The hotel and lodging industry is progressing quite well in the
first half of 2012, based on strong global travel demand and
sustainable U.S economic growth. With the global economy gradually
recovering, leading to turnaround in business, higher leisure
travelers and decelerating supply growth, pricing power is expected
to remain stable for the year.
Moreover, easing U.S. visa procedures, European Soccer
championships in Poland and the Ukraine, followed by the Olympic
Games in London will further boost tourism in 2012 in the US and
Europe, respectively.
Recovery in the U.S. economy and the consequent rise in operating
metrics helped most of the hoteliers report strong quarterly
results. Group bookings appear to be gaining momentum and the
companies registered strong advance bookings and pricing for 2012
and beyond.
However, the sovereign debt crisis in Europe and slowdown in
emerging markets will restrain industry growth in 2012. Overall,
the long-term outlook of the sector remains promising.
International Growth
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 prevailing higher pace of
economic growth. The operating environment in those markets enabled
hoteliers to grab a bigger share of the overseas pie.
A number of U.S.-based companies are targeting the fast-growing
emerging economies. Major players in the industry like
Starwood Hotels and Resorts Worldwide Inc. (HOT)
and
Marriott International Inc. (MAR) are eyeing
the Asia-Pacific and Latin American regions.
The stellar performance of the Asia-Pacific region is expected to
continue. Hotels in the Asia-Pacific region have been registering
significant upside across all three key performance metrics,
according to Smith Travel Research. The region's Occupancy, ADR and
RevPAR increased a respective 4.4%, 4.8% and 9.4% to 69.4%, $145.64
and $101.01 in March 2012.
Major growth markets within Asia-Pacific, China and India remained
more or less unaffected by the global economic turmoil and
long-term growth prospects remain strong. The availability of local
capital is another positive factor.
China is set to fuel a recovery in global tourism, and by 2020 is
expected to be the world's most popular travel destination. Both
Starwood and Marriott generate their second largest revenue chunk
from China.
Apart from China, India is another hot spot for the western
hoteliers. India possesses a compelling investment proposition with
its rising importance 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.
Moreover, western hoteliers also find the built-cost to operating
returns favorable. According to the latest Tourism Satellite
Accounting (TSA) research published by the World Travel and Tourism
Council (WTTC), the demand for travel and tourism in India is
expected to grow by 8.2% between 2010 and 2019.
The prospects for Latin America, particularly Brazil, remain
outstanding. Brazil is the largest country in South America and is
Latin America's fastest-growing travel and tourism economy. For
tourists, particularly domestic travelers, the region is becoming
one of the hottest destinations. Brazil primarily attracts domestic
tourists, owing to the resurgence of the middle class.
Moreover, with major events like FIFA World Cup in 2014 and
Olympics in 2016 coming up, the Brazilian government has turned its
focus to improving the infrastructure of the country 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 be constructed in the
country to cash in on the FIFA World Cup scheduled in 2014 and the
Olympics in 2016. Business Monetary International forecasts 21.5%
growth in tourist arrivals in Brazil through 2015, totaling over
6.73 million tourists.
Metrics Analysis
In evaluating hotel companies, we pay close attention to changes in
average daily room rate (ADR) to figure out the likely pace of
improvement in the sector.
A key operating metric in the lodging industry is RevPAR (revenue
per available room), which is derived by multiplying the occupancy
percentage of a hotel over a given period by ADR over that same
period. Changes in either occupancy or ADR will impact RevPAR, but
with different implications for bottom-line profitability.
With the recovery in the U.S. economy, the hotel occupancy
percentage is stepping up due to strong demand, along with
continued higher pricing. However, declining occupancy percentages
during the recession compelled some hoteliers to slash room rates
in a bid to woo visitors. Large group hotels are still being
impacted by group business booked in 2008-2009, which were
recessionary years. In most cases, this tactic results in material
long-term damage to the business primarily for some reasons:
First, increase in occupancy is accompanied by escalating
operating expenses. For every room that is occupied, there are
additional costs such as housekeeping, laundry and utilities that
must be incurred. Margins are compressed when room rates decline
and variable operating expenses increase. Changes in ADR, however,
affect the bottom line considerably.
Second and more importantly, cuts in ADR will be difficult to
recoup when the operating environment eventually improves. After
slashing room rates in an effort to fill up rooms, attempts to
restore these to the previous levels are likely to be met with
significant resistance from clients. The ability to benefit from an
improving economy will thus be delayed.
Finally, the ability of lodging companies to sustain room rates
should have a significant impact on their capability to weather any
kind of economic uncertainty. By keeping an eye on changes in ADR,
investors can gain some insight into companies that are best poised
to benefit with the economic revival.
OPPORTUNITIES
The hotel industry continues to witness upside and remains on track
for improved performance. We expect the positive demand growth
trend to continue in 2012 and beyond. According to Smith Travel
Research, the leading information and data provider for the lodging
industry, the U.S. hotel industry reported increased results across
all three key performance measures -- occupancy level, ADR and
RevPAR for the first quarter of 2012 as well as for the third week
of April.
Comparing the operating metrics on a year-over-year basis, the
industry's occupancy, average daily rate and RevPAR at the end of
the week increased 12.6%, 7.8% and 21.4% to 65.5%, US$106.66 and
US$69.91, respectively.
In its April projection, The International Monetary Fund's (IMF)
also raised its US growth forecast for 2012 to 2.1% from its
previous projection of 1.8% in January.
