Editor's Choice

3 Lodging Stocks That Could Move Higher

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

After outperforming for most of 2012, lodging stocks have underperformed recently amid concerns about a wobble in 4Q RevPAR (Revenue Per Available Room) extending into 2013. Over the last one month, the stocks of some big hotel companies like Marriott International (NYSE: MAR), Starwood Hotel and Restaurants Worldwide (NYSE: HOT), Wyndham Worldwide Corporation (NYSE: WYN) and Intercontinental Hotels Group (NYSE: IHG), have all underperformed Standard & Poor’s 500.

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I don’t think Starwood Hotels is a good buy at the current levels, as it has the highest PEG ratio among these companies. However, I feel Marriot, Wyndham, and Intercontinental Hotels have a good upside potential. Here’s a look at these stocks in detail.

Marriott International

Marriott's brands are some of the most recognizable hotel brands in the world, and include Marriott, Ritz-Carlton, Residence Inn by Marriott, and others. With the completed spin-off of its timeshare business, Marriott can focus on its asset-light, less volatile, and higher margin management and franchise businesses. This structural change could lead to multiple expansion from current valuations.  Marriott is trading at a forward P/E of 18.30, which is at a slight discount to Starwood Hotels (trading at a forward P/E of 19.82). However, Marriott has a far better expected growth rate over the next five years (18.98%, as compared to Starwood’s 14.92%) and thus, looks undervalued on a PEG basis.

Moreover, the company has been aggressively repurchasing its shares (share count has declined 20% since 3Q 2006), and I expect this trend to continue as the company has $1 billion of free cash (~9% of its market cap), which is probably going to be used for additional share repurchases through 2014. The company also offers a dividend yield of 1.4%; thus these share repurchase activities will limit any downside risk.

Wyndham Worldwide Corporation

Wyndham Worldwide Corporation encompasses approximately 7,380 franchised hotels and vacation ownership resorts, with approximately 633,700 rooms worldwide. Wyndham possesses a very resilient and fairly low capital-intensive set of hospitality businesses that generate meaningful free cash flow ($600 million to $700 million annually) that can be harvested to shrink the share count while maintaining investment-grade credit statistics. The company has made great strides in timeshare business to position Vacation Ownership as a sustainable, positive contributor to shareholder value.

Vacation Ownership improvements, combined with current positive trends in the lodging space, have resulted in significant earnings improvement and free cash flow generation. As a result, the stock has more than tripled over the last 3 years. However, I believe the stock still has a strong upside potential, as the company is trading at a discount to its peers and looks highly undervalued on a PEG basis (PEG ratio of 0.88).

Intercontinental Hotels Group

InterContinental Hotels Group is a global hotel company, operating seven brands internationally. While the outlook for 2012 appears uncertain in Europe, I expect Intercontinental Hotels’ favorable geographic mix (65% of EBIT from US) and asset light model to continue outperforming. InterContinental’s development pipeline is among the largest of its peers, and its international footprint provides exposure to high growth markets such as Asia. The company has seen impressive growth in China over the last few years and is expected to post high-single digit to low double-digit RevPAR growth in China in the current quarter.

Additionally, the Holiday Inn re-brand initiative provides a significant opportunity for growth as refreshed hotels should offer a better RevPAR growth profile, and the potential for multiple expansion over time as brand perception is improved. Although Intercontinental has the highest PEG ratio when compared to Marriot and Wyndham, it also provides the highest dividend at the lowest payout ratio. Thus, the risk/reward profile looks attractive to me.

To sum up, I am optimistic about the lodging stocks mentioned above, and believe that there is solid upside potential despite an impressive year to date run up. All these companies have a history of returning substantial capital to shareholders through share buybacks and dividends, and I expect this trend to continue given a strong balance sheet and cash flow visibility.

Wyndham looks particularly attractive at the current levels, given a PEG ratio of 0.88. Marriot and Intercontinental have the potential for multiple expansion over time. The spinoff of timeshare business will gradually result in multiple expansion for Marriot, and Holiday Inn re-brand initiatives will improve Intercontinental Hotels’ brand perception and will help it attain a higher multiple over time. Thus, I recommend buying these stocks.

sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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