The U.S. hotel industry cycle appears to be moderating to historical norms, coming off years of accelerated growth that started in 2010 following the Great Recession. This moderating trend is expected to continue this year as well, with many industry players projected to experience muted growth.
Solid lodging fundamentals, a steady rise in business and leisure travel on the back of an improving economy and positive employment numbers are favorable developments for the industry. Strong investor appetite thanks to higher transaction volumes should also help.
Prospects of lower taxes, reduced regulations and updated trade policies should contribute to improving economic conditions, surging capital markets and rising business and consumer confidence. This is likely to support growth in corporate transient demand, which was bumpy all through 2016.
On the flip side, geopolitical uncertainties are expected to continue weighing on the performance of the U.S. lodging industry. Also, rising costs, the strengthening U.S. dollar and its impact on inbound, international travel along withpockets of geopolitical instability and economic slowdown,are all expected to keep the industry’s growth in check.
We thus expect the lodging cycle to more or less align with the broader business cycle, going forward. This is reflected in the group’s recent stock price performance as well, which has been roughly in-line with the S&P 500 index over the past year.
What Do the Numbers Say?
Statistics underscore the expectation of a more or less flat performance by the hotel industry. A recent report by PricewaterhouseCoopers (“PwC”) shows that new supply is likely to rise 1.9% in 2017, outpacing demand growth of 1.6%. This is likely to affect occupancy rates, which are expected to fall marginally by 0.3% in 2017.
Meanwhile, though average daily rate’s (ADR) projected rise of 2.6% in 2017 will be lower than 2016’s rise, it will still be impressive. As a result, revenue per available room (RevPAR) is expected to increase 2.3%. This will be however lower than the average RevPAR growth recorded in the past few years.
Moreover, the Baird/STR Hotel Stock Index, which comprises 20 of the largest market capitalization hotel companies publicly traded on a U.S. exchange and attempts to characterize the performance of hotel stocks, rose 0.7% in Feb 2017.
Additionally, according to Smith Travel Research (STR), a leading information and data provider for the lodging industry and Tourism Economics,overall occupancy at U.S. hotels was up 1.9% year over year for the week ended Mar 4, 2017. ADR rose 1.6% year over year and RevPAR grew 3.6% in the same timeframe.
Hoteliers have been focusing on renovation and digital and marketing initiatives to boost traffic and capitalize on growing tourism numbers. However, to do so, the steep costs incurred by leading hoteliers are taking a toll on profits. Moreover, high labor costs will continue to be a major concern for hoteliers, and as they won’t be able to boost ADRs as much as they would like, it is likely to further dent their profits. In fact, online travel agents like Expedia Inc. (EXPE - Free Report) , TripAdvisor (TRIP - Free Report) and The Priceline Group Inc. PCLN are also limiting the pricing power of these brands.
Moreover, negative sentiment related to travelling to and from the U.S. following President Donald Trump’s recent travel ban brings bad news for hotels that play a crucial role in the travel supply chain.
Meanwhile, the slowdown in China, lingering uncertainty in various international markets, and increased supply are likely to continue to pose headwinds. Particularly, in Europe, economic/political conditions are expected to be challenging post-Brexit.
Another major threat comes from home sharing companies, like Airbnb, Inc., which offer a digital service allowing travelers to book homes at holiday destinations. With lower overhead costs and far less regulations than what hotel companies have to comply with, these firms have made steady inroads into the industry and are grabbing share from giants like Marriott International, Inc. (MAR - Free Report) and Hilton Worldwide Holdings Inc. (HLT - Free Report) . Notably, both Marriott and Wyndham carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
What Can Drive Growth?
The hotel industry is particularly vulnerable to the ebbs and flows of economic conditions. So the present solid economic fundamentals that should spur consumer spending in 2017 raises optimism for hoteliers.
Moreover, hoteliers will be able to counter any economic volatility better, if they keep moving from owning real estate to franchising their brands and services.
Particularly, hoteliers must look for ways to sustain their growth as online private accommodation aggregators flood the marketplace with new inventory. In fact, Marriott’s acquisition of Starwood Hotels & Resorts Worldwide Inc. is being viewed as a move to combat the rising threat from online travel agents and home sharing companies. Other hoteliers like Hyatt Hotels Corporation (H - Free Report) and Wyndham Worldwide Corporation WYN are also investing in home sharing start-ups to combat Airbnb.
Thus, as hoteliers strive to enhance value and competitiveness, industry-best practices such as sustainability, brand refreshment and increased visibility through technological innovation and social networking – especially among the millennials – will remain the priorities.
Why Hotel Stocks Still Have Some Upside Left
While the industry outperformed the broader market over the last five years, it seems there is still a value-oriented path ahead. Looking at the industry’s EV/EBITDA ratio (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization), which is the best multiple for valuing hotels as they are highly capital intensive, investors might still want to own these stocks.
The industry currently has a trailing 12-month EV/EBITDA ratio of 11.4X, which compares favorably with what it saw in the last five years. The ratio is lower than the average level of 12.7X and its high of 17.4X over this period.
Moreover, it compares somewhat favorably with the market at large, as the current EV/EBITDA for the S&P 500 is at 13.7X and the median level is 11.4X.
Overall, the valuation of the industry from an EV/EBITDA perspective looks attractive when compared with its own range in the same time period. Moreover, its lower-than-market positioning calls for some more upside in the quarters ahead.
Zacks Industry Rank
Within the Zacks Industry classification, hotel companies are broadly grouped in the Consumer Discretionary sector (one of the 16 Zacks sectors).
We rank 265 industries into 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our X industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).
Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by more than twice as much. The Zacks Industry Rank for Hotels & Motels industryis currently at #92 (Top 35%).
The ranking is available on the Zacks Industry Rank page.
The Hotels & Motels industry falls under the broader Consumer Discretionary sector.
If we look at the overall results of the sector, earnings grew 10% in the December quarter while total revenues rose 11.3% in the quarter.
Meanwhile, for the March quarter, though revenues are expected to rise 11.5%, earnings are projected to record a gain of mere 1.2%. However, for 2017, both earnings and revenues are expected to rise roughly 7.3% and 4.1%, respectively.
For more details about earnings for this sector and others, please read our ‘Earnings Preview’ report.
Looking at the recent economic indicators and the industry’s cheap valuation, the growth prospects of the industry appear bright. With their focus on innovation, hoteliers could turn some of the challenges into opportunities in 2017.
We note that lodging is a cyclical business. Although flat performance seems dispiriting, the compelling fundamentals supporting continued growth in travel will avert an outright fall from the present peak levels.
Thus, though industry-wide headwinds continue to weigh on sentiment, hoteliers are cautiously optimistic moving ahead in 2017.
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