Hotel- And Lodging-Stock Outlook

The year 2013 is expected to end on a positive note for the hotel & lodging industry based on growing global travel demand and improving lodging performance indicators in most parts of the world. The recent run in the sector was largely supported by better-than-expected improvement in the job market in Oct 2013.

Though the partial U.S. government shutdown in early October had been a dampener, the lodging sector should continue its recovery into next year, underpinned by rising consumer confidence, growing U.S. business and strong international travel and tourism volumes.

Other important factors like higher barriers to entry and lower reliance on third-party wholesalers have positioned the hoteliers to attain peak levels not seen since the onset of the global economic crisis in 2007. The hoteliers are making every effort to improve their primary performance metrics like occupancy and RevPAR (revenue per available room).

A recent report by Price Waterhouse Coopers shows that the fiscal cliff notwithstanding, the lodging sector will continue to outperform in 2014 and 2015 on the back of robust booking trend and a solid travel and tourism market. The market researcher expects RevPAR growth of 5.5% in 2013 and 5.9% in 2014, driven by increased occupancy rate and higher average daily rate (ADR). As per Price Waterhouse Coopers, 2014 will be the fifth consecutive year of positive RevPAR growth.

Price Waterhouse Coopers also added that high-priced segments will be the major driver of industry growth.

Furthermore, mega sporting events in South America scheduled in 2014 through 2016 will boost tourism. As owners and operators strive to enhance value and competitiveness, industry-best practices, like sustainability and brand refreshment, will remain industry priorities.
 
How Well Did Leading Hoteliers Do in Q3?

The third quarter of 2013 was quite strong for most of the sector heavyweights – Starwood Hotels and Resorts Worldwide Inc. (HOT), Marriott International, Inc. (MAR), Wyndham Worldwide Corp. (WYN) and Home Inns & Hotels Management Inc. (HMIN). All these hoteliers surpassed their respective Zacks Consensus Estimate for both earnings and revenue.

Most of these hoteliers have witnessed significant growth in both RevPAR and ADR during the quarter. Moreover, Wyndham and Starwood have both raised their earnings guidance for the full year on the back of strong third-quarter performance.

Zacks Industry Rank
Within the Zacks Industry classification, we rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry.

As a guideline, the outlook for industries in the top 1/3rd of all Industry Ranks or a Zacks Industry Rank of #88 and lower is 'Positive'; the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is 'Neutral' and the bottom 1/3rd or Zacks Industry Rank of #177 and higher is 'Negative.'

The Zacks Industry Rank for the hotels/motels industry is currently #15. This is in the top 1/3rd of all industries ranked, highlighting the group’s near-term bullish outlook. The group’s favorable Zacks Rank placement is essentially a function of many a company improving its earnings picture, eliciting a positive estimate revision trend by the Street.

OPPORTUNITIES
Demand Exceeds Supply: A gradual recovery in the broader economy has boosted the hotel industry as demand rises both for leisure as well as transient business travel. With limited supply, the room rates are going up backed by strong demand.

Smith Travel Research (STR), the leading information and data provider for the lodging industry, expects the sector’s demand growth to be 2.2% in 2013 in the U.S. with only a 0.8% increase in supply. As per STR, supply growth is expected to be 1.1% in 2014, lower than the long-term average of 1.7%.
 
According to Marriott, low supply combined with nearly peak occupancy levels will help hoteliers charge higher for rooms in 2013. In a nutshell, with lower supply and robust demand, RevPAR is going up steadily backed by higher pricing.

The North American Recovery: System-wide occupancies in North America appear to be pretty steady and above the prior peak level achieved in 2006 following the gradual improvement in the economy.

According to STR, the U.S. hotel industry will continue to perform well in late 2013 and in 2014 across all three key performance measures -- occupancy level, ADR and RevPAR. STR expects that with a 4.2% and 4.6% rise in ADR, RevPAR would grow 5.7% and 6.0% in the U.S. in 2013 and 2014, respectively.
 
STR also predicts upper-tier lodging segments are expected to witness maximum RevPAR growth in 2013. The U.S. hospitality sector, specifically in Houston, Oahu Island and San Francisco, continues to display strong signs of expansion and growth.

The bullish forecast seems to have pumped fresh blood into the hospitality sector. Hotel owners are investing huge money and driving innovations in the hope of a brighter future. Marriott expects nearly 50% of its 2013 openings will be in the U.S. as a positive business environment prevails in North America.

In Europe, too, the scenario is improving. In fact, select markets in Southern Europe, which were hard hit during the recession, have begun to report growth. The bullish trend on two continents can be validated by Starwood’s system-wide occupancy data in the third quarter, which surpassed 76% in the U.S. and 73.9% in Europe.

