Hotel Sector Strong

Revpar growth comes from two sources: increased occupancy and room rates. Typically, in the early part of a recovery, most revpar growth comes from rising occupancy levels. Later, however, hotels find themselves able to raise rates on strong demand, and those higher rates tend to flow directly down to the bottom line, causing margins and earnings to swell.

Certain U.S. markets, such as New York City, are seeing particularly robust demand, giving hoteliers pricing power, notes Kazim. That situation should continue as businesses beef up travel budgets. Kazim foresees about four percentage points of margin expansion for large hoteliers between now and 2007. "Right now, every dollar of [room] rate is probably giving you about 40 to 50 cents after covering your fixed costs," he said. "As we go forward and see rate momentum building, we'll see 70 or 80 cents going through to the bottom line."

Increased pricing power should allow hotels to offset the impact of higher interest rates as the Fed continues its tightening cycle, and utility expenses, contends Deutsche Bank analyst Marc Falcone. "Unlike most other classes of real estate (i.e. apartments, office buildings), hotels have the ability to reprice inventory (i.e. raise room rates on a daily basis)," he wrote in a recent research note. "We believe this effectively provides natural insulation against rising interest rates." Deutsche Bank does and seeks to do business with companies covered in its research reports.

Furthermore, Falcone cites a Smith Travel Research study showing energy/utility expenses represent less than 4% of room revenue for full-service hotels and 4.5% to 5% for limited-service hotels. For each occupied room, "utility expenses average less than $8 for full-service hotels and under $4 for limited-service hotels," Falcone wrote. "Accordingly, we do not believe higher energy costs ... should be a significant threat to margins."