Using the Lodging/Hotel industry as an example, Relativity Capital portfolio manager and OptionsHawk founder Joe Kunkle walks through his strategy for creating an industry snapshot to help guide trading decisions.
As I have indicated in previous writings I feel it is very important to stay informed across all industries and understand the key trends, key companies, and applicable metrics to assess those companies. In doing so you can set up a framework to easily allow for comparing valuation, growth and other metrics that will speed up your decision making to identify the best and worst stocks in each industry group. I have divided the market into approximately 50 sub-industry groups and maintain stock watchlists to be able to quickly switch from one industry to the next.
I cover these groups in the 2020 OptionsHawk Market Outlook. The process is arduous, but in the end it prepares me for the year ahead to quickly act on investments when they come into an optimal price zone. I look at the large and small players, identify the key metrics, and for many create custom key performance indicators based on all the available financial data. I also look to the industry as a whole to see what economic data it historically correlates to, resources for staying on top of current industry news and trends, and comb through management commentary from earnings reports and conference presentations to really get a strong foundation to assess the health of the industry and its components.
As an example, I want to look at the Lodging/Hotel industry. It’s comprised of very few public companies, but makes an interesting case study with plenty of industry-specific metrics. There is also an entire REIT industry for Hotel/Lodging but that group requires looking more at REIT metrics, so we just want to look at the C-Corps. The top names by market cap include Marriott [MAR], Hilton [HLT], Hyatt [H], Wyndham [WH] Extended Stay [STAY] and Choice [CHH] in the US, while a separate group is the specialty vacation ownership & resort names like Marriott Vacations [VAC], Hilton Grand Vacation [HGV], Wyndham Destinations [WYND], Bluegreen Vacations [BXG], and Playa Hotels [PLYA]. A couple of International names trade on US exchanges, such as InterContinental [IHG] in the UK and Huazhu Group [HTHT] in China. I prefer to separate the Casinos/Resorts names into their own group. A good breakdown of the key Hotel players is below:
If we take a broader view of the Lodging industry, it is one that is highly fragmented with a multitude of brands and different price levels, accommodations, and amenities. One major revenue driver for hotel companies is corporate travel budgets with conferences and conventions, which is a key demand factor and closely correlated to the macro economy. Supply plays a pivotal role with construction starts and new room additions as it factors into occupancy rates and room rates. The recent trend of home-sharing with Home-Away, Airbnb and others has also increased supply, which can weigh on rates. Hotels have clearly seen the push towards OTAs (Online Travel Agents) but also realise it is an expensive booking channel and have tried to minimize distribution via that means and instead built loyalty programs. A good way to get a view of an industry is to read the financial documents of the companies that tend to discuss the drivers of its industry.
There are numerous metrics of importance when analyzing Hotel companies, with Revenue Per Available Room (RevPAR) one of the most frequently cited, and which has a high correlation to employment trends. Other metrics we observe include Average Daily Rate (ADR), Total Available Rooms, Occupancy Rates, and Gross Operating Profit Per Available Room (GOPAR). STR Global, which was acquired by CoStar Group for $450M earlier this year, is a provider of industry data that can be helpful for staying on top of trends. Outside of those industry-specific metrics, we look at EV/EBITDA for valuation and also look at revenue growth rates, margins, ROIC, FCF yield, Debt/EBITDA, and expense trends.
The outlook for the Lodging industry into 2020 is subdued, with data from the US Department of Commerce and US Travel Association showing weakening international visitation (tourism) since 2016 and similar trends in travel spending. Lodging stocks have historically underperformed when RevPAR is decelerating, and estimates have moved lower to under 1% for 2019 and 2020 according to STR and Tourism Economics’ final forecast revision this year. They note: “US hotels have posted nine straight years with RevPAR increases of basically 3% or higher, so growth levels below 1% will clearly represent the industry’s worst years since the recession,” said Amanda Hite, STR’s president.
“At the risk of sounding like a broken record, the major factor in our revisions continues to be a lack of pricing confidence,” Hite said. “Supply growth is coming in ahead of demand growth a bit sooner than expected, so occupancy levels are slightly lower than projected. The major difference is with ADR, where we downgraded by 80 basis points for 2019 and 60 basis points for 2020. ADR has grown below the level of inflation for five consecutive quarters. Fortunately, demand is going to continue to grow beyond the record levels the industry has already achieved. Domestic travel continues to increase with forward-looking domestic air bookings remaining strong. Vacation intentions are also holding above last year’s levels. The trend that is not as positive, that could negatively affect demand, are the mixed results we’re seeing in overseas arrivals.”
