This Priceline Downgrade Makes No Sense: Here Is Why

By Markets Fool.com

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Source: Priceline

Priceline stock is down by more than 23% from its highs of the year, mostly due to concerns over currency headwinds and rising competitive pressure. Adding to the negativity, Priceline was downgraded by brokerage firm Stifel Nicolaus last week.

However, while Priceline is facing considerable headwinds in 2015, pessimism seems to be overextended, and the recent downgrade doesn't make much sense from the perspective of long-term investors.

A hard landing for Priceline?
Stifel Nicolaus downgraded Priceline from buy to hold last Thursday. The decision was based on a combination of three factors: The depreciation of the Euro is hurting the company's revenues and profits coming from Europe, rising marketing expenses are having a negative impact on profit margins, and competitive pressure is on the rise.

According to Benzinga, the research report said:

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We are downgrading Priceline shares from a Buy to a Hold with a $1,160 fair value. While we continue to favor Priceline's leading industry position, long-term prospects, and strong organic execution, we believe that three key headwinds reduce the attractiveness of shares on a risk-to-reward basis: (1) FX negatively impacting 2015 results, (2) marketing deleveraging as a percent of gross profit, contracting margins, and (3) increasing competition limiting global market share gains. The online travel market continues to benefit from secular tailwinds such as mobile adoption, but we believe that shifts in the competitive landscape and macro headwinds warrant a moderate 2015 outlook.

No big news
The depreciation of the euro and general economic weakness in the eurozone could create a considerable drag on Priceline's performance during 2015. Management was quite straightforward about this in the last conference call, and the company's guidance for the December quarter seems to be clearly incorporating this risk.

Management expects revenue growth to be in the range of 11% to 18% during the December quarter, a material deceleration versus a 25% jump in sales for the quarter ended in September. Priceline tends to under-promise and over-deliver, so there is a good chance that actual sales numbers will be above guidance. In any case, currency headwinds can hardly be considered a major novelty for investors in Priceline stock at this stage.

Marketing expenses are rising faster than sales, which is having a negative impact on profit margins. Including online advertising, offline advertising, and sales and marketing expenses, the total year-over-year increase was over 34% during the last quarter.

However, it's important to keep in mind that Priceline is still an extraordinarily profitable business. Profit margins vary substantially from quarter to quarter, but on an annual basis operating margin is approximately 37% of sales and 41% of gross profit. Even if marketing expenditures may weigh on margins in the middle term, the big picture when it comes to profitability is still remarkably healthy.

Priceline's closest competitor is Expedia , which owns a leading position in the U.S market. Approximately 58% of Expedia's $13.5 billion in gross bookings during the third quarter came from the U.S. Priceline produced a similar $13.8 billion in gross bookings in quarter, but more than 87% of those bookings came from international markets.

Priceline's international gross bookings increased 31.6% during the last quarter, outperforming Expedia and its 22% increase in international gross bookings. Priceline is not only the global market leader in the industry, the company is also outgrowing its main competitor.

Bigger players such as Amazon and Google are making inroads in the online travel business, and this is a relevant risk to watch. However, selling Priceline at this stage because of this possible future threat is at least a premature decision.

Short-term uncertainty creates long-term opportunity
Priceline is in fact entering a particularly uncertain period, but the uncertainties surrounding the company seem to be reflected on valuation to a considerable degree. Priceline trades at a forward P/E ratio around 17 times earnings forecasts for 2015, roughly in line with the S&P 500 Index. Considering Priceline's long term growth prospects and superior profitability, the company should arguably trade at a premium vs. the overall index.

From a historical point of view, Priceline looks quite cheap in terms of different valuation ratios, such as P/E, price to free cash flow, and enterprise value to EBITDA.

PCLN PE Ratio (TTM) Chart

PCLN P/E Ratio (TTM) data by YCharts

While the company is facing considerable risks in the coming quarters, the long-term growth story remains intact, and current valuation looks quite attractive. If anything, the decline in Priceline stock looks like a buying opportunity for long-term investors.

The article This Priceline Downgrade Makes No Sense: Here Is Why originally appeared on Fool.com.

Andrs Cardenal owns shares of Amazon.com, Google (A shares), Google (C shares), and Priceline Group. The Motley Fool recommends Amazon.com, Google (A shares), Google (C shares), and Priceline Group. The Motley Fool owns shares of Amazon.com, Google (A shares), Google (C shares), and Priceline Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.