Description

Cendant Corporation is heavily associated with travel through many of its operations, but it may be the ‘baby tossed out with the bathwater’! Cendant operates in 4 segments: Hospitality: hotels and time shares; Real Estate Services: brokerage, mortgages and employee relocation services; Vehicle Services: car rentals, fleet management and parking facilities; and Financial Services, involved in insurance and financial products to consumers and has the number two tax prep service.

It is a balanced operation in that some of these businesses do well in good economic times, while others thrive in the low interest environment of poorer economies. It is also important to understand that many of these are franchise, as opposed to company owned operations. Thus, fixed costs for Cendant are far less a problem than a pure operating company. Well-known brands include Days Inn, Ramada, Super 8, Howard Johnson, Travelodge, Century 21, Coldwell Banker, ERA, Avis, and Jackson-Hewitt.

Cross marketing between the various segments is utilized to a high degree. Someone booking a hotel can be transferred to Avis to arrange a car for example. Cendant has been acquiring additional complementary businesses. Buyouts of Fairfield Resorts and Avis were closed in the first half. The acquisition of Galileo International, a global travel services distributor like Sabre, closed 10/1 at a sharply reduced cost, and Cheap Tickets, a distributor of discounted travel products, will be added to the fold later in October. Both are expected to be accretive to earnings, although at lower levels.

The balance sheet is in good shape. Debt is .85 of equity at 6/30. There is a liability of $2.85B for a litigation settlement related to accounting irregularities at the former CUC International pre-1998. That will likely be funded out of cash, credit facilities and debt next May. Strong cash flow from operations (nearly 2.5B or $2.92/share in the twelve months ending 6/30), makes this manageable. Cash on 9/30 will be $2.8B. From this, $550M will go to debt reduction by year end, and $630M will fund the two acquisitions this month. There will also be some nonrecurring costs related to the 9/11 event. Cendant will maintain its investment grade credit rating; thus there will be no share buybacks.

This cash generating capacity accompanies a strong earnings growth vehicle. Even in the face of a weakening economy, CD revised earnings upward in August. Since 9/11, those estimates have become obsolete, but in a conference call 9/28, management reduced 3rd quarter adjusted earnings expectations down a penny to 32 cents/share. In the 4th quarter, the adjusted earnings are expected to be .15-.19/share, down from a previously forecast .24/share. (Adjusted earnings are before nonrecurring items and the cumulative effect of an accounting change.)

Year 2000 adjusted income was .90/share on 735.7M shares at the end of the year. For the six months through 6/30 adjusted income was $519M. Based on 857M shares on 9/30, adjusted income will be $274M for the third quarter. CD issued 116M shares for the purchase of Galileo. 15 cents on 973M shares implies adjusted income of $146M. So, for the year adjusted income will be $939M on year end shares of 973M, or .97/share versus the pre 9/11 expectation of 1.08. From this reduced base, the company expects adjusted earnings to increase 15-25% in 2002, or to 1.11 to 1.21. The rebound is dependent on business and consumer spending and travel volumes. But management has experience from the Gulf War downturn so there is a rational basis to this new guidance. The stock rose nearly 12% on this ‘not as bad as expected’ news on 9/28.

Even with the Friday jump, the stock is off about 30% from its early September levels. Yet year over year adjusted income growth remains at 8% on reduced expectations with a much better rate next year. As investor confidence returns next year, pricing of these adjusted earnings may return to mid 2000 multiples of around 18.5. That suggests a 12 month price target of $21 for a 66% return on Monday’s close of $12.67. Given the market’s heavy discount, that is a decent return relative to further downside risk.

Catalyst

No near term catalyst is at hand; this is an investment waiting for the market to become more selective in which travel businesses it heavily discounts. In Cendant’s case, this discount does not reflect actual or expected results. While air travel may be down 20% in 2002, the market is not accounting for CD’s ability to manage its costs to expected volumes and it has applied a blanket discount to all of CD’s businesses. The hotels are oriented to the automotive traveler versus the premium business traveler for example. These hotels had a less than 10% downturn as a result of the Gulf War. Avis bookings declines are at 23% now compared to 35% in the week following 9/11. A fraction of the downturn is normal post Labor Day trends, and recovery from the initial 9/11 effect has already begun. Eventually the market will recognize the ongoing earnings power here and reprice accordingly. Buy on any near term weakness.