($HOT) Hotels & Lodging Stock Review – March 2010 – Industry Outlook

March 1st, 2010

The operating environment in the hotels and lodging industry has continued to deteriorate in the last several quarters, and we expect the operating metrics to remain stretched in the near term. As the recession continues, both business and leisure travelers are cutting back on trips.

However, with some early signs of economic recovery, the industry is experiencing an increase in demand. While hotel occupancy levels have somewhat improved, we noticed that pricing pressures persists as hotels continue to offer heavily discounted rates to draw in travelers. As such, we expect profits to remain restricted in this environment.

In evaluating hotel companies such as Starwood Hotels and Resorts Worldwide Inc. (HOT) and Marriott International Inc. (MAR), we will be paying close attention to changes in average daily room rates as an indication of how quickly the sector may recover once the economy improves.

A key operating metric in the lodging industry is RevPAR (revenue per available room). This metric is derived by multiplying the occupancy percentage of a hotel over a given period by the average daily room rate (ADR) over that same period. Changes in either occupancy or ADR will impact RevPAR, but with different implications for bottom-line profitability.

Given the current state of the U.S. economy, it is no surprise that hotel occupancy percentages have been down. However, some hotel owners have initiated a slashing of room rates in an attempt to fill beds. In most cases, this tactic will result in material long-term damage to the business for two primary reasons:

First Incorporatedreases in occupancy are accompanied by increases in operating expenses. For every room that is filled, there are additional costs such as housekeeping, laundry and utilities that must be borne. When room rates decline while variable operating expenses increase, margins are compressed. Changes in ADR, however, fall almost entirely to the bottom line.
Second, and more importantly, cuts to ADR are difficult to recoup when the operating environment eventually improves. After slashing room rates in an effort to fill a hotel, attempts to restore those rates to previous levels are likely to be met with significant resistance by the clients. As such, the ability to benefit from an improving economy will be delayed.

Ultimately, the ability of lodging companies to maintain room rates as much as possible should have a significant impact on their ability to weather the downturn. Cutting rates meaningfully should be an absolute last-ditch effort to survive. By keeping an eye on changes in ADR, investors can gain some insight to the companies that are the best poised to benefit when economic growth rebounds.

OPPORTUNITIES

According to the data from Smith Travel Research, the U.S. hotel industry reported declines in all three key performance measurements during Jan. 2010. The industry’s occupancy remained almost flat with a 0.4% decrease to 45.1%. Average daily rate declined 7.1% to finish the month at $93.93. These declines resulted in a 7.4% drop in RevPAR in January to finish at $42.35.

What we see is an improvement in occupancy levels from the prior periods. Additionally, the deterioration in other hotel industry performance metrics have started to moderate. We believe that the recovery of the hotel industry has begun. This trend of positive demand growth is expected to continue with the rebound of the economy in 2010. For instance, we are positive about the prospects of Red Lion Hotels Corporation (RLH), which has a Zacks #2 Rank (Buy).

Going forward, we expect stability in the hotel industry performance metrics. However, the pace of improvement is expected to slow as the economy is projected to improve at a sluggish rate this year. We also note that the year-over-year comparison in the fourth quarter of 2009 was easier as this quarter reflected the one-year anniversary of the abrupt decline in lodging demand.

When researching potential investments in the sector, however, we would advise investors to pay close attention to the ADR reported by lodging companies. We expect that companies with a solid balance sheet will be the best able to maintain room rates through the downturn and be better positioned to capitalize with improvements in the economic conditions.

There are currently a number of stocks in the hotel industry universe with a Zacks #3 Rank (Hold) including Marriott, Starwood, Choice Hotels International Inc. (CHH), Great Wolf Resorts Inc. (WOLF), Home Inns & Hotels Management Inc. (HMIN), Hyatt Hotels Corporation (H), Intercontinental Hotels Group plc. (IHG), Interstate Hotels & Resorts Inc. (IHR), Lodgian Inc. (LGN), The Marcus Corporation (MCS), Orient-Express Hotels Ltd. (OEH) and Wyndham Worldwide Corporation (WYN).

We believe that companies such as Marriott and Starwood are better positioned to command a premium room rate relative to the overall lodging industry.

WEAKNESSES

Though occupancy levels have somewhat stabilized, the rate of decline in ADR has continued. This clearly indicates a slow recovery of the industry. Given the lower levels of room revenue, we expect margins to remain restricted in the near term.

Corporates are controlling their expenses more than they ever have. Additionally, the unemployment rate is also expected to remain high in 2010. These factors are pushing the room rates down as hoteliers are desperately looking to fill up their rooms by slashing rates. Also, with new hotels continuing to open, we noticed that supply hasn’t slowed as expected earlier.

In addition, companies with weak balance sheets — or even limited financial flexibility — will likely have a harder time navigating the challenges created by the economic recession. Hence at this moment, it is difficult to become extremely positive on any stock and this reflects in our Hold recommendations on the majority of stocks in our coverage universe. We are also concerned about the prospects of Morgans Hotel Group Co. (MHGC) which currently has Zacks #4 Rank (Sell).

Zacks Investment Research

Stock Blog Hub

($HOT) Hotels & Lodging Stock Review – March 2010 – Industry Outlook

Author

Keyword Topics

Stock Blog Hub

($HOT) Hotels & Lodging Stock Review – March 2010 – Industry Outlook

Author

Keyword Topics

Tag Cloud

Share This Post