Hotels Gain on Upgrade

Hotel stocks rallied Tuesday after Banc of America Securities upgraded Starwood Hotels (HOT Quote), Host Marriott (HMT Quote) and Hilton Hotels (HLT Quote) to buy, telling investors the sector was on the verge of a second leg of a bull run.

According to analyst Jeremy Cogan, hotel stocks are due for significant upside over the next two years, driven by better-than-expected room rates, tight supplies and increasing demand for lodging. After touring more than 20 hotels in four key markets, the analyst raised his 2005 estimates for earnings per share and revenue per available room, a key industry metric also known as revpar.

"Our lodging index has now cooled a bit in 2004 -- just as lodging stocks did in 1994 -- as interest rates go higher and investors take a break to survey the future profit landscape," Cogan said. "If the cycle truly repeats, the 'second leg of the lightning bolt' -- another meaningful bull move for lodging stocks -- could be coming next [and] could last roughly two years." (Bank of America does and seeks to do business with the companies covered in its research reports.)

Indeed, hotel stocks have taken a breather. So far this year, the Dow Jones Hotel Index is up 16% after gaining 50% in 2003. On Tuesday, hotel stocks got a bid, thanks to Cogan's upgrade, with the Dow Hotels up 1.5%, driven by Starwood's gain of $1.28, or 2.9%, to $45.85. Host Marriott rose 37 cents, or 2.7%, to $13.96, while Hilton rose 38 cents, or 2.1%, to $18.57.

The rally may have already started. Since Aug. 10, when Four Seasons (FS Quote) easily beat Wall Street expectations and raised guidance for the second half of the year, the Dow Hotels have gained 10%. As TheStreet.com pointed out in a story from five weeks ago, industry fundamentals such as occupancy and average daily room rates continue to show year-over-year improvement, forcing earnings estimates higher and offsetting interest rate concerns.

One big factor in Cogan's upgrade is that year-over-year comparisons are still relatively easy, especially after the peak earnings seen in 2000. The recovering industry has been able to show double-digit percentage growth in revpar this year -- and according to Cogan, it may be able to repeat that feat next year, and that would mean earnings estimates are still too conservative.

"Just because 2004 is playing out better than originally expected does not necessarily imply that 2005 now faces 'tough comps,'" Cogan said. "In fact, revpar in a number of key markets -- including Boston, Chicago and San Francisco -- will still be 25% to 30% below 2000 levels, even after 2004."