A Hot and Cold Investment

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you believe in the economic recovery, then Starwood Hotels & Resorts (NYSE: HOT) should be on your radar. If the job market continues to improve, consumers will have more discretionary income. This could lead to higher occupancy rates for Starwood and its peers. The entire industry seems to be very confident about the direction of the economy and consumption. They should be optimistic after last year’s performance. However, something doesn’t seem quite right.

The economy and the industry

The lodging industry has enjoyed rising demand since the Great Recession. According to the Hotel Price Index provided by Hotels.com, the average room price in the United States increased 5% in 2012. On a global basis, the average room price rose 3%. These are both strong numbers, but note that the global average room price jumped 4% in 2011, which indicates slowing growth. But a lot depends on location. For instance, the Middle East and Europe have seen declines in average room price (expected), while North America and the Caribbean have been top performers. Note: these numbers are based on actual prices paid by guests.

The industry expects revenue per available room to increase by an average of 7.2% over the next four years. This is largely based on projected job market and housing improvements. However, employment numbers haven’t moved much, but the most important factor is that the number of people looking for jobs continues to decline. This fact, combined with increased payroll taxes, a decline in average wages, spiking oil prices, and the eventual reduction of entitlements, doesn’t bode well for the lodging industry. Oil is up due to rising tensions in the Middle East, but all other commodities are falling, which is almost always an early sign of decreased demand and a slowdown in the global economy. If this trend reaches the stock market, then discretionary spending will slow considerably. As far as housing goes, it’s still afloat, and home prices are affordable compared to historic norms, but with mortgage rates steadily increasing, it’s only a matter of time before demand falls there as well. This, in turn, will also hurt the lodging industry.

Company-specific analysis

Starwood is the largest operator of luxury and upscale hotels. Its brand diversification is superb, and those brands include St. Regis, The Luxury Collection, W, Westin, Sheraton, and Four Points. This diversification allows Starwood to set different price points and establish customer loyalty. If a traveler stays at a Sheraton and enjoys it, but that traveler wants to visit a different location without a Sheraton the following year, Starwood can offer a different type of property for that location. 

Starwood’s revenue increased in the past three years, and 2012 revenue exceeded the 2008 level. The latter is a positive sign as many companies throughout the broader market haven’t been able to accomplish this goal. Another positive sign is earnings growth. Below is the diluted EPS breakdown over the past five years:

  • 2008: 1.77
  • 2009: 0.41
  • 2010: 2.51
  • 2011: 2.51
  • 2012: 2.86

Even though earnings can be manipulated, it’s still a major factor when it comes to stock price appreciation. Perhaps the most important and impressive aspect of Starwood’s recent earnings history is that it remained profitable in 2008 and 2009. 

Starwood’s profit margin of 17.67% indicates good efficiency and strong management. Starwood is currently trading at 20 times earnings, which makes it more affordable then soon-to-be-mentioned peers. Starwood also yields 1.90%.

On the other hand, according to Alexa.com, online traffic hasn't been so hot as of late. Over the past three months for starwoodhotels.com, page-views-per-user declined 4.68%, time-on-site dropped 6%, and searches (often indicates first-timers) plummeted 14%. These numbers don't guarantee anything, but they certainly don't indicate surging demand. 

Marriot (NYSE: MAR) is very similar in size, with both companies owning a market cap between $12.50 billion and $12.81 billion. Marriot saw revenue increases in 2010 and 2011, but revenue declined in 2012. Earnings have also been inconsistent over the past several years. Earnings jumped in 2012, but it should be noted that Marriot reported a loss in 2009. What makes this somewhat ironic is that despite the loss, Marriot’s stock held up better than Starwood’s stock at the time. This was likely related to Marriot’s size. For example, Marriot currently operates 3,800 properties in 74 countries, whereas Starwood operates 1,146 properties in 100 countries. Marriot also sports a healthy profit margin -- 24.26%, which demonstrates efficiency. Marriot is trading at 22 times earnings, and it yields 1.60%, both similar to Starwood. 

Hyatt (NYSE: H) is a smaller company, operating 508 properties in 46 countries, and with a market cap of $6.67 billion. This makes Hyatt more susceptible to stock market corrections. It also sports a profit margin of 3.55% -- not terrible, but not nearly as efficient as its peers. Additionally, Hyatt doesn’t offer any dividend. Though revenue has consistently improved over the past three years, earnings declined in 2012. And Hyatt also reported a loss in 2009, showing that it’s not as resilient to economic downturns as Starwood. One final point here is that Hyatt is trading at 79 times earnings, making it very expensive compared to peers. 

Conclusion

If you’re going to invest in one of these companies, then Starwood or Marriot should be considered over Hyatt. However, the industry seems to be overconfident in future prospects. It’s doubtful that consumers will shrug off a multitude of headwinds over the next several years. Investing in any of these names at the present time isn't recommended. 

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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