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Should you pile into this Neil Woodford growth pick?

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Hostel-focused online booking platform provider Hostelworld Group (LSE: HSW) delivered decent full-year results today. Constant currency revenue was up 10% compared to a year ago and adjusted earnings per share were 12% higher. The directors expressed their satisfaction with the year’s outcome, and their confidence in the outlook, by pushing up the total dividend 13%.

A lot to like

The firm’s shares appear in the both the Neil Woodford Equity Income fund and his Income Focus Fund. My assumption is that he picked the company for its ability to pay and grow its dividend, which is a stock picking method he publicly fleshed out some time ago. And why not? There’s a lot to like about the company including its debt-free balance sheet and a business model that generates strong free cash flow conversion.

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The enterprise generated revenue of €86.7m during 2017, 60% of which came from Europe, 21% from Oceania and 19% from the Americas. There’s no denying that Hostelworld has more than just a toehold in its focused market and the shares did well last year, rising around 64% since January 2017. But has the growth story got further to run or will other platforms eat into the firm’s lunch? Apart from specialising in a narrow sector, the company doesn’t appear, at first glance, to enjoy much of an economic moat to protect the business from other booking agencies that could easily poach traffic in the hostel sector.

An efficient business model

However, I don’t think we should underestimate how convenient it is for young travellers to go to one booking platform knowing that most hostel options will be presented in an easy-to-use format. The firm’s simple and comprehensive” online mechanism provides a shop window for hostels and other budget accommodation and an efficient way for customers to make a booking. Hostelworld pockets the deposit and that’s what makes up the firm’s revenue.

Agents of all kinds usually run efficient and profitable business models like this that simply skim off part of the turnover of a transaction between customer and end provider, and it’s a major part of their attraction. There’s no need for agents like Hostelword to get involved with the nuts and bolts of actually providing the end service, but the firm can’t add value to any transaction without providing a top-notch user experience, which demands a strong focus on technology.

Maintaining an edge

A new development centre in Porto, Portugal, aims to increase the “pace and volume”of new product features and functionality for customers and hostel providers. The company also pilot-launched a new free cancellation booking option in February, which “resulted in a noticeable increase in conversion and booking levels.” Such initiatives demonstrate how the firm is working to keep its competitive advantage in the hostel market, which is estimated to grow around 5% a year until 2020.

City analysts following the firm expect earnings to contract 4% this year and to expand by 6% during 2019. Meanwhile, at today’s share price around 371p, the forward price-to-earnings ratio for 2019 is just over 18 and the forward dividend yield sits close to 4%. I think the valuation looks fair, as long as Hostelworld keeps winning market share by remaining ‘hip and relevant’ with young travellers. So far, there’s every reason to expect it will.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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