SCHYY Sands China Ltd (PK)

The U.S. hotel & lodging industry wrapped up the year 2013 on a mixed note as the economy struggled to gradually get back to health. The year was led by strong demand from business as well as leisure travelers which, along with limited supply, gave hoteliers strong pricing power throughout the year.

In fact, 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 making every effort to improve their primary performance metrics like occupancy and revenue per available room (RevPAR).

However, higher cost and expenses incurred for continued renovation and other initiatives taken by leading hoteliers to improve traffic have dampened the bottom line. Moreover, economic and political uncertainty in most parts of the world remained as challenges.

In spite of these headwinds, the lodging performance indicators showed year-over-year improvements. According to Smith Travel Research (“STR”), the leading information and data provider for the lodging industry, the average daily rate (“ADR”) at U.S. hotels in 2013 was up 3.9% year over year.  Overall occupancy was up 1.5% year over year.

Notwithstanding the common macroeconomic hurdles, the lodging sector is expected to continue to recover this year, thanks to an improving U.S. business as well as strong international travel and tourism volumes. In fact, the uptrend visible in occupancy rate, average daily rate as well as RevPar for the first and second weeks of March, if it is any clue, speaks well for 2014 on the whole.

Statistics bear out this relatively favorable environment. A recent report by Price Waterhouse Coopers shows that the lodging sector will continue to outperform in 2014 and 2015 on the back of robust booking trend and a solid travel and tourism market. The market researcher expects RevPAR growth of 6.0% in 2014, driven by increased ADR of 4.5% which is better than 3.9% in 2013.

As per Price Waterhouse Coopers, 2014 will be the fifth consecutive year of positive RevPAR growth. Price Waterhouse Coopers also added that high-priced segments will be the major driver of industry growth.

Furthermore, mega sporting events in South America scheduled in 2014 through 2016 is expected to boost tourism. As owners and operators strive to enhance value and competitiveness, industry-best practices, like sustainability and brand refreshment, will remain industry priorities.

OPPORTUNITIES

Demand Exceeds Supply: A gradual recovery in the broader economy has boosted the hotel industry as demand picks up for both leisure and transient business travel. With limited supply and strong demand, the room rates are seeing a northward movement.

Smith Travel Research expects the sector’s demand growth to be 2.4% in 2014 in the U.S. with only a 0.1% increase in supply.

According to Hyatt Hotels Corporation (H) and Hilton Worldwide Holdings Inc. (HLT), the supply-demand environment in the business is favorable with healthy demand growth outpacing levels of supply growth that are still well below long-term averages. This would lead to incremental rate increases, thereby driving RevPar higher.

The North American Recovery: System-wide occupancies in North America appear to be pretty steady and above the prior peak level achieved in 2006 following the gradual improvement in the economy.

With the boost in the economic sector and an improving travel and tourism industry, hotel companies are well poised for growth. North America is still the largest market for Starwood Hotels & Resorts Worldwide Inc. (HOT). In 2014, the company expects another year of robust growth in North America and plans to open about one-third of its new hotels in the region.

International Expansion: Owing to the saturation in the U.S market, major hoteliers are exploring growth opportunities abroad. Some international markets offer greater potential based on the higher pace of economic growth. The demand for hotels in the international market is greater than in the U.S. and the pace of recovery is particularly faster. The positive fundamentals in foreign markets have spurred hoteliers to grab a larger piece of the overseas pie.

A number of U.S.-based hoteliers are targeting the unsaturated markets of Asia-Pacific, Brazil, Russia and Africa. Within Asia, China promises lucrative growth opportunities with visits expected to increase substantially in 2014. China is in fact a major contributor to both Starwood Hotels and Marriott International, Inc. (MAR) revenues.

Apart from China, India is now becoming a hot spot for western hoteliers, as the country is emerging as a global business hub. Major players in the industry are also eyeing the Latin American countries, particularly Brazil and Mexico. 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. The events will significantly increase tourism in the country and the demand for hotel rooms will shoot up.

In Europe, too, the scenario is improving. In fact, select markets in Southern Europe, which were hard hit during the recession, have begun to report growth. The bullish trend can be validated by Starwood’s system-wide occupancy data in the fourth quarter, which was an impressive 68.0% in Europe. Other major players like Hilton Worldwide, Choice Hotels International Inc. (CHH) and Wyndham Worldwide Corporation (WYN) are also eyeing the European market.

Asset Disposition Strategy: Since late 2010, the transition to an ‘asset light’ business model has gained momentum in the hotels and REIT industry. Asset sale remains a long-term strategy for greater financial flexibility. The companies are likely to 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.

Several hoteliers like Marriott International, Hyatt Hotels and Starwood Hotels followed this industry trend to rebalance their portfolios.

Renovation to Boost Growth: Hotel companies are diligently working on guest satisfaction to enhance their position in a cut-throat environment. Hence, brand conversion and remodeling has become the in thing for major hoteliers. Many leading hoteliers like Starwood Hotels, Marriott International, Orient-Express Hotels Ltd. (OEH), Hyatt Hotels and The Marcus Corporation (MCS) have tread 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.

