WOLF Great Wolf Resorts, Inc. (MM)

The year 2012 is likely to end on a positive note for the hotel & lodging industry, with lodging performance indicators witnessing considerable improvement in most parts of the world. In the recently concluded third quarter of 2012, most of the sector heavyweights -- Starwood Hotels and Resorts Worldwide Inc. (HOT), Marriott International Inc. (MAR), Wyndham Worldwide Corp. (WYN) and Hyatt Hotels Corp. (H) -- surpassed their earnings expectations.

However, global economic and political issues like sovereign debt, currency fluctuation, the U.S. fiscal cliff and sustained economic instability in various countries will continue to affect lodging companies in the first half of 2013.

Notwithstanding the hurdles expected ahead, the lodging sector should continue its recovery into next year. International travel and tourism volumes are anticipated to increase. Both Starwood and Marriott expect corporate rate negotiations which will likely lead to a high-single-digit increase in 2013.

Furthermore, big events in Europe and South America scheduled in 2012 through 2016 are expected to boost tourism. As owners and operators strive to enhance value and competitiveness, industry-best practices like sustainability and brand refreshment will remain priorities in the industry.

Coming to near-term industry dynamics, hoteliers will likely report modest RevPAR (revenue per available room) growth in the fourth quarter backed by the improvement in room rates, strong group performance occurring the week before an early Thanksgiving, partially offset by somewhat lower occupancy growth due to looming political concerns.

According to Smith Travel Research (STR), a leading information and data provider for the lodging industry, hoteliers will end the year with 2.6─2.8% growth in room nights sold with ADR growth over 4.0%.

International Expansion

Owing to the saturation in the U.S. market, major hoteliers have been exploring growth opportunities abroad. Some international markets offer greater potential riding on a stepped-up pace of economic growth. The operating environments in these markets help hoteliers grab a bigger share of the overseas pie.

A number of U.S.-based hoteliers are targeting unsaturated markets of India, Brazil, China, Russia and Africa. Major players in the industry like Starwood and Marriott are primarily eyeing the Asia-Pacific, Africa and Latin American regions.

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.

India is another hot spot for the western hoteliers. The country possesses a compelling investment proposition and is growing in prominence as a global business hub, where the demand for moderate-tier as well as upscale branded hotels is expected to considerably outpace the supply over the next three to four years.

The prospects for Latin America, particularly Brazil, remain outstanding. Brazil is the largest country in South America and is the fastest-growing travel and tourism economy in Latin America. For tourists, particularly domestic travelers, the region is becoming one of the hottest destinations. Brazil primarily attracts affluent domestic tourists in the flush of an economic resurgence.

Moreover, with major events like the FIFA World Cup in 2014 and the Summer Olympics in 2016, the Brazilian government has turned its focus on improving the country’s infrastructure as demand for hotel rooms will shoot up and the events will significantly increase tourism in the country.

According to Jones Lang LaSalle, hotel investment in Brazil will be around $2.4 billion by 2014. The real estate consulting company predicts that a large number of hotels will come up in the country to cash in on the FIFA World Cup and the Olympics. Mexico is also on the path of recovery with the crime situation improving gradually.

However, Argentina has been negatively impacting Latin American RevPAR for the last six months. The situation is not likely to improve in the near future with its stern economic and political situation, adverse currency impact and strict government control on imports. Starwood felt the brunt of this disruption in the third quarter of 2012, with Latin American RevPAR declining by 450 basis points. In the Middle East, while Saudi Arabia and the Gulf are performing well, the political situation in Egypt is still unreliable.

Business conditions in Canada have been sluggish for most of the year due to a stronger currency resulting in slower U.S. inbounds and group demand. However, things seem to be easing now with a sequential improvement noted in the third quarter of 2012.

OPPORTUNITIES

The hotel industry continues to witness an upside and remains on track for improved performance. With lower supply in the U.S., RevPAR is improving based on strong demand and sustained higher pricing. This is a turnaround from the recession when sagging occupancy percentage led hoteliers to slash room rates in a bid to woo visitors.

According to statistics released by the U.S. Department of Commerce in November, total spending of international tourists visiting the U.S. was $13.8 billion in August 2012, up 3% year over year. We expect demand growth to continue in 2013 as well.

The U.S. government has also implemented a new National Travel and Tourism Strategy, whose main objective is to attract more than 100 million international visitors by 2021. The government believes that this will provide significant growth stimulus for the local economy. The strategy, if successful, will reap profits for the U.S. hoteliers.

