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U.S. Hotel Industry Outlook - November 2017

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So far, 2017 has been welcoming for the U.S. hotel industry with moderate demand growth supporting increases in both occupancy and average daily rate (ADR). Resultantly, revenue per available room (RevPAR) witnessed a rise of 3.4% and 2.7%, respectively, in the first two quarters.

This is further reflected in the industry’s stock-price performance. Over the past year, the Zacks Hotels and Motels Industry has fared better than the broader S&P 500 index. While the industry has gained 36.1%, the broader index has added only 21%.

Though first-quarter GDP growth remained moderate at 1.2%, the economy picked up pace in the second quarter, expanding at an annual rate of 3.1%, better than initially estimated. We note that rising employment, higher real income, and increased household net worth reinforced consumer confidence and sentiment. This has resulted in a steady rise in business and leisure travel, and higher transaction volumes, which are likely to continue.

Going forward, consumer and business spending are expected to keep the mood upbeat, suggesting that the U.S. economy will remain on solid footing for the balance of 2017. In fact, the Atlanta Federal Reserve’s GDPNow model forecasts gross domestic product (GDP) to grow a healthy 2.7% (annualized rate) in third-quarter 2017.

However, peaking supply growth continues to be a meaningful downside risk and is expected to put pressure on pricing power, thereby tempering the performance somewhat.

What Do the Numbers Say?

Statistics underscore the expectation of moderating but positiveperformance by the hotel industry. A recent report by PricewaterhouseCoopers (PwC) shows that new supply is likely to rise 1.9% in 2017, slightly below the anticipated demand growth of 2.1%. This is likely to result in a 0.2% rise in occupancy rates in 2017 to 65.6%.Though ADRand RevPAR are projected to climb 2.1% and 2.3%, respectively, in 2017, the rate of increase will be less than the average growth recorded in the past few years.

Meanwhile, 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 5.3% in September 2017. In fact, year to date, the index is up 16.6%. Higher interest rates, enhanced prospects for potential tax reform, and anticipated hurricane-related demand tailwinds aided the outperformance.

Additionally, according to Smith Travel Research (STR), a leading information and data provider for the lodging industry and Tourism Economics, U.S. hotels continue to witness robust improvement across all metrics. While overall occupancy at U.S. hotels was up 2.4% year over year for the week ended Oct 14, 2017, ADR rose 5.3%. Resultantly, RevPAR grew 7.8% in the same time frame.

Obstacles Facing Hoteliers

Uncertainty, both international and domestic, may continue to weigh on the performance of the U.S. lodging industry.

On the one hand, negative sentiment related to traveling to and from the United States given the Trump administration’s stringent policies on immigration and tourism visasis bad for hotels. On the other hand, if the U.S. dollar gains strength, this may keep the industry’s growth at check, given its impact on inbound, international travel.

Additionally, higher costs and increased supply along with pockets of geopolitical instability and economic slowdown are likely to continue to pose as headwinds.

Meanwhile, hoteliers have been focusing on renovation and digital and marketing initiatives to boost traffic and capitalize on growing tourism numbers. However, to do so, 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, their profits may be dented further. 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.

Another major threat comes from home-sharing companies, like Airbnb, Inc., which offer 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 the companies carry a Zacks Rank #2 (Buy). 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 is likely to continue to spur consumer spending in the remaining of 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.

Meanwhile, keeping aside the necessary hotel renovation and reconstruction which could be costly and time-consuming, other post-hurricane dynamics could work to the advantage of the lodging industry.

Also, 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. was being viewed as a move to combat the rising threat from online travel agents and home-sharing companies. Other hoteliers like Hyatt Hotels Corp. (H - Free Report) and Wyndham Worldwide Corp. WYN are also investing in home-sharing start-ups to combat Airbnb.

So far in 2017, the hotel industry has proved to be resilient during this marketplace shift. Going forward, the industry is estimated to witness continued success.

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 millennials – will remain the priorities. Acute, focused investment in infrastructure to attract more business and leisure travelers will also hold the key to growth.

Why Hotel Stocks Still Have Some Upside Left

As the industry has underperformed the broader market over the last five years, it seems there is 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 pay more.

The industry currently has a trailing 12-month EV/EBITDA ratio of 11.7, which compares favorably with what it saw in the last five years. The ratio is lower than the average of 12.7x and the high of 17.8x over the last five years.

Moreover, it compares somewhat favorably with the market at large, as the current EV/EBITDA for the S&P 500 is 11.6x.

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 somewhat 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).

In fact, ourback-testing shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1. 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 #86 (Top 32%).

The ranking is available on the Zacks Industry Rank page.

Earnings Trends

So far, in third-quarter 2017, the performance of the hotel stocks have been a mixed bag. While Hilton surpassed the Zacks Consensus Estimate for earnings and revenues, Wyndham beat the consensus mark for earnings but missed on revenues.

The Hotels & Motels industry falls under the broader Consumer Discretionary sector.

If we look at the overall results of the sector, earnings grew 4.7% in the June quarter while total revenues rose 8.8%.

Meanwhile, for the September quarter, though revenues are expected to rise 2.8%, earnings are projected to record a decline of 1.1%.

For more details about earnings for this sector and others, please read our ‘Earnings Preview’ report.

Conclusion

Looking at the recent economic indicators and the industry’s cheap valuation, growth prospects of the U.S. hotel industry appear bright.

Though industry-wide headwinds continue to weigh on investor sentiment, hotel companies have good reasons to remain optimistic. Particularly, those willing to venture out of their comfort zones and be responsive to changing consumer expectations to provide a more holistic offering, are sure to emerge winners.

Overall, despite the ongoing economic and political uncertainty, economic fundamentals appear strong enough to support more modest growth in the short-to medium-term without any additional stimulus.

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