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Ctrip.com Stock Upgraded: What You Need to Know

Rich Smith, The Motley Fool

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Fear of China shook the stock market yesterday -- or more precisely, fear that Chinese recalcitrance on trade talks would spark a new wave of tariffs on Chinese goods by the Trump White House...which would in turn derail trade negotiations between the U.S. and China entirely.

Now, you might expect investor worries like these to be bad news for Ctrip.com (NASDAQ: CTRP), the Chinese online travel reservation company -- and you'd be right. Ctrip shares sank 5% in Monday trading, and are down a further 3% already today. Those losses suffered by current shareholders, however, may perversely provide new investors a chance to buy Ctrip stock at a nice price.

At least, according to analysts at Mizuho, they might. Here's what you need to know.

Hands counting Chinese yuan notes

Image source: Getty Images.

A stock rightly priced

Flat over the last 52 weeks against a 10% rise for the S&P 500, Ctrip shares actually look almost exactly rightly priced today. Ctrip carries a $23.2 billion market capitalization, according to data from S&P Global Market Intelligence, and up until yesterday, Mizuho Securities expected Ctrip to grow earnings before interest, taxes, depreciation, and amortization at about 23% annually over the next five years (a prediction right in line with Wall Street's consensus expectation for 23.9% growth).

At that price, and that growth rate, you'd ordinarily want to see Ctrip generating about $1 billion a year in free cash flow -- and indeed, S&P Global data shows that in 2018, the company generated about $936 million (and $1.006 billion in 2017).

Ctrip the light fantastic

But here's the thing: According to Mizuho's latest report, which came out just last night, Mizuho no longer expects Ctrip to grow EBITDA at 23%. It thinks EBITDA will grow at 35% instead!

StreetInsider.com (subscription required) has the details. On Monday, while everyone else was selling Ctrip, Mizuho put out a report citing "declining domestic competition and rising outbound outlook" as supportive of the company's business.

China's macro economy is "improving," and the Chinese yuan is "appreciating" in value, says Mizuho, both factors that could lead to greater recreational travel both within the country and without. Based on this analysis, Mizuho is raising its "3-year EBITDA" compound annual growth rate estimate for the company "from 23% to 35%." In the medium term, it's also raising its 2021 EBITDA prediction for the travel specialist's earnings by 10%, predicting Ctrip will report 13.1 billion yuan two years from now.

What it means to investors

Now, I admit that I don't spend a lot of time thinking about EBITDA myself. The "before interest, taxes, depreciation, and amortization" bits have always felt like too many caveats to place on a company's actual earnings to suit my taste. What I do place faith in, though, is the actual cash profits that a business produces -- the free cash flow. And I have to say that when viewed from the perspective of FCF, Mizuho's argument makes a lot of sense to me.

If the appropriate price for Ctrip is 23 times $1 billion-ish in free cash flow when Ctrip is growing at 23% a year, then the appropriate price for a Ctrip growing at 35% should be at least 50% higher. For its part, Mizuho estimates that a faster growth rate should make Ctrip worth $55 a share, or more than 50% above its previous price target of $35.

From where I sit, therefore, investors' decision to sell off Ctrip stock today, despite Mizuho's bullish argument in its favor, is a mistake. If the yuan is strengthening, the Chinese economy growing, and Ctrip can grow EBITDA at 35%, then Mizuho is clearly right -- and Ctrip stock is a buy.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Ctrip.com International. The Motley Fool has a disclosure policy.