How to Trade These Lodging Stocks in 2013

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

2012 was a great year for the lodging companies with occupancy and RevPAR trends improving. Stock prices of these companies followed their business fundamentals and Marriott International (NYSE: MAR), Wyndham Worldwide (NYSE: WYN) and Intercontinental Hotels (NYSE: IHG) significantly outperformed the S&P 500. The following table shows some of the key parameters for these companies.

<table> <tbody> <tr> <td> <p><strong>Company Name</strong></p> </td> <td> <p><strong>% Gain in Stock 2012</strong></p> </td> <td> <p><strong>% increase in EPS 2012</strong></p> </td> <td> <p><strong>5 Yr Expected PEG</strong></p> </td> </tr> <tr> <td> <p>Intercontinental Hotels</p> </td> <td> <p>56%</p> </td> <td> <p>2.20%</p> </td> <td> <p>1.51</p> </td> </tr> <tr> <td> <p>Marriott International</p> </td> <td> <p>25%</p> </td> <td> <p>27.80%</p> </td> <td> <p>1.23</p> </td> </tr> <tr> <td> <p>Wyndham Worldwide</p> </td> <td> <p>42%</p> </td> <td> <p>27.70%</p> </td> <td> <p>0.95</p> </td> </tr> <tr> <td colspan="4"> <p><strong>Note:</strong> % increase in EPS and Forward PE data is sourced from Yahoo Finance and uses consensus estimates</p> </td> </tr> </tbody> </table>

As the broader economy continues to improve, I thought it would be interesting to analyze the fundamental aspects of these companies going forward. Here’s a look at each of these stocks in detail.

Intercontinental Hotels is among those few companies which might have an interesting restructuring story for the next two years or so. Asset sales and greater cash returns remain the key drivers for the company's potential future growth. The company plans to dispose of four of its assets by 2015 in order to generate more cash returns for its shareholders.

  • Intercontinental Barclay NY & Intercontinental London Park Lane to be sold off in 2013. Expected sale proceeds to be around $800 million in cash.
  • Assets in Hong Kong and Paris to be put up on sale in 2014 & 2015. Expected sale proceeds to be ~$1.1 billion.

Post all these restructuring activities, I expect ROCE which has always remained a key attraction for the company to jump around 56% and an EPS increment of ~10-14% annually.

Apart from the restructuring activities, the company has also launched two new brands EVEN Hotels and HUALUXE Hotels & Resorts. The company’s EVEN brand is the first ever hotel brand designed for health conscious travelers. Recently, IHG signed its first property signing for EVEN hotels in New York City which is scheduled to be opened in 2014. With this initiative, the company will be able to develop its portfolio with a set of brands for the new type of guests focused on wellness in terms of food, work, exercise and rest. Its HUALUXE brand is the world’s first international hotel brand which is specially designed for Chinese customers. After the launch, eight contracts have been signed for hotels in Beijing and Shanghai as well as six other locations across the country, a significant achievement in just five months. These strategic initiatives would lead to ~$150 million of capex growth in 2013. However, in the long run, it would enhance the company's portfolio of brands and would be helpful for its top-line growth. Moreover, I expect the company's favorable geographical mix and its 'asset light' approach will continue to outperform in the future.

Another lodging stock is Marriott International, which has around 99% of its properties under franchise or management agreements. These agreements generally have a long-term duration with initial periods of 20-30 years and a renewal option of around 50 years thereafter. This has been one of the key drivers for Marriott's success as it gives predictability for the company's earnings.

Talking about the long-term growth factors, Marriott has solid expansion plans in Asia to strengthen its portfolio. It already has a strong foothold in North America with around 81% of its total rooms’ concentration in this region only. So in order to expand its base in Asia, it has plans to double its hotels with prime focus onto China. In China, the company is targeting at around 125 hotels from the current level of 60 by 2016 which will nearly cover 75% of the Chinese provinces. This expansion is the company's move to attract the growing number of Chinese travelers which saw an increase of 21% in 2012 in China. Prior to this, in 2010 Marriott announced to expand its hotel base in India up to 100 hotels by 2015 which is currently on track with total 41 hotels to be done by 2013. In India, the hotels will be across all its seven leading brands and will also include the budget brand Fairfield Inn & Suites for the first time. This solid pipeline of new hotels clearly depicts the rapid growth of the company along with the improved market share in the next few years. Considering these plans, I expect ~9% top-line growth for the company through 2014.

Wyndham Worldwide's stock has shown a good growth with around 43% returns in the last one year which is mainly driven by its earnings from its vacation exchange and rental segment. I still see a further upside in the stock price as it is highly undervalued based on its PEG ratio for the next five years (0.95 against industry average of 1.23). To further enhance this segment in its continuing global expansion, the company recently closed three acquisitions in the US and UK. In the US, Wyndham acquired rental assets of Oceana Resorts and Kaiser Realty and in UK it acquired Cumbrian Cottages. All the three players have a strong portfolio of vacation homes at preferred destinations and are well positioned in the industry. Following these acquisitions, Wyndham's rental portfolio now consists of around 100000 properties in 500 destinations. I see these deals as a highly positive aspect as it will increase the room supply and will give more access to the company in the vacation rental market.

Another attractive factor for Wyndham is its meaningful free cash flow generation over the last 3-4 years. For FY2012, the company remains on track to generate ~$600-700 million of free cash flow. Looking at its history, I believe the company will return a larger part of free cash flow to its shareholder via dividends and share repurchases in the next two-three years. Considering all these factors, I expect an EPS growth of 20% annually till 2015.

To sum it up, I remain optimistic about the three lodging stocks discussed above. All the three companies have an 'asset light' approach in their business models that reduces their capex and working capital needs and improves ROIC. Moreover, these companies have a good history of returning cash to its shareholders which I believe will continue in the future looking at their cash flow generation.

madhudube 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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