Hotel & Lodging Stocks: Future Looking Up - Industry Outlook

By Zacks | July 29, 2014 AAA

After a tough 2013, 2014 started on a better note for hoteliers with the economy gradually returning to health. Despite patches of economic and political uncertainty around the world, the global tourism scenario is encouraging. This trend is expected to pick up for the remaining part of 2014.

Although, the improving economic backdrop has the potential to invigorate the hotel sector, certain challenges will persist. Owners and operators are pressed to achieve profitable growth and hoteliers will try to capitalize on the improved tourism numbers. However, higher cost and expenses incurred for renovation and other digital and marketing initiatives taken by the leading hoteliers to improve traffic are hurting profits.

In spite of these headwinds, the lodging performance indicators showed year-over-year improvement. 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 Jun 2014 was up 4.3% year over year. Overall occupancy was up 2.9% 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, ADR as well as revenue per available room (RevPAR) for the first and second weeks of July, if it is any clue, indicates a robust 2014.

Statistics bear out this relatively favorable environment. A recent report by PricewaterhouseCoopers (PwC) 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 6.5% in 2014, driven by increased ADR of 4.3%, better than 3.9% recorded in 2013. PwC also added that upscale and luxury segments together will be the major driver of industry growth.

Furthermore, mega sporting events in South America scheduled in the second half of 2014 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 industry priorities. The currently ended FIFA World Cup in Brazil also had a significant positive impact.

OPPORTUNITIES

Demand Exceeds Supply: The gradual recovery in the broader economy has boosted the hotel industry as demand is picking up for both leisure and transient business travel. With limited supply and strong demand, room rates are seeing an upward movement. According to Hyatt Hotels Corporation (H) and Hilton Worldwide Holdings Inc. (HLT), the supply-demand environment in the U.S. is favorable with healthy demand growth outpacing supply growth that are still below long-term averages. This would lead to rate increases, thereby driving RevPAR higher.

In fact, STR expects the sector’s demand growth to be 2.6% in 2014 in the U.S. with only 1.2% increase in supply.

The North American Recovery: System-wide occupancies in North America appear to be pretty steady and above the prior peak 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 in the second half. North America is still the largest market for Starwood Hotels & Resorts Worldwide Inc. (HOT) where it plans to open about one-third of its hotels expecting 2014 to be yet another year of robust growth in the region.

International Expansion: Major hoteliers are exploring growth opportunities abroad, especially in the emerging markets. These international markets offer greater potential due to the higher pace of economic growth. The demand for hotels in these emerging markets is greater than in the U.S. In fact, Economist Intelligence Unit forecasts that the Chinese GDP will grow at a rate of 8.0% this year and these high growth rates are expected to continue at least until 2020. These positive fundamentals have induced hoteliers to grab a larger share 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. In fact, China is a major revenue contributor to both Starwood Hotels and Marriott International, Inc. (MAR).

Apart from China, India is also becoming a hot spot for western hoteliers with its emergence as a global business hub. Although economic growth rates are slightly lower than in China, India has great long-term growth potential as a tourism market. Major players in the industry are also eying high-potential countries such as Turkey, United Arab Emirates (UAE) and South Korea which offer well developed infrastructure. Although most of the Latin American countries are high-growth markets, Brazil continues to lag other emerging markets, mainly due to slowdown in tourist arrivals.

Moreover, with the upcoming Summer Olympics in 2016, the Brazilian government focused on improving the country’s infrastructure. The event will significantly increase tourism in the country, leading to a proportionate increase in the demand for hotel rooms.

In Europe, too, the scenario is improving. In fact, select markets in Southern Europe, which were hard hit during the recession, are witnessing growth. The bullish trend can be validated by Starwood’s system-wide occupancy data for the first quarter, which was an impressive 57.7% in Europe. Other major players like Hilton Worldwide, Choice Hotels International Inc. (CHH) and Wyndham Worldwide Corporation (WYN) are also eying 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 restructure their portfolios.

Brand Renovation to Boost Growth: Hotel companies are diligently working on guest satisfaction to enhance their position in this highly competitive environment. Hence, brand conversion and re-modelling have become the order of the day. In fact, brand perception is likely to have a growing influence in the large mass-market segment. With the market becoming increasingly saturated, hotels will need to increasingly differentiate themselves.

