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The U.S. hotel & lodging industry wrapped up the year 2012 on a positive note, with lodging performance indicators witnessing considerable improvement in most parts of the world. In the fourth quarter, these sector heavyweights surpassed our earnings expectations: Starwood Hotels and Resorts Worldwide Inc. (HOT - Analyst Report), Marriott International Inc. (MAR - Analyst Report), Wyndham Worldwide Corp. (WYN - Analyst Report), Choice Hotels International (CHH - Snapshot Report) and Hyatt Hotels Corp. (H - Snapshot Report).
Notwithstanding the common macroeconomic hurdles expected ahead, the lodging sector should continue its recovery this year, underpinned by improving U.S. business as well as strong international travel and tourism volumes. The number of hotels Starwood opened and new deals signed in North America in 2012 were much higher the past couple of years.
Coming to the near-term industry dynamics, hoteliers will likely report significant RevPAR (revenue per available room) growth in the first quarter mainly on improved room rates which will be powered by stronger group business.
Market researcher Price Waterhouse Coopers expects RevPAR growth of 5.9% in 2013, representing the fourth year of lodging recovery. According to the market researcher, hotels across the gamut of price tiers, in particular the higher-priced ones, are expected to drive this recovery and consequent growth in the sector.
Improving Trends in North America: Owing to gradual economic recovery, the hotel industry continues to witness an upside. With lower supply in the U.S., RevPAR is improving on strong demand and continued higher pricing. System-wide occupancies in North America appear steady and above the prior peak level in 2006.
On a positive note, Canada also improved sequentially in the fourth quarter of 2012, and hoteliers expect to witness RevPAR growth from their Canadian businesses in 2013. Starwood expects 2013 to be its strongest year since the recession, in terms of hotel openings in North America.
The U.S. government has also implemented a new National Travel and Tourism Strategy, the main objective of which is to attract more than 100 million international visitors by 2021. The government believes that this will provide a significant growth stimulus for the local economy. The strategy, if successful, will reap profits for the U.S. hoteliers.
For 2013, Smith Travel Research predicts occupancy to be virtually flat with a 0.3% increase to 61.4%, ADR to rise 4.6% to $111.01 and RevPAR to grow 4.9% to $68.17.
Demand Exceeds Supply: Room rates are on the rise in an environment marked by higher demand and lower supply. PWC forecasts 0.8% supply growth and around 1.8% demand growth in 2013. This scenario is anticipated to push up occupancy levels. Supply growth is expected to remain low for a few years to come.
According to Marriott, fewer supplies combined with nearly peak occupancy levels will help hoteliers charge higher for rooms in 2013. Smith Travel Research anticipates room rates to reach 2008 levels on a nominal basis, going forward.
Shift Toward Asset-Light Model: Since late 2010, transition to an "asset light" business model has gained prominence in hotels and REIT industries. Asset sales remain a long-term strategy to strengthen financial flexibility, helping companies 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.
Hence, hoteliers are focused on rebalancing their portfolios by increasing contributions from managed and franchised hotels. This fee-based business is attractive as growth is powered by multiple sources like RevPAR, unit additions and incentive fee escalation. The business is also capital efficient as owner/developer partners provide the capital and the company earns a fee by managing/franchising the property.
Following the industry trend, many industry players like Morgans Hotel Group Co. (MHGC), Red Lion Hotels Corporation (RLH) and Starwood have moved toward an asset disposition strategy.
Renovation Gaining Precedence: Lately, most of the hoteliers are increasingly investing on property renovations. Hotel companies are diligently working on guest satisfaction to enhance their position in a cut-throat environment. Brand conversion and remodeling have become industry trends. Many industry biggies like Starwood, Marriott and InterContinental Hotels Group (IHG - Snapshot Report) have tread 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 this year.
International Expansion: Owing to saturation in the U.S. market, major hoteliers are exploring growth opportunities abroad. Some international markets offer greater potential riding on a stepped-up pace of economic growth. The operating environments in these markets help hoteliers grab a bigger share of the overseas pie.
A number of U.S.-based hoteliers are targeting the unsaturated markets of India, Brazil, China, Russia and Africa. Major players in the industry like Starwood and Marriott are primarily eyeing the Asia-Pacific, Africa and Latin American regions.
