Prepare for take-off with this travel agent

Online holiday retailer On the Beach (OTB) is benefiting from this demand environment. Ahead of its annual results in early December, the company has disclosed that summer holiday volumes were up 13 per cent year on year. This drove total transaction value to a record £1.2bn for the year to September (the metric surpassed the £1bn milestone for the first time in 2023). The group is on track to hit its adjusted pre-tax profit forecast of £31mn, therefore, up 44 per cent on last year. 

Looking ahead, winter volumes are currently a third higher than last year, and the company flagged "very encouraging" bookings for next summer too.

However, profits and margins haven't yet recovered to their pre-pandemic levels, which is one reason why the stock has underperformed the FTSE All-Share index year to date after a strong run. Concerns about seat capacity and competition have also put some investors off.

As On the Beach eyes up a greater share of the lucrative premium and long-haul holiday market, however, these worries may fall by the wayside. 

An asset-light operating model

On the Beach has historically focused on cheap, short-haul beach holidays, jetting customers off to popular hotspots around the Mediterranean. Indeed, it has a 20 per cent share of this online market. However, it now offers long-haul options too, including the US, Mexico and the United Arab Emirates.  

Its consumer division is key, contributing 70 per cent of total revenue and pretty much the entirety of gross profit in the latest half-year results. Here, the company acts as an agent and sells package holidays online, receiving a commission.

The smaller business-to-business division, which now trades under the Classic Collection brand, was loss-making in the half-year results, but management expects performance to improve as operating changes take effect after a strategic review. In this segment, holidays are sold to high-street travel agencies for a commission.

Profits are approaching pre-pandemic levels; if the company delivers earnings in line with expectations this year they will be 10 per cent below the 2019 benchmark. But they are being held back by marketing costs, as the company fights against package holiday competitors such as Jet2 (JET2) and EasyJet (EZJ).

Online and offline marketing is On the Beach’s key outgoing, sitting at over £40mn last year. However, overheads such as contact centre wages and IT expenditure have also been rising fast. Annual overheads at the central On the Beach division were around 30 per cent of revenue in 2022 and 2023, whereas they represented under 20 per cent of sales before the pandemic.

After significant investment, however, operating leverage benefits are now flowing through. Overheads equated to 31.7 per cent of revenue in the latest half, compared with 32.4 per cent the year before. Marketing costs as a percentage of revenue also came down from 53 per cent to 48 per cent.

There are other reasons to feel optimistic too. The company has an asset-light business model, given it owns no airlines or hotels and its supply comes from direct and third-party relationships. Last year, 91 per cent of hotel sales were directly contracted. 

This model has its attractions. There is no outstanding debt on the balance sheet, with working capital requirements funded through cash (as of last month, the cash balance sat at around £95mn) and a revolving credit facility. The combination of a strong balance sheet and improved trading supported the payment of a dividend in June for the first time since 2019, and management plans to recommend a final dividend alongside the full-year results in December. 

Berenberg analyst Benjamin Sandland-Taylor said "the lack of inventory risk insulates the company from downturns". However, he warned that it could result in a lack of supply. 

Some good news on flight supply emerged in February, when the company confirmed that it had signed a long-term distribution agreement with Ryanair (IE:RYA) that gives it "free and fair access" to the airline's seat supply. This ended long-running legal strife between the two parties and removed a key risk hanging over the shares. 

The premium opportunity 

As the deal with Ryanair suggests, On the Beach will continue to invest in short-haul beach holidays. However, key to its future prospects are the premium (typically 5-star) and long-haul markets. Together, it forecasts a total addressable market of 17mn passengers every year, but its presence at the pricier end of the spectrum remains fairly small.

The growth opportunity could be huge. If it can tap into this market, as management put it, "the revenue margin opportunity on each individual [premium] booking is significantly greater" in a market that is 2.5 times bigger in price-tag terms than its three-star counterpart. Average booking value per person is around £400 in the budget holiday market, compared with £1,000 in premium.

The group is already making good progress. In the latest half-year, the total value of five-star holidays booked by consumers jumped by 41 per cent. Meanwhile, the premium holiday mix improved from 30 per cent to 34 per cent of group transaction value. Upselling customers to premium packages with the promise of access to airport lounges could also prove lucrative. 

Analysts at Shore Capital think that if the company can replicate its short-haul success, then it could "more than double its revenue base and potentially Ebitda". 

Investors' prior interest in the company has dwindled recently. The shares have risen by almost 60 per cent over the past year, but have fallen by a tenth since January. This has left the valuation at nine times forward consensus earnings compared with a five-year average of 19.2.

Given the opportunity posed by wealthier holidaymakers and the favourable outlook for consumer spending on travel generally, the rating is attractive. City analysts have a mean target price of around 230p, which suggests that there could be some nice gains for investors who buy in at the current price.