International Expansion: The demand for hotels in the international market is greater than in the U.S. and the pace of recovery is particularly fast in those regions. The positive fundamentals in foreign markets have spurred hoteliers to grab a larger share of the overseas pie.

A number of U.S.-based hoteliers are targeting the unsaturated markets of Asia-Pacific, Brazil, Russia and Africa. Within Asia, China promises immense growth potential with visits expected to increase substantially by 2014. Both Starwood and Marriott generate their second largest revenue stream from China.

Apart from China, India is now becoming a hot spot for western hoteliers, as the country is emerging as a global business hub. Major players in the industry are also eyeing the Latin American countries, particularly Brazil and Mexico. Brazil primarily attracts affluent domestic tourists in the flush of an economic resurgence.

Moreover, with major events like the FIFA World Cup in 2014 and the Summer Olympics in 2016, the Brazilian government has turned its focus on improving the country’s infrastructure. The events will significantly increase tourism in the country and the demand for hotel rooms will shoot up.

Asset Disposition Strategy: Since late 2010, the transition to an ‘asset light’ business model has gained momentum in the hotels and REIT industry. Asset sale remains a long-term strategy for greater financial flexibility. The companies are likely to grow through management and licensing arrangements instead of direct ownership of real estate. A higher concentration of management and franchise fees reduces earnings volatility and provides a more stable growth profile.

Several hoteliers like Morgans Hotel Group Co. , Red Lion Hotels Corp. , Marriott and Starwood followed this industry trend to rebalance their portfolios.

Renovation to Boost Growth: Hotel companies are diligently working on guest satisfaction to enhance their position in a cut-throat environment. Hence, brand conversion and remodeling has become the in thing for major hoteliers. Many of the industry's biggest companies, like Starwood, Marriott and InterContinental Hotels Group (IHG) have treaded the same path.
There are several well-positioned, older hotels in metro markets which are good candidates for restructuring. In view of that, we foresee several renovations in the coming year.

WEAKNESSES
Lingering Uncertainty in Many Quarters: Despite immense growth potential, the hoteliers are still caught up with several macroeconomic issues like the probability of tapering quantitative easing by the Fed, ongoing austerity measures in Europe resulting from the sovereign debt crisis and decelerating growth in Asia.

Budget sequestration, effective since Mar 1, 2013, is expected to hamper the business travel in North America to some extent. Lower government spending on travel will hurt the group and transient bookings trend.

We believe the European tourism industry will continue to face challenges until it recovers from its nagging economic difficulties. Even though the broader picture has materially stabilized, most data from the region still shows continued sluggishness.

Growth has slowed down in a number of major emerging economies, especially in Brazil, China and India. We expect some slowdown in China due to the new government policies. Brazil is also experiencing the dual pressures of a deteriorating political situation and a slowing economy.

Operating Margins Under Pressure: Though RevPAR has fairly picked up since the recovery in the industry in 2009, operating margins have yet to reach the industry peak of 2007 in the U.S. This is due to the spike in overall inflation. As a result of economic uncertainty, it is now estimated that peak levels will not be achieved anytime soon.

Some hoteliers like Marriott even feel that the golden days of the lodging industry will not return before 2014 or 2015.

Earnings Trends
The hotel industry falls under the broader Consumer Discretionary sector, which displays stable earnings trends. The third quarter of 2013 results for the sector has been impressive in terms of both beat ratios (percentage of companies coming out with positive surprises) and growth.

The earnings "beat ratio" was 79.3%, while the revenue "beat ratio" was 31.0%. Total earnings for this sector increased 11.9% in the third quarter, reflecting a decline from 15.8% growth registered in the second quarter. Total revenue grew 4.6% in the quarter versus a 6.8% jump in the previous quarter.

We are also encouraged by the positive trend seen in the earnings consensus, with fourth quarter 2013 earnings expected to rise 9.7%, thereby pegging the full-year 2013 growth outlook at 15.3%. For 2014, the sector’s earnings are poised to expand around 15.3% with 7.0% growth in the first quarter itself.

Moving Into the Fourth Quarter
Coming to near-term industry dynamics, hoteliers will likely report modest RevPAR growth in the fourth quarter of 2013 backed by an improvement in room rates and strong demand, offset by economic uncertainties.

Marriott expects the government shutdown to hurt the North American RevPAR by 1% in the fourth quarter.

Bottom Line
Overall, the performance of the hotel and lodging sector was essentially satisfactory. Our proprietary Zacks Ranks indicate the movement of the stocks over the short term (1 to 3 months). At present, 41.7% and 58.3% stocks, respectively, hold a positive and neutral outlook. None of the hotel and lodging stocks currently carry a negative rating.

We recommend few stocks in the sector at this point, as these companies are showing significant growth despite the secular headwinds. The stocks in our coverage with a Zacks Rank #1 (Strong Buy) include Home Inns & Hotels Management Inc. and Sands China Ltd.

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