Brands that can offer something uniquely compelling are likely to grab market share and the ability to innovate will be a key driver for success. Therefore, many leading hoteliers like Starwood Hotels, Marriott International, Orient-Express Hotels Ltd. (OEH), Hyatt Hotels and The Marcus Corporation (MCS) are firing on all engines to make their brands more relevant in today’s environment.

Embracing Social Media and the Smartphone Technology to Build Loyalty: Digital innovations and social media are starting to play an increasingly important role in hotel bookings.

Social media can enhance a brand’s prospects by connecting directly with guests, which in turn can lead to increased loyalty and market share. Social media sites like Facebook, Inc. (FB), Twitter, Inc. (TWTR), TripAdvisor Inc. (TRIP) are now increasingly playing an important role in helping travelers select a hotel.

Moreover, hoteliers are also increasingly using mobile technology like applications to help guests manage their bookings, interactive maps/GPS as well as reward programs. Keeping up with the latest technology is no longer an option but a necessity for the hotel industry to be successful.

Many companies are setting up analytics tools to understand consumer preferences — and deliver a differentiated experience — which could eventually motivate customers to visit frequently, stay longer and spend more. Loyalty programs are a major part of the brand experience and hoteliers are continuously reengineering loyalty programs aimed at providing a more rewarding experience for consumers

Currently, Marcus Corporation and Marriott Vacations Worldwide Corp. (VAC) enjoy a Zacks Rank #1 (Strong Buy). However, Starwood, Wyndham Worldwide, Hilton Worldwide and Choice Hotels 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 optimistic outlook for 2014. Similarly, we are also positive on Zacks Rank #3 (Hold) company Marriott International and Intercontinental Hotels Group plc (IHG) 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 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.

Lingering Uncertainty in Other Regions: Despite immense growth potential, hoteliers are still caught up with several macroeconomic issues in international markets like the 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 arrested the overall Latin American sales. The upcoming elections in Brazil add to the woes. 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 hoteliers, particularly in the northern and western parts where the government is a major customer. Although tourism in India has recovered post elections, the controversial anti-government protests in Thailand have significantly hurt business.

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. We have no companies carrying a Zacks Rank #4 (Sell) for now. However, Sands China Ltd. (SCHYY) carries a Zacks Rank #5 (Strong Sell), mainly due to China's economic slowdown, liquidity fears and a crackdown on luxury spending.

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 #38. This is lower in all industries ranked, highlighting the group’s near-term positive outlook.

The group’s positive Zacks Rank placement is essentially a function of many a company improving on their top line, primarily due to increased tourism numbers.

Earnings Trends

The hotel industry falls under the broader Consumer Discretionary sector.

The second-quarter earnings season so far 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 beat the Consensus mark on both the earnings and revenue front.

The earnings "beat ratio" was 66.7%, while the revenue "beat ratio" was 55.6% in the second quarter so far. Total earnings for this sector increased 14.9% in the second quarter so far, compared with 13.7% in the first quarter. Total revenue grew 5.0% in the quarter versus a 8.8% increase in the previous quarter.

Second quarter 2014 earnings are expected to rise 4.9%, thereby pegging the full-year 2014 growth outlook at 13.8%. For 2015, the sector’s earnings are poised to expand around 15.5%.

Revenue is expected to grow 4.0% in the second quarter of 2014, pegging the full-year 2014 growth outlook at 5.3%. For 2015, the sector’s revenues are poised to expand around 5.9%.  

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

A look at the Earnings ESP in the table below shows that Hilton and Extended Stay America, Inc. (STAY) could miss the Zacks Consensus Estimate in the next quarter, while Choice Hotels International Inc. could easily surpass.

Bottom Line

We firmly believe that despite a lackluster performance by the U.S. economy in the first quarter, the lodging sector outperformed expectations. This makes it a worthy investment proposition for 2014 buoyed by the ongoing recovery in the economy as well as the low supply and high demand scenario in the hotel industry. Although risks have continued to ease out, near-term risks related to tepid recovery in the domestic housing sector continue to remain the overhangs.

Our proprietary Zacks Rank indicates the movement of the stocks over the short term (1 to 3 months). At present, 35.3% and 58.8% of the stocks hold a positive and neutral outlook, respectively, while the remaining 5.9% are negative.

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