The Hindu Business Line : Thomas Cook: Hold

Thomas Cook's inorganic growth initiatives augur well for medium-term growth; the stock's valuation, however, appears to price in most of the benefits

Four acquisitions in the current calendar
Healthy margins in financial services biz
Fund raising plans could be in the offing

Mr Udayan Bose, Chairman, Thomas Cook In

There has been a lot of buzz around the Thomas Cook (TC) stock in recent times. Since its acquisition by Dubai Financial early on this calendar, the company has been busy putting together a series of buys to strengthen its position in the financial services and the travel and tourism-related businesses. At the current price of about Rs 520, the stock trades at about 33 times its trailing four-quarter earnings per share.

Though that looks expensive, the street appears to be pricing in most of the positives that will flow from the recent acquisitions once they take full effect.

We, however, are circumspect at this juncture, as equity expansion and/or debt raising plans to fund inorganic growth may be around the corner. In our view, shareholders can retain their holdings of the stock.

Thomas Cook used to follow a November-October fiscal; from next year, the calendar year will represent its financial year. The ongoing fiscal thus would be of 14 months long (November 2005-December 2006).

The first acquisition was that of LKP Forex, a subsidiary of LKP Merchant Financing. LKP's strength in the foreign exchange business will complement TC's business in the same space, in which it is an established player.

The merger, through a share-swap route, is likely to be completed any time now. TC went on to acquire the inbound travel business of Thomas Cook Thailand for Rs 15 crore.

Earlier this month, TC announced the acquisition of Travel Corporation of India (TCI) in an all-cash transaction of about Rs 180 crore; with its entire shareholding to be bought out, the latter will become a 100-per cent subsidiary. TC is also picking up a 76-per cent stake in the visa facilitation services business of TT Enterprises for a cash consideration of Rs 17 crore.

Business impact

Clearly, all the acquisitions possess synergies with the existing operations of TC. While the LKP merger will lend greater scale to the financial services business and provide cross-sell opportunities on account of geographical reach, the TCI acquisition will give fillip to the inbound tourism business, an area in which TC does not have a significant presence.

The stake pick-up in TT Enterprises should strengthen TC's presence in a niche area.

On the business front, for the 12-month period ended October, there has been significant traction on the revenues front, which logged a 30 per cent growth at about Rs 170 crore. But a faster rise in staff costs and other expenditure led to a muted performance in operating profits. Margins on the financial services business continue to be healthy at over 50 per cent; on the travel-related services business, margins dropped a few percentage points.

While the impact of the amalgamation and the acquisitions is likely to be earnings accretive, a tighter control on costs could propel earnings significantly.

We would watch out for any expansion in TC's equity — subsequent to the LKP amalgamation — to fund its inorganic growth plans. The mode of fund raising is yet to be firmed up; TC could also raise debt, though this would be reflected in the form of higher interest costs and partially offset the synergistic benefits of the acquisitions that would flow into the bottomline.

Valuation

TC has always quoted at a rich valuation of 25 times the earnings, even in years when its earnings hit a trough on account of extraneous circumstances (as in 2002 and 2003). Though earnings did move up sharply in 2004 and plateaued subsequently, we believe the market's optimism about the company's performance, and not unjustifiably so, is what is driving the price.

Even as TC has made the right moves by stepping on the gas, it will be its delivery on the earnings front that would merit close attention. Stay invested.