According to Smith Travel Research the U.S. hotel industry reported increased occupancy level, ADR and RevPAR for the third quarter of 2012. Results were favorable for the fourth week of November as well.

Comparing the operating metrics on a year-over-year basis, the industry's occupancy, average daily rate and RevPAR in the third quarter inched up 1.2% to 67.1%, 3.9% to $107.34 and 5.1% to $72.00, respectively.

A similar trend was noticed in November. At the end of the week ending November 24, the industry's occupancy, average daily rate and RevPAR jumped 5.2% to 47.2%, 5.9% to $96.06 and 11.4% to $45.36, respectively.

For 2013, Smith Travel Research predicts occupancy to be virtually flat with a 0.3% increase to 61.4%, ADR to rise 4.6% to $111.01 and RevPAR to grow 4.9% to $68.17.

Demand Exceeds Supply

In the U.S., Smith Travel Research expects the sector to end the year with 0.5% increase in supply and 2.6% growth in demand.

Room rates are on the rise in an environment marked by higher demand and lower supply. PWC, Smith Travel Research and Lodging Econometrics are all forecasting less than 1% supply growth in 2013 while Smith Travel Research predicts demand growth to be around 1.2% in 2013.

According to Marriott International, fewer supplies combined with nearly peak occupancy levels will help hoteliers charge higher for the rooms in 2013. Smith Travel Research anticipates room rates will likely reach 2008 levels on a nominal basis, going forward.

According to data published by Smith Travel Research in November, the total active U.S. hotel development pipeline comprises 2,590 projects, down 6.6% year over year. Among the chain scale segments, Luxury reported the largest increase in rooms in the total active pipeline (up 54.4%).

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.

Hence, the hoteliers are focused on rebalancing their portfolios by increasing contributions from managed and franchised hotels. This fee-based business is attractive as growth is powered by multiple sources like RevPAR growth, unit additions and incentive fee escalation. The business is also capital efficient as owner/developer partners provide the capital and the company earns a fee by managing/franchising the property.

Following the industry trend, many industry players like Morgans Hotel Group Co. (MHGC), Red Lion Hotels Corporation (RLH), Great Wolf Resorts Inc. (WOLF) and Starwood embarked on an asset disposition strategy.

Increased Capital Expenditure on Renovation

Most of the hoteliers are increasingly investing on property renovations in recent times. Hotel companies are diligently working on guest satisfaction to enhance their position in a cut-throat environment. Brand conversion and remodeling has emerged as a trend for major hoteliers. Many industry bigs like Starwood, Marriott and InterContinental Hotels Group (IHG) have walked the same path.

There are several well-positioned, older hotels in metro markets, which are good candidates for restructuring. Hence, we believe that 2013 will likely witness further renovations.

Among the more bullish names, Marriott Vacations Worldwide Corp. (VAC) holds a Zacks #1 Rank (short-term Strong Buy rating) and Choice Hotels International Inc. (CHH) holds a Zacks #2 Rank (short-term Buy rating).

WEAKNESSES

Deterrents for Fourth-Quarter 2012

The performance of the U.S. hotel industry in the fourth quarter of 2012 is expected to be muted due to the persisting global economic uncertainty, looming fiscal cliff, inclusion of US presidential election week (November 6) and a mid-week Halloween in the U.S. According to Marriott and Starwood, these factors will likely disturb last-minute business-related hospitality demand in the quarter. We support this view.

There is also Hurricane Sandy to bother some hoteliers’ financials in the fourth quarter due to the cancellation of bookings for quite a few days. Sandy, which hit the U.S. East Coast on October 28, led to a two-day shutdown of the U.S. stock market. Notably, MGM Resorts International (MGM) believes it will lose 4,000 room nights on account of the storm, leading to an anticipated revenue loss of about $1 million. As the majority of cancellations occurred during one of the biggest conventions, namely ‘SEMA,’ MGM management expects the impact on revenue to be harsh in the fourth quarter.

The International Monetary Fund (IMF) anticipates the U.S. economy to recover at a slower pace in 2013 at about 2.4%. However, any sudden deterioration in the European debt crisis and a rise in gas prices could undermine the momentum. If the recovery is actually thwarted, growth in the hotel sector – one of the key indicators of measuring discretionary spending of consumers – would be the worst hit.

