Hotels & Lodging Stock Outlook - Aug. 2013 - Zacks Analyst Interviews

The U.S. hotel & lodging industry saw a solid start to 2013, with lodging performance indicators going up in most parts of the world. With concerns still lingering over a number of macro issues that could still leave the sector in disarray, we have now come halfway through 2013 and would like to take a close look at how things are shaping up.

In the second quarter, two of the sector heavyweights -- Starwood Hotels and Resorts Worldwide Inc. ( HOT ) and Wyndham Worldwide Corp. ( WYN ) -- surpassed their respective Zacks Consensus Estimates on earnings. While Wyndham managed to beat on revenues, Starwood missed. Both have raised earnings guidance for the full year.

Notwithstanding the common macroeconomic hurdles expected ahead, the lodging sector would continue its recovery trail this year thanks to improving U.S. business as well as strong international travel and tourism volumes. The number of hotels Starwood opened and new deals signed in North America in 2012 were much more than the past couple of years.

Other important factors like higher barriers to entry and lower reliance on third-party wholesalers have positioned the hoteliers to attain peak levels not seen since the onset of the global economic crisis in 2007. The hoteliers are giving every effort to improve their primary performance metrics like occupancy and RevPAR (revenue per available room).

Market researcher Price Waterhouse Coopers expects RevPAR growth of 5.9% in 2013, representing the fourth year of lodging recovery. According to the market researcher, hotels across the gamut of price tiers, in particular the higher-priced ones, are expected to drive this recovery and a consequent growth in the sector.

Zacks Industry Rank

Within the Zacks Industry classification, we rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank .

As a guideline, the outlook for industries in the top 1/3rd of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive,' the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks Industry Rank of #177 and higher is 'Negative.'

The Zacks Industry Rank for the hotels/motels industry is currently #65. This is in the top 1/3rd of all industries ranked, highlighting the group's near-term Positive outlook. The group's favorable Zacks Rank placement is essentially a function of many companies' improving their earnings picture which prompted analysts to raise their estimates. Notably, this group of 13 companies benefited from 31% positive revisions to annual earnings estimates.


Demand Exceeds Supply: Owing to gradual economic recovery, the hotel industry continues to see upside. Starwood has estimated high-end travel spending to have grown nearly 40% over the last four years, almost double as fast as global GPD. The supply situation remains tight both in the U.S. and Europe . PWC forecasts 0.8% supply growth and around 1.8% demand growth in 2013. This scenario is anticipated to push up occupancy levels. Supply growth is expected to remain low for a few years to come.

For 2014, PKF Hospitality Research predicts RevPAR to increase 7.7% buoyed by a 3.3% rise in demand and an occupancy level of 63.8%. As per the research firm, this is going to be the highest annual occupancy level since 1997.

According to Marriott International ( MAR ), fewer supplies combined with nearly peak occupancy levels will help hoteliers charge higher for the rooms in 2013. In a nutshell, with lower supply, RevPAR is improving on strong demand and continued higher pricing.

Improving Trends in North America & Europe: System-wide occupancies in North America appear steady. Starwood expects 2013 to be its strongest year since the recession in terms of hotel openings in North America. As per Smith Travel Research, the U.S. lodging sector has now seen RevPAR growth for 13 straight quarters.

In Europe, too, the scenario is improving. Consumer confidence in the Eurozone was recorded close to a two-year high for the month of July. In fact, select markets in Southern Europe which was hard hit during recession began to report growth. The bullish trend on two continents can be validated by Starwood's occupancy data in the second quarter which surpassed 76% in the U.S. and 72% in Europe.

Renovation Gaining Precedence: Lately, most of the hoteliers are increasingly investing on property renovations. Hotel companies are diligently working on guest satisfaction to enhance their position in a cut-throat environment. Brand conversion and remodeling have become industry trends. Many industry biggies like Starwood, Marriott and InterContinental Hotels Group ( IHG ) have treaded the same path.

There are several well-positioned, older hotels in metro markets, which are good candidates for restructuring. In view of that, we foresee several renovations this year.

International Expansion: Owing to saturation in the U.S. market, major hoteliers are exploring growth opportunities abroad. Some international markets offer greater potential on their stepped-up pace of economic growth.

A number of U.S.-based hoteliers are targeting the unsaturated markets of India, Brazil, China, Russia and Africa. China is set to fuel a recovery in global tourism, and is expected to emerge as the world's most popular travel destination by 2020. Both Starwood and Marriott generate their second largest revenue stream from China.

Apart from China, India is another hot spot for western hoteliers as the country is emerging as a global business hub. The prospect for Latin America, particularly Mexico, remains outstanding. Lower crime rates in the country have ensured that U.S. groups are once again taking an interest in Mexico. Further, major events like the FIFA World Cup in 2014 and the Summer Olympics in 2016 in Brazil is also boosting the country's infrastructure as demand for hotel rooms will grow and the events will significantly increase tourism in the country.

Shift Toward Asset-Light Model: Since late 2010, transitioning to an "asset light" business model has gained prominence in hotels and REIT industries. Asset sales remain a long-term strategy to strengthen financial flexibility, which help companies grow through management and licensing arrangements instead of direct ownership of real estate. A higher concentration of management and franchise fees reduces earnings volatility and provides a more stable growth profile.

