Hotel Valuations Ahead of Fundamentals

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William Mack submits:

Lodging industry stocks have performed well over the past two years, with the seven names I follow up close to 30% year to date, and nearly 50% since late 2008.

This run has brought the forward EBITDA multiple, on my 2011 estimates, to about 13.5x, essentially the same as the actual EBITDA multiple to end 2007 (please see the table below). Thus, now is a good time to more closely look at the assumptions supporting more bullish forecasts, before considering my own estimates for RevPAR and EBIT margins at the end of this note.


11E 10E 09 08 07
AC.FP 9.0x 9.6x 9.4x 6.3x 8.8x
[[CHH]] 13.7x 14.6x 13.4x 11.5x 12.4x
[[H]] 11.6x 13.3x 11.6x na na
[[IHG]] 11.7x 12.7x 7.9x 6.0x 11.3x
[[MAR]] 14.8x 16.8x 13.6x 11.2x 10.7x
[[OEH]] 20.7x 22.5x 33.5x 22.0x 27.3x
[[HOT]] 13.8x 15.6x 13.2x 7.5x 11.2x
Average 13.6x 15.0x 14.7x 10.8x 13.6x

These higher valuations appear to reflect RevPAR growth in the mid- to high single digit (percentages) level recently forecast by operators including Marriott and Starwood. These estimates are supported by projections from Smith Travel Research (( STR )) and PricewaterhouseCoopers (( PWC )), which call for slower growth in hotel supply, along with occupancy and room rate increases comparable to the most recent cycle upturn, in 2004. I argue, however, that comparisons to the most recent lodging up-cycle are unjustified, since both supply and demand for rooms are unlikely to be as favorable this time around.


First, consider supply growth during the past downturn, from 2001-2003, when the US room count rose by a total of 4.3% (about 180,000 rooms), just over half the 8.0% increase (353,000) from 2007-2009. Moreover, the last recovery was spurred by room counts that actually fell slightly in the first two years of the upturn ('04-05). As we look toward the first two years of the current recovery (starting with '10), even the most muted independent forecasts expect room counts to climb. Indeed, STR anticipates a 2% increase in 2010 supply, followed by another increase in 2011.

The large chains appear to be growing at an even faster rate than the industry overall. Industry leader Marriott Int'l expects to grow net rooms by 3.5% annually to 2013. Rival Intercontinental Hotels, with more than 650,000 rooms globally, is on pace to increase this year's net room count by 2%. Even Starwood, with a focus on the high end hotels expected to benefit from the slowest segment growth, has seen little slowdown in property count, with a 4.7% increase in system-wide hotels through just the first nine months of 2010 (please see the table below).

Units (Hotels)
11E 10E 09 08 07
AC.FP 4,263 4,191 4,111 3,982 4,111
[[CHH]] 6,227 6,196 6,021 5,827 5,570
[[H]] 467 445 424 399 381
[[IHG]] 4,708 4,571 4,438 4,186 3,949
[[MAR]] 3,840 3,620 3,420 3,178 2,999
[[OEH]] 37 36 35 36 36
[[HOT]] 1,082 1,030 979 942 897
Avg chg. 2.7% 3.4% 4.7% 3.4% 3.7%

Occupancy Precedes Rate

The initial stage of the current lodging recovery has been driven almost exclusively by occupancy increases. Occupancy began its ascent toward the end of 2009, climbing steadily through the first three quarters of this year. Yet this rebound in occupancy should be seen as normalization - from a 30-year low of 55% in 2009 - rather than as a signal of firm absolute demand. Any significant increases in demand would by now have been reflected in higher average daily rates. That's partly because consolidation during the recent cycle has helped make the industry more rational - willing to trade occupancy for rate. As evidence, consider that in 2007 and 2008, ADRs rose a total of 10%, even as occupancy fell almost 5%.

As is typical in a lodging recovery, higher occupancy rates are beginning to support higher room rates. Recent indications suggest ADR comparisons began to flatten in mid-2010, and in some cases, started trending upward through Q3. Though ADR should rise further, the magnitude of increases will be limited by an industry that appears to have pushed rates too hard in the latter stages of the past cycle. Indeed, this year's expected US occupancy level of 57-58% suggests the wide, late-cycle price hikes mentioned above, coupled with relatively rapid room growth, have yet to be fully absorbed. It seems unlikely hotel operators will be able to drive pricing solidly higher with occupancy still materially below the 60% threshold that accompanied the start of the past up-cycle.

An equally important obstacle to much higher ADRs is broader economic activity and price levels that compare unfavorably to past lodging recoveries. In 2003, nominal GDP grew 4.7%, but RevPAR fell modestly, in part due to the SARS epidemic of that year. But by 2004, nominal GDP continued to surge, climbing 6.5%. Faster economic activity and inflation, aided by pent up demand from the prior year, pushed RevPAR 7.7% higher in 2004. By contrast, economists expect nominal US GDP in the year ahead to grow at about half the 2004 level, and there are few signs of unsatisfied travel demand from what remains of 2010.

More Cautious View Offered

Investors in hotel stocks should expect low- to mid single digit RevPAR growth in 2011, or at least two to three percentage points below today's forecasts. With minimal inflation in essential items, like food and housing, it's probable that prices for hotel rooms will climb no more than 2% next year, about half the level anticipated by PWC and STR (please see the table below).

11E 10E 09 08 07
AC.FP 4.0% 6.6% -7.9% 2.8% 6.5%
[[CHH]] 3.0% 1.7% -14.4% -1.9% 6.4%
[[H]] 4.0% 8.5% -18.7% 5.5% 11.0%
[[IHG]] 3.5% 5.0% -14.7% 0.9% 7.0%
[[MAR]] 4.0% 6.0% -18.3% -1.5% 6.5%
[[OEH]] 4.0% 11.4% -17.3% 3.0% 11.0%
[[HOT]] 5.0% 9.0% -20.0% -1.2% 10.2%
Average 3.9% 6.9% -15.9% 1.1% 8.4%

RevPAR growing at around 4% next year should provide another solid lift to operating profit margins in 2011 (please see the table below). This rate of improvement, though less spectacular than investors seem to anticipate, could lay the groundwork for a more balanced, more durable lodging cycle.

EBIT Margin
11E 10E 09 08 07
AC.FP 7.7% 7.2% 3.9% 6.9% 7.8%
[[CHH]] 27.8% 27.0% 26.2% 27.2% 30.1%
[[H]] 4.1% 3.4% 1.4% 9.5% 10.3 %
[[IHG]] 22.9% 22.4% 23.6% 28.9% 26.8%
[[MAR]] 7.4% 7.0% 5.8% 7.2% 9.1%
[[OEH]] 5.6% 4.8% 4.3% 17.4% 19.5%
[[HOT]] 11.8% 10.1% 8.5% 10.6% 14.0%
Average 12.5% 11.7% 10.6% 15.4% 16.8%

Disclosure: Long AC.FP, [[CHH]], [[HOT]], short [[OEH]]

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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