Tension in the Eurozone

Hoteliers' expansion plan through management and franchise deals in Europe seem to be under pressure due to the prevailing credit crunch. European banks have curtailed lending to real estate developers in the wake of the Eurozone debt crisis. Until the prevailing economic challenges are resolved in Europe, the tourism industry will remain challenged.

Hence, hoteliers will likely witness a soft booking trend in the region as most of their European businesses are driven by the leisure segments located specifically in Spain, Italy and Greece. Notably, two markets posted double-digit RevPAR decreases: Athens, Greece (-14.2% to EUR58.54) and Lisbon, Portugal (-12.2% to EUR67.81) in October 2012. These European countries are significantly exposed to sovereign debt challenges. The economic crisis is not uniform across the region.

As per the IMF's October 2012 projection, Eurozone economic growth is expected to shrink 0.4% in 2012 and inch up 0.2% in 2013. Both the estimates were cut down from the July forecast of 0.3% reduction in 2012 and 0.7% growth in 2013.

In addition, in 2013, hoteliers will be facing tough comparisons in Europe as they will lap some major events of 2012 like the Olympics, the Euro Cup Championship, and a grand 2012 fair schedule in Germany.

Slowdown in Emerging Markets

As per IMF, the emerging markets have started to witness a slowdown owing to weaker external environment, a sharp deceleration in domestic demand and policy tightening as well as a fragile export environment which could possibly hurt the performance of the lodging sector in the near term.

The IMF has trimmed its forecast for emerging economies in October. Growth has slowed in a number of major emerging economies, especially in Brazil, China and India. Apart from slower GDP growth, RevPAR in 2013 will suffer on account of higher supply growth in a few emerging markets and lower in-bound traffic from Europe.

The GDP figure for China remains lackluster. In the third quarter of 2012, the country recorded GDP growth of 7.4%, declining for the seventh straight quarter and the first miss of the official target since the first quarter of 2009. As per IMF’s October forecast, China is expected to grow by 7.8% in 2012, down from its earlier July forecast of 8.0%.

The IMF has warned that the worsening debt crisis in the Eurozone will pose a "key risk" to China 's growth. For 2013, growth in China is now expected to be 8.0% as compared to the earlier projection of 8.5%. The recent China-Japan and Korea-Japan political tension, transition in Chinese government and monetary tightening in China are hurting lodging sector bookings.

The agency estimates weakening growth in India for 2012 and 2013. In its October projection, the agency cut down its growth forecast for India from 6.1% and 6.5% to 4.9% and 6.0%, respectively. For Brazil, the agency reduced its growth forecast from 2.5% and 4.6% to 1.5% and 4.0%, respectively, in 2012 and 2013.

Stiff Competition

Competition is also getting more intense across the sector. Every hotel company is not only competing with major hotel chains in national and international venues but also with home-grown hotels in regional markets. Heightened competition and potential addition of new supply will restrict market share gains.

Operating Margins Under Pressure

Though RevPAR has fairly picked up since the recovery in the industry in 2009, operating margins are yet to reach the industry peak of 2007 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. The impact of unfavorable currency, given the recessionary scenario, raises concerns about the ability of hoteliers to post stronger earnings.

By the look of things, we currently refrain from getting too enthusiastic on a number of stocks in our universe, which continue to hold a Zacks #3 Rank (Hold). These include Starwood (HOT), Marriott (MAR), The Marcus Corporation (MCS), China Lodging Group Limited (HTHT), Wyndham Worldwide Corporation (WYN), Home Inns & Hotels Management Inc. (HMIN), Intercontinental Hotels (IHG), Orient-Express Hotels Ltd. (OEH) and Hyatt Hotels (H).

We also remain concerned about the prospects of Morgans Hotel Group (MHGC), which currently retains a Zacks #4 Rank (Sell).

 
HYATT HOTELS CP (H): Free Stock Analysis Report
 
HOME INNS&HOTEL (HMIN): Free Stock Analysis Report
 
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INTERCONTL HTLS (IHG): Free Stock Analysis Report
 
MARRIOTT INTL-A (MAR): Free Stock Analysis Report
 
MARCUS CORP (MCS): Free Stock Analysis Report
 
MORGANS HOTEL (MHGC): Free Stock Analysis Report
 
ORIENT EXP HOTL (OEH): Free Stock Analysis Report
 
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