CBRE Hotels Research is another great provider of insight, and in its December 2019 edition of “Hotel Horizons” notes:
“Throughout the recovery from the Great Recession, we have seen the US Lodging industry deviate from economic norms,” said R. Mark Woodworth, senior managing director, CBRE Hotels Research. “Despite an economy that has supported strong growth in Lodging demand and record occupancy levels, hoteliers have been unable to achieve gains in ADR commensurate with what we have seen during equally strong market conditions. We believe an environment of high occupancy with low ADR growth will persist for the foreseeable future.”
“We believe that uncertainty, tighter lending requirements and escalating construction costs will mitigate the volume of new supply and risk of oversupply. Concurrently, the economy continues to support the demand for Lodging accommodations, thus perpetuating occupancy levels above 65.5%,” Woodworth noted.
“By our measure, the U.S. Lodging industry reached the peak of its current cycle in 2018. History calls for a downturn in 2020 or 2021. However, because the forecast declines in occupancy and real ADR are minimal, we are seeing a slight rollback in performance, which leads to sustained expansion starting in 2022. We expect to see a mini-cycle within the cycle. Despite the 2020 and 2021 forecast performance slowdown, US hotels are operating at near record levels of occupancy and efficiency. The growth story is not great, but we expect the US Lodging industry to circle back to 2018 performance levels, and beyond, starting in 2022,” he concluded.
In a case where we are dealing with industry headwinds one can invest in a few ways rather than simply owning the highest-quality name. One approach is pairs trading, so an investor would be long the best of breed stock and short the worst of breed stock at equal weighting and look to make Alpha, excess return versus the benchmark, in the spread of the two stock’s performances. Another option for more advanced investors is instead of looking for the stock to be long, simply be short the weakest name in an industry facing headwinds.
The 19 December report from STR did show strength with US hotel industry occupancy +5.6% YoY, Average Daily Rate +5.3%, and RevPAR +11.2%. Luxury and Upscale outperformed. It is always prudent to seek out management commentary and Marriott presented at the Barclays Lodging Conference in early December and these were some highlights:
On its Q3 +1.5% RevPar growth:
“So I would really attribute that overwhelmingly to the power of Marriott Bonvoy. If you think about the way Marriott Bonvoy has evolved, really, 2019 has been the first year where you've seen the program fully come together not only in terms of the 2 platforms, of the 2 previous systems of SPG and Marriott Rewards being together for all of our members, but also, the program's been combined. You've also got -- for the first year, you've got all the inventory of our 7,200 hotels all in 1 place for our customers to be able to find. And so I think with the growth in Marriott Bonvoy, with the presentation of the new program to the consumers at the Oscars in January, you saw a really tremendous recognition on the part of the customers of this platform. And with penetration going up over 300 basis points in the quarter from our loyalty members as well as through strong redemptions that we're seeing in our hotels, I think that was one of the biggest drivers to the RevPAR index gains.”
On reducing its unit growth outlook:
“I would say it's overwhelmingly related to a couple of things. One is clearly the reality that the market for construction labor is really tight. So clearly, as you're trying to get the different subcontractors that you need to finish, whether it's the plumbing, whether it's the wallpapering, whether it is helping with the furniture, et cetera, there's obviously a tough time getting that labor in a really tight labor market. But I also think there's the reality that in many of our projects, we are dealing in markets or in projects that are, at the margin, a hair more complex than they were, say, 10 years ago.”
On China, which is a key unit growth story for the industry:
“We've actually seen our RevPAR premiums this year continue to gain ground in our brands in China. The consumer really loves what we're doing with our brands there. The combination of the products and the services, where we've had extraordinary growth through our Alibaba JV in terms of new Bonvoy members, and they're going out and trying our hotels. We're doing more across the full spectrum of our products. So we're doing -- we've always had some great upper upscale and luxury pipeline. We're now really building out the full depth of our pipeline in China, which we're seeing really strong demand for. So we have not seen that there's a change in attitude.”
Valuation & Growth
When looking at all the numbers, Hilton is my preferred name with its industry leading FCF yield, upscale exposure, consistent strength in room bookings and RevPar, and better margins than its upscale peers. Hyatt is a name trading at a steep discount, 11.7X EV/EBITDA, and a potential source of upside is if it moves to a more asset-light franchise model like peers Marriott and Hilton that have a much higher franchise mix. On the negative side, Choice Hotels was a former favorite for its high margin/ROIC combination but now at 18X EBITDA appears over-valued. Choice are also seeing some of the weaker RevPAR numbers in the industry as well as rising expenses.
This is an example of the approach I take with each industry into each New Year, which I feel prepares me well to make informed decisions.