Profit From This Boom

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If you’re going to invest in hospitality, then you might want to consider the biggest provider of hotel rooms in the world.

Popular brands 

It’s possible that you have never heard of InterContinental Hotels (NYSE: IHG). However, there's an excellent chance that you have heard of its brand hotels, such as Holiday Inn, Holiday Inn Express, and Crowne Plaza. You might also want to familiarize yourself with its new brand names of Hualuxe (luxury hotel brand in China), and Even Hotels (wellness brand, with two locations opening in Midtown Manhattan).

Whenever a company is opening new locations, it’s a sign of upper management's confidence in that company’s future prospects. At the same time, the hospitality sector is highly cyclical, which can make investments dangerous.

The consumer hasn’t been very strong recently, yet InterContinental Hotels and its peers have continued to perform well. You might be wondering why that’s the case, but it all comes down to one reason.

Demand remains high

To answer the question above, it simply comes down to low supply. Due to uncertain economic conditions, hotel owners and management companies don’t want to spread themselves too thin. This has led to low supply, which has in turn led to increased demand, as well as increases in RevPAR (revenue per available room).

In the second quarter, RevPAR for InterContinental Hotels jumped 4.6% year-over-year. The Americas showed great strength, which was a major positive considering 49% of the company’s sales come from the Americas. Europe remained flat, and the only RevPAR decline (1.9% year-over-year) was found in China. The latter was attributed to natural disasters and tightened spending. However, InterContinental Hotels is confident in the long-term story for the consumer in China.

InterContinental Hotels is also enjoying rewards from the trend of outbound travel from China. Many of these travelers choose a Holiday Inn at their arrival location thanks to brand familiarity.

Since 99% of InterContinental's locations are franchised/managed, capital expenditures are low, margins are high, and switching costs are significant. Another added benefit is that contracts are often long term, sometimes reaching as long as 30 years.

InterContinential Hotels sports an impressive net margin (amount of profit per dollar invested) of 29.6%, and it yields 3%. The company continues to return excess capital to shareholders. For example, it recently hiked its dividend 10%, and there will be a $350 million special dividend in October.

All that said, InterContinental Hotels owns a lofty debt-to-equity ratio of nearly 4.0 versus an industry average of 1.2. If demand were to wane, then high debt loads could wreak havoc on growth potential. Due to the industry’s highly cyclical nature, it’s only a matter of time. However, all is well for right now.

Related options

Marriott International (NYSE: MAR) is also a well-known brand, but this company’s brand exposure goes well beyond just Marriott. It includes Courtyard, Renaissance, Ritz-Carlton, and Fairfield.

Marriott is the second-largest hotel chain in the United States. Like InterContinental Hotels, most properties are franchised/managed. Also like InterContinental Hotels, Marriott has been reaping the benefits of low supply/high demand. Increased occupancy rates have allowed for higher room rates. As far as growth is concerned, Marriott is looking overseas.

In the second quarter, Marriott’s profit jumped 25%, and revenue increased 18%. However, Marriott guided lower, now expecting FY 2013 EPS of $1.92 to $2.03 versus an earlier expectation of $1.93 to $2.08. Investors despise lowered guidance, as it may indicate slowing top and/or bottom-line growth. 

Marriott is the only company of the three mentioned in this article that saw revenue decline in 2012, which is concerning. Earnings have also been inconsistent throughout the years. Due to a decline in top-line growth and reduced earnings guidance, Marriott doesn’t look to be the best investment option of this group. Perhaps the following company presents a better investment opportunity.

Wyndham Worldwide (NYSE: WYN) has seen revenue and earnings improvements over the past three years. It’s the largest operator of hotels and timeshares in the world (by units). Unlike Marriott, it recently upped its full-year earnings guidance from a range of $3.60-$3.70 to between $3.66 and $3.76.

Wyndham is currently enjoying increased occupancy rates in the United States, which, once again, leads to higher rates. Its time-share business also leads to strong cash flow (overall, cash from operations has gone from $950 million to $1.1 billion for the trailing-12 months). This is why Wyndham is looking to grow its time-share business. Furthermore, Wyndham continuously rewards shareholders via share buybacks and dividends. It recently announced a $750 million buyback plan, and it currently yields 1.8%. 

Conclusion

This first thing that should be pointed out is that none of these companies are resilient whatsoever. In other words, if the market comes down, investors will be punished. On the other hand, industry trends favor speculative trades in the industry at this time. Wyndham is likely best positioned for near-term gains. 

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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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