually remove it from the portfolio. I’ll be working on explaining other sells and buys from that group over the next week or so as well.

What worries me about International in the long-term? Growth.

Oh, not the top-line growth of revenue. That continues to hum along. In the third quarter of 2010, reported on November 2,, the largest travel agent in China, reported total revenue of $129 million, a 48% increase from the third quarter of 2009.

No, it’s the growth in costs that troubles me, because it makes me wonder if Ctrip’s operating margins—which ran at a 38% level for the third quarter—are sustainable in the long term.

In the third quarter, product development expenses climbed by 53% from the third quarter of 2009. Sales and marketing expenses rose by 33%. General and administration expenses increased by 69%.

What’s behind those increased costs? Part of the growth is perfectly normal and in fact what an investor would like to see. As a company’s business grows, it needs to add more sales and administration personnel.

But there are signs in these cost numbers that is having to spend more money and work harder for its revenue growth.

For example, most of the time you’d like to see general and administration expenses growing by less than total revenue. If this cost is growing faster than revenue—as it did for in the third quarter (revenue growth 48% but general and administration expenses 69%)—an investor needs to ask if the company is going after more labor-intensive sources of revenue to keep growth going, or if it has lost control of compensation.

To take another example, most of the time an investor isn’t terribly concerned if the company is spending more on research and product development. Money spent in those areas today will turn into revenue and profits tomorrow, investors hope.

But a 53% increase in product development expenses is a big enough jump to lead to questions. Is spending so much more to roll out new products because competitors are nipping at its heels? And is that also connected to the jump in general and administration and sales and marketing expenses?

There’s some evidence that rising costs are related to rising competition from other Internet-based travel services and from travel companies themselves. E-commerce sites such as and Qunar—plus long-time rival Elong, a unit of Expedia (Nasdaq: EXPE)—are all going hard after the fast-growing market for travel inside China and to overseas destinations.

But the bigger competitive threat in the long term may be from airlines and hotel companies that are looking to either cut the commissions they pay (and others) to sell their products or who are moving into online sales themselves. Direct sales by airlines account for only 10% of total ticket bookings in China right now. That’s certain to grow as airlines add their own Internet sales sites. Hotel companies are engaged in the same process.

None of that will put out of business. The company has developed solid loyalty among the business travelers that make up the majority of its customer base.

But I do expect these competitive trends to continue to raise costs at and to gradually bring down the current 38% operating margin. I think it will be a while before sees operating margins shrink to the 20% level at Expedia, for example, but then Expedia (P/E ratio of 15.7) doesn’t trade at’s multiple of 45 times trailing 12-month earnings per share.

All in all, this adds up to a stock with too much uncertainty to go in my Jubak Picks 50 long-term portfolio. Which is why I dropped it from the portfolio on my annual update of that group on January 18.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. The fund did not own shares of or Expedia or any other stock mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of December, see the fund’s portfolio here.

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