Following the industry trend, many industry players like Morgans Hotel Group Co. ( MHGC ), Red Lion Hotels Corp. ( RLH ) and Starwood have taken resorts to an asset disposition strategy.


Global Economic Backdrop Yet to Fully Recover: Despite the strengths, the companies are still caught up with macroeconomic tensions like the probability of tapering quantitative easing by the Fed, ongoing austerity measures in Europe owing to the sovereign debt crisis and decelerating growth in Asia.

The budget sequestration, effective since Mar 1, 2013, to fight issues like high unemployment and tighter credit availability might hamper business travel in North America to some extent. Government is likely to cut its group and transient bookings. Therefore, declining government business is expected to affect the company's RevPAR for the rest of 2013.

We believe the European tourism industry will likely remain challenged until the continent tides over its nagging economic difficulties. Most data from the region still shows continued problems, even though the broader picture has materially stabilized.

Growth has also slowed in a number of major emerging economies, especially in Brazil, China and India. A weaker external environment, a sharp deceleration in domestic demand and a fragile export environment could possibly hurt the performance of the lodging sector in the near term.

The shadow banking system in China has created trouble and India raised concerns due to its recent economic weakness. Brazil is feeling the dual pressures of slower growth and heightened inflation. Apart from slower GDP growth, RevPAR in 2013 might slowdown on account of higher supply growth in a few emerging markets.

Operating Margins Under Pressure: Though RevPAR has fairly picked up since the recovery in the industry, operating margins are yet to reach the industry peak in the U.S. This is due to the spike in overall inflation. As a result of economic uncertainty, it is now estimated that peak levels will not be achieved anytime soon. Some hoteliers like Marriott even feel that the golden days of the lodging industry will not be back before 2014 or 2015.

Earnings Trends

Hotel industry falls under the broader Consumer Discretionary sector, which portrays stable earnings trends. The second quarter 2013 results for the sector have been impressive in terms of both beat ratios (percentage of companies coming out with positive surprises) and growth.

The earnings "beat ratio" was 72.7%, while the revenue "beat ratio" was 45.5%. However, most earnings results from this sector have yet to be released with just 35.5% reported as of July 25. Total earnings for this sector are expected to go up 11.6% in the second quarter, modestly down from the 14.0% growth in the first quarter of 2013. The lag in sequential earnings growth came from margin shortfall.

On the revenue front, the sector has been witnessing a remarkable recovery. Expectation for total revenue expanded 5.9% in the quarter on the top of a 4.6% increase in the prior quarter.

Looking at the consensus earnings expectations for the rest of the year, we are encouraged since earnings are expected to grow 5.4% in the third quarter of 2013 and 16.2% in the fourth quarter, thereby registering full-year 2013 growth of 12.9%. For the next year, the sector is poised to expand around 15.9% with 13.8% growth in the first quarter itself.

For more details about earnings for this sector and others, please read our ' Earnings Trends ' report.

Moving Into the Third Quarter

Hoteliers will be facing tough comparison in Europe as the biggest event of 2012 -- the Summer Olympics -- brought in extra business in the comparable period of last year. In the Gulf, Saudi visa restrictions are harshly reducing Ramadan-related travel. Turmoil is also creeping up in the apparently improving Egypt. The recent protests in Turkey will also likely mar the country's lodging business in the third quarter. However, according to Starwood, all these threats should subside by the fourth quarter.

On the positive front, Argentina which had been adversely affecting Latin American RevPAR for the last nine months mainly due to a negative currency impact will likely represent an easy comparison in the third quarter. Markets of Canada and Australia which boast ample of resources should bode well for the big hoteliers' business.

Bottom Line

In hindsight, the performance of the hotel sector was essentially satisfactory. Our proprietary Zacks Ranks indicate the movement of the stocks over the short term (1 to 3 months). At present, respectively 46% and 24% stocks sport a positive and neutral outlook.

Stocks which will likely outperform the broader market and currently hold a favorable Zacks Rank include Home Inns & Hotels Management Inc. ( HMIN ), The Marcus Corporation ( MCS ), Wyndham ( WYN ) and Orient-Express Hotels Ltd. ( OEH ). We currently refrain from getting too enthusiastic on the three stocks in our universe that continue to hold a Zacks #3 Rank (Hold). These stocks are Intercontinental, Starwood and Red Lion.

However, there are two bellwethers -- Marriott International Inc. ( MAR ) and Hyatt ( H ) -- that currently carry Zacks Rank #4 (Sell).

CHOICE HTL INTL (CHH): Free Stock Analysis Report

HYATT HOTELS CP (H): Free Stock Analysis Report

HOME INNS&HOTEL (HMIN): Free Stock Analysis Report

STARWOOD HOTELS (HOT): Free Stock Analysis Report

CHINA LODGING (HTHT): Free Stock Analysis Report

INTERCONTL HTLS (IHG): Free Stock Analysis Report

MARRIOTT INTL-A (MAR): Free Stock Analysis Report

ORIENT EXP HOTL (OEH): Free Stock Analysis Report

RED LION HOTELS (RLH): Free Stock Analysis Report

MARRIOT VAC WW (VAC): Free Stock Analysis Report

WYNDHAM WORLDWD (WYN): Free Stock Analysis Report

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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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