Red Roof Inn Collapses

Another Major Hotel Default

Privately-owned hotel chain Red Roof Inn has defaulted on $467 million in mortgage debt.

The news is yet another example of the impact that the current operating downturn is having on highly-leveraged hotel companies. Given our present outlook for the industry, we would expect more such news in the near term.

Already this month we have seen a high-profile publicly-traded REIT default on a mortgage and hand over a high-end hotel to its lenders, as well as the bankruptcy filing of another highly-leveraged private hotel chain.

These mark just the most notable such examples, as many individual hotels throughout the country have defaulted on their debt and have declared bankruptcy.

Average weekly revenue per available room, or RevPAR, is down near 20% year-to-date. Deterioration of this magnitude puts an incredible amount of stress on even the best capitalized hotel owners. In the case of highly-levered firms with little or no balance sheet flexibility, it can be enough to sink the company entirely.

Large hotel franchisors such as Starwood Hotels Worldwide (HOT - Analyst Report) and Marriott International (MAR - Analyst Report) have for the most part exited the hotel-ownership business. While each company continues to hold some property assets, the majority of their business stems from franchising, licensing and managing hotels utilizing their brands.

While this business shift has protected the companies to some extent during this downturn, the massive declines in occupancy and room rate still have a major impact on their bottom-line profitability. We project that earnings per share will decline this year by more than 35% at Marriott and by more than 60% at Starwood.

Despite the obvious headwinds in the industry, lodging stocks had remained resilient, moving higher along with the market since early March. Recently, however, the stocks have shown signs of weakness.

As we do not expect a quick turnaround in industry fundamentals, we expect that the shares will remain under pressure going forward. Additionally, as more hotel owners default on their debt or file for bankruptcy, the stocks are subject to some measure of headline risk in the near term.

We reiterate our negative outlook on the group, as well as our Sell ratings on both Starwood and Marriott.