Don't Get Carried Away By Expedia Earnings!

Earlier today, shares of Expedia shot up more than 18% on news that it exceeded analyst expectations for its third fiscal quarter ending in September. Analysts had expected the company to report earnings per share of $1.35, an increase of 11.6% from the $1.21 per share it reported in the same quarter a year ago.

On top of performing well on an earnings per share basis, Expedia also saw its revenue increase at a nice clip. For the quarter, the company saw its revenue come in at $1.4 billion, a 16.8% increase from the $1.2 billion the company reported in the same quarter last year. The underlying cause for the company's significant revenue growth can be chalked up to two factors; a rise in room night growth and a higher amount of gross bookings.

Attractive metrics driving growth
For the quarter, the company saw its number of room nights grow by 20.2% from 36.7 million to 44.1 million. Even more impressive is the growth seen when comparing it to the company's third fiscal quarter of 2011. Over this time horizon, the company saw its room nights grow from 28.9 million to 44.1 million, an aggregate increase of 52.6%.

In addition to experiencing an explosion in the number of room nights, the company has also seen a similar (albeit, less impressive) growth in its number of gross bookings. During its third fiscal quarter, gross bookings increased by 15.2% from $9.06 billion to about $10.44 billion. While Expedia's domestic gross bookings rose by 13.1% from $5.16 billion to $5.83 billion, its international bookings grew even faster, rising by 18.1% from $3.9 billion in the same quarter last year to $4.61 billion this year.

Not everything's as pretty as you might think
Certainly, this is good news for shareholders and management alike, as it demonstrates the company's ability to grow both in terms of top line results and in terms of profitability seen by shareholders. However, before you get terribly excited about the company's results, I highly encourage you to look at everything in a bit more detail, as the rest of the company's metrics are somewhat lackluster.

This is primarily illustrated by analyzing the company's net income year-over-year. For the most recent fiscal quarter, management reported that net income attributable to Expedia common shareholders actually declined by 0.4% from $171.48 million to $170.86 million. Now, admittedly, if you remove the company's $1.5 million that was booked as a gain from discontinued operations in the third quarter of last year, you actually see that net income rose by 0.5%, a number that is, nevertheless, disappointing.

For the company's three fiscal quarters of this year compared to the same period a year ago, the results are even worse. Net income over this time horizon decreased by 49.5% from $273.4 million to $138.1 million. Even after you remove the company's expenses relating to acquisitions and other related items, you arrive at net income of $183.3 million (net of tax adjustments), or a decline of 33%, with the largest remaining decrease relating to the company's legal reserve and occupancy taxes increasing by 1,287% to $74.7 million.

In addition to irregular charges, the company also saw its margins decline significantly as a result of its selling and marketing expenses increasing from 42.2% of sales in the same quarter a year ago to 44.6% of sales for its most recent quarter. Although this may signal that the company is effectively utilizing its resources now for the sake of bringing in revenue in the future, the Foolish investor would be wise to keep an eye on this metric as a continued increase as a percentage of sales may signify cost containment issues.

Expedia still falls short
Aside from the problems listed above, there is something else to take into consideration here; Expedia's competitors. Perhaps the most important competitor to Expedia today is , a company who, over its past four fiscal years, has increased its revenue by 125%, while Expedia has seen its revenue grow by a more modest 36.4%.

In another article on Expedia, I discuss in more detail the disparity between the two companies. However, the greatest single description of their difference in strength can be summed up in one table:

(table made by author with data from MSN Money)

In the table above, I looked at the net profit margin of both Expedia and over a four-year period to see how each has changed. What we see is rather intriguing. As has grown significantly, it has rapidly gained significant market power. This, in turn, has allowed the company to achieve economies of scale, effectively resulting in a higher (and still rising) net profit margin (though, as a note of caution, the Year-to-Date category for each may not be comparable as has only reported two quarters compared to the three quarters of Expedia).

In juxtaposition, Expedia has seen the exact opposite happening. As time has progressed, market pressure imposed on it by competitors like has caused the company to grow slower and to compete on price as a price taker, not a price maker. Long-term, this could mean that the Expedia value proposition could disappear entirely as it is pushed into a situation whereby it may have to accept net losses as opposed to razor-thin gains. Such a predicament spread out over a large timeframe typically only leads to one result, and it's not pretty for shareholders or management.

Foolish takeaway
As we can see by this analysis, Expedia did report blowout earnings and revenue growth. However, the Foolish investor shouldn't get carried away and immediately conclude that the company's prospects are bright. Rather, the exact opposite may be true.

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Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of 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.

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