Demand Exceeds Supply
In the U.S., Smith Travel Research expects supply in 2012 to inch
up 0.8% but demand to increase 1.3%. In 2013, supply is estimated
to rise 1.4%, but demand is expected to jump 2%.
Room rates swung back to profit in an environment marked with
higher demand and lower supply, thus resulting in RevPAR growth in
2012.
According to data published by Smith Travel Research in March, the
total active U.S. hotel development pipeline comprises 2,752
projects totaling 293,850 rooms, down 9.5% year over year. Among
the chain scale segments, Luxury reported the largest increase in
rooms in the total active pipeline, up 17.8% with 16,772 rooms.
However, despite reporting maximum upside in both rooms under
construction and rooms in the total active pipeline, the Luxury
segment still accounts for a small number of actual rooms compared
to other segments.
Shift Toward Asset-Light Model
Since late 2010, transition to an "asset light" business model has
gained prominence in the hotels and REIT industry. Asset sale
remains a long-term strategy to strengthen financial flexibility,
which help the 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 in Renovation
Most of the hoteliers are increasingly investing on property
renovations in recent times. Hotel companies are working hard on
guest satisfaction to enhance their positions in a cut-throat
environment. Brand conversion and remodeling has emerged as a trend
for major hoteliers. Many industry biggies like Starwood, Marriott,
and others have treaded the same path.
There are several well positioned, older hotels in metro markets,
which are good candidates for restructuring. Hence, we believe that
2012 will likely witness further renovations.
Currently, Starwood (HOT),
Marriott (MAR), Intercontinental Hotels
Group plc (IHG), Orient-Express Hotels
Ltd. (OEH) and The Marcus Corporation
(MCS) hold Zacks #2 Ranks (short-term Buy rating). Whereas,
Wyndham Worldwide Corporation (WYN) holds a Zacks
#1 Rank (short-term Strong Buy rating).
Simplified U.S. Visa Process
To boost travel and tourism in the U. S., the government has
recently signed an administrative order aimed at simplifying the
visa process. The government aims at increasing its share of the
international travel market by easing the visa procedure. Hotel
companies remain upbeat regarding the government's initiative and
expect to enjoy more visitations in the U.S., which remained
hampered earlier due to stringent visa policy.
WEAKNESSES
Tough Comparisons in 2012
The U.S. hotel industry is expected to witness fragmented growth
across all the three metrics in 2012. Smith Travel Research remains
apprehensive regarding the three key performance metrics for 2012,
due to the persisting global economic uncertainty and the tougher
year-over-year comparisons.
In January 2012, Smith Travel Research slightly raised its forecast
for 2012 from its previous projection in November last year.
Occupancy is expected to rise 0.5% to 60.4% as compared to the
earlier projection of 0.2% to 60.0%, ADR will increase 3.8% to
US$105.45 versus 3.7% to US$105.29, while RevPAR is expected to end
the year with an upside of 4.3% to US$63.68 compared with an
increase of 3.9% to US$63.18.
IMF projections for 2012 indicate a global growth of 3.5%, up
slightly from 3.3% forecasted in January, but down from the
forecast of 4.1% in September. The financial turmoil and the
deepening Eurozone crisis are responsible for sluggish global
growth outlook and weak investor projections. Hence, lack of
worldwide growth and strong demand last year will make the
situation tougher in 2012.
Tension in 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 not resolved in Europe, customer
will continue to remain cautious in visiting Europe.
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.
However, European Soccer championships in Poland and the Ukraine,
followed by the Olympic Games in London, might drive higher
visitors in Europe.
These European countries are significantly exposed to sovereign
debt challenges. Some companies anticipate weak performance in the
British provinces, arising from the government austerity efforts.
However, the effect of crisis is not uniform across the region.
As per the IMF's April 2012 projection Eurozone economic growth is
expected to shrink by 0.3% in 2012.
Slowdown in Emerging Markets
The emerging markets have started to witness a slowdown, which
could possibly hurt the performance of the lodging sector in the
near term. The growth prospects for China remains lackluster as in
the first quarter of 2012, the country recorded only 7.2%
sequential growth on a seasonally adjusted basis for 2012, below
the government's newly-revised 7.5% full-year growth target. In
January, the IMF expected China to grow by 8.2% in 2012 and
currently reiterated its forecast for the region.
The IMF also estimates slightly weakening growth for India in 2012.
In its April 2012 projection, the agency cut down its growth
forecast for India from 7.0% to 6.9%.
Stiff Competition
Competition is also growing considerably 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.
Comparatively Slower Growth in ADR
Though occupancy levels have fairly picked up, ADR is yet to show
meaningful improvement in the U.S. We believe that the acceleration
in room rates will not reach the peak level, seen in 2007, before
the end of 2012. Additionally, the rebound is not uniform as many
secondary and tertiary markets are yet to see strong recovery.
Moreover, surging commodity prices raise concerns about the ability
of hotel companies to control costs.
By the looks of things, we currently refrain from being too
enthusiastic on a number of stocks in our universe, which continue
to have a Zacks #3 Rank (Hold). These include Great Wolf
Resort (WOLF) and Hyatt Hotels Corp.
(H).
We also remain concerned about the prospects of Morgans
Hotel Group (MHGC) which currently retains a Zacks #4 Rank
(Sell) as well as China Lodging Group Limited
(HTHT) and Home Inns & Hotels Management Inc.
(HMIN) which hold Zacks #5 Ranks (Strong Sell).
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