Currently, we have Marcus Corporation as a Zacks Rank #1 (Strong Buy) stock. However, Sands China Ltd. (SCHYY) and Marriott International hold a Zacks Rank #2 (Buy). Despite the Zacks Rank #3 (Hold) tag, we are optimistic on Hyatt Hotels and Huazhu Hotels Group Ltd (HTHT) based on its strong fourth quarter results and an optimistic outlook for 2014. Similarly, we are also positive on Zacks Ranked #3 (Hold) company Starwood Hotels given the momentum in its underlying businesses.

WEAKNESSES

Operating Margins Under Pressure: Though RevPAR has fairly picked up since the recovery in the industry in 2009, operating margins have 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.

Lingering Uncertainty in Other Regions: Despite its immense growth potential, the hoteliers are still caught up with several macroeconomic issues like the probability of further tapering by the Fed, ongoing austerity measures in Europe resulting from the sovereign debt crisis and decelerating growth in Asia.

Moreover, a deteriorating political situation and a weak economy have put the brakes on overall Latin American sales.  The upcoming elections in Brazil make the situation much more unpredictable. Additionally, the situation in Argentina has gone from bad to worse as police strikes led to chaos across several cities in Dec 2013.

The troubles in Egypt and Syria cast a shadow over the performance of the entire African and Middle Eastern region. Economic headwinds and political unrest have hampered growth in other parts of the world as well. Saudi visa restrictions due to the continuing renovation activity in Mecca also remain an issue.

Uncertainty over the new government’s policy in China is also a concern. The new leadership in China has asked government officials to put an end to their extravagant ways. Tighter government spending is expected to affect the food and beverage business of the company, particularly in the north and west where the government is a major customer. The situation in India remains uncertain with elections coming up while the controversial anti-government protests in Thailand have significantly hurt business in this crucial market for hoteliers.

Health Care Reforms to Hurt Profitability: Federal health care legislation mandates employers to provide health coverage to full-time employees who log in more than 30 hours per week. With this provision going into effect, it would increase the cost of the leading hoteliers.

There are some names in the space that induce our cautious-to-bearish outlook. These include Home Inns & Hotels Management Inc. (HMIN), Intercontinental Hotels Group plc (IHG), Choice Hotels International, and Orient-Express Hotels, each carrying a Zacks Rank #4 (Sell). We have no companies carrying a Zacks Rank #5 (Strong Sell) for now. Intrawest Resorts Holdings, Inc. (SNOW), Marriott Vacations Worldwide Corp. (VAC), Hilton Worldwide and Wyndham Worldwide all hold a Zacks Rank #3 (Hold) on the back of sluggish results in the last reported quarter.

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 #104. This is in the middle 1/3rd of all industries ranked, highlighting the group’s near-term neutral outlook. The group’s neutral Zacks Rank placement is essentially a function of many a company improving on their top line but floundering on their bottom line due to higher expenses.

Earnings Trends

The hotel industry falls under the broader Consumer Discretionary sector. The fourth quarter of 2013 results for the sector has been decent in terms of both beat ratios (percentage of companies coming out with positive surprises) and growth.

The earnings "beat ratio" was 50.0%, while the revenue "beat ratio" was 53.1%. Total earnings for this sector increased 12.0% in the fourth quarter, compared with 12.1% in the third quarter. Total revenue grew 3.3% in the quarter versus a 3.2% increase in the previous quarter.

First quarter 2014 earnings are expected to rise 5.4%, thereby pegging the full-year 2014 growth outlook at 12.5%. For 2015, the sector’s earnings are poised to expand around 15.7%.

Revenue is expected to grow 3.7% in the first quarter of 2014, pegging the full-year 2014 growth outlook at 4.5%. For 2015, the sector is poised to expand around 4.4% with 6.2% growth in full year 2014.  

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

The fourth-quarter earnings season has shown a mixed trend in the hotel and motel industry.

While Starwood Hotels beat Zacks earnings expectations, it missed the same on revenues. On the other hand, Wyndham Worldwide missed the Consensus mark on the earnings front while surpassing revenue estimates. Marriott International missed the Zacks Consensus Estimate squarely on both earnings and revenues while Hyatt Hotels easily surpassed on both lines.

A look at the Earnings ESP in the table below shows that Extended Stay America, Inc. (STAY), Hyatt Hotels, Marcus Corp. and Marriott International could miss the Zacks Consensus Estimate in the next quarter (first quarter 2014) while Wyndham Worldwide could easily surpass the same.



Bottom Line

We firmly believe that despite a few stumbles, the lodging sector offers a worthy investment proposition for 2014 given the ongoing recovery in the economy as well as the low supply scenario in the hotel industry.

Our proprietary Zacks Rank indicates the movement of the stocks over the short term (1 to 3 months). At present, 20.0% and 53.3% of the stocks hold a positive and neutral outlook, respectively, while the remaining 26.7% are negative.
 
CHOICE HTL INTL (CHH): Free Stock Analysis Report
 
HYATT HOTELS CP (H): Free Stock Analysis Report
 
HILTON WW HLDG (HLT): 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
 
MARCUS CORP (MCS): Free Stock Analysis Report
 
ORIENT EXP HOTL (OEH): Free Stock Analysis Report
 
SANDS CHINA LTD (SCHYY): Get Free Report
 
INTRAWEST RESRT (SNOW): Free Stock Analysis Report
 
EXTENDED STAY (STAY): Free Stock Analysis Report
 
MARRIOT VAC WW (VAC): Free Stock Analysis Report
 
WYNDHAM WORLDWD (WYN): Free Stock Analysis Report
 
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