A company hitting or missing its earnings targets can result in wild swings in its share price. That's why an increased number of ASX-listed companies have moved away from providing guidance around expected half year or full year earnings numbers at the preceding results announcement.
This is arguably smart strategy, as it frees management from being tempted to artificially boost interim numbers while also insulating investors from unexpected lurches in the share price.
However, Flight Centre Travel Group (ASX: FLT) is one company that still provides the market with guidance about its upcoming earnings. Based on a range of factors, it seems that the company may miss those numbers. Here's why.
The current target
At the recent half year results, Flight Centre management announced to the market that they expected Australia's largest physical travel agent to record underlying profit growth of between 4% – 8%. Based on last year's numbers, that would translate to a profit of between $380 million and $395 million.
However, there are signs that management might be trying to prepare the market for a slightly weaker-than-expected result. As recently as the beginning of this month the company has stated that meeting its stated forecast would "not be a formality" in a company presentation given to the market. It also stated that much would depend on the cyclical upswing in travel spending that normally occurs mid-year.
The headwinds
The concern for investors is the general principle that forecasts become more accurate as they draw closer to the date that they will be verified, as information quality increases and the expected range of the variables decreases.
The cautious language and use of qualifiers points in one direction, and that direction is not outperformance.
In addition, the Federal election campaign could cause a delay in travel bookings as businesses and consumers defer decisions in the face of uncertainty.
Canaries in the coal mine?
The evidence is also mounting that the more profitable international travel market is weakening to consistently lower levels. For example, if you visited the United States or the United Kingdom three years ago (when Flight Centre shares were regularly beating their all time highs) then you would have paid 25% – 35% more in airfares than today.
The company hopes that increased competition on price by the airlines will stimulate travel demand to international destinations, which will offset lower commissions. However, travel is relatively price inelastic, meaning that lower prices don't have as much of a stimulatory effect as other industries.
In addition, many Australians took the opportunity to go to these "once in a decade" travel destinations in recent years when the Aussie dollar was much stronger, and therefore are less likely to repeat the trip so soon, especially when their purchasing power is much lower than it was previously.
Foolish takeaway
Flight Centre remains an attractive business with a dominant national brand, however, the risks to the stated earnings numbers seem higher than the potential rewards at the current share price.
Investors who have been looking at adding Flight Centre to their portfolio at cheaper prices may get the chance to do so soon if the share price overreacts on the downside after any earnings disappointment.