China is set to fuel a recovery in global tourism, and is expected to emerge as the world's most popular travel destination by 2020. Both Starwood and Marriott generate their second largest revenue stream from China.
Apart from China, India is another hot spot for the western hoteliers. India possesses a compelling investment proposition and is growing in prominence as a global business hub, where the demand for moderate-tier as well as upscale branded hotels is expected to considerably outpace the supply over the next three to four years.
The prospects for Latin America, particularly Brazil, remain outstanding. Brazil is the fastest-growing travel and tourism economy in Latin America. For tourists, particularly domestic travelers, the region is becoming one of the hottest destinations. Brazil primarily attracts affluent domestic tourists.
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 as demand for hotel rooms will shoot up and the events will significantly increase tourism in the country.
However, not everything is rosy in Latin America; Argentina has been adversely affecting Latin American RevPAR for the last nine months. The situation is not likely to improve in the near future with economic and political tension, an adverse currency impact and strict government control on imports.
Tension in the Eurozone: The European tourism industry will remain challenged until the continent tides over its nagging economic difficulties. According to Smith Travel Research, Europe showed no such movement during 2012, with occupancy inching up 0.1%, ADR and RevPAR declining 4.0% each (in USD). Russia and Germany were better-performing markets in the region. Though the scenario is improving, not much progress is expected in 2013.
A soft booking trend in the region is expected as most of the European businesses of U.S. hoteliers are driven by the leisure segments located specifically in Spain, Italy and Greece. These European countries are significantly exposed to sovereign debt challenges. However, the economic crisis is not uniform across the region.
In addition, in 2013, hoteliers will be facing tough comparison in Europe as some major events of 2012 like the Olympics, the Euro Cup Championship, and a grand fair in Germany brought in extra business last year.
Slowdown in Emerging Markets: As per IMF, the emerging markets have started to witness a slowdown owing to weaker external environment, a sharp deceleration in domestic demand and policy tightening as well as a fragile export environment which could possibly hurt the performance of the lodging sector in the near term.
Growth has slowed in a number of major emerging economies, especially in Brazil, China and India. Apart from slower GDP growth, RevPAR in 2013 may slow down on account of higher supply growth in a few emerging markets.
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 be back before 2014 or 2015. Also, any sudden deterioration in the European debt crisis and a rise in gas prices could undermine the winning momentum in hotel industry. If the economic recovery is actually thwarted, growth in the hotel sector -- one of the key indicators of measuring discretionary spending of consumers -- will be the worst hit.
The earnings results of most of the hotels like Starwood, Wyndham, Marriott, Choice Hotels, Hyatt Hotels and Home Inns & Hotels Management Inc. (HMIN - Snapshot Report) surpassed the Zacks Consensus Estimates. The highest positive surprise of 333.23% came from China-based Home Inns followed by 81.82% from U.S.-based Hyatt. The lowest surprise of 1.82% came from Marriott.
On the other hand, results from Orient-Express Hotels Ltd. (OEH - Snapshot Report) and Morgans were lower than the Zacks Consensus Estimates with a negative surprise of 266.67% from Orient followed by a 118.18% negative surprise from Morgans.
Our proprietary Zacks Ranks indicate the movement of the stocks over the short term (1 to 3 months). By the look of things, we currently refrain from getting too enthusiastic on a number of stocks in our universe that continue to hold a Zacks #3 Rank (Hold). These include Starwood, Marriott, Wyndham, Hyatt, Morgan Hotels, Orient-Express and The Marcus Corporation (MCS).
However, there are some lodging industry stocks which will likely outperform the broader market and currently hold a favorable Zacks Rank. These include Home Inns and Choice Hotels. While Home Inns retains a Zacks Rank #1 (Strong Buy), Choice Hotels holds Zacks Ranked #2 (Buy).
In hindsight, the fourth quarter earnings results of the hotel sector were essentially satisfactory. Hence, we have a Hold rating for the majority of stocks in our coverage in this sector. There were no stocks with the Zacks Rank #4 (Sell) or #5 (Strong Sell).
To sum up, we firmly believe that despite a few pitfalls, the lodging sector offers a worthy investment proposition for 2013 given the ongoing recovery in the economy as well as the low supply scenario in the hotel industry.