Starwood Shines as Next Hot Hotel Play

Editor's note: "Bricks and Mortar" is a series of columns written by real estate reporter Nicholas Yulico meant to help TheStreet.com readers generate real estate and gaming-related stock ideas.

With Hilton Hotels(HLT) being sold at a hefty premium to private-equity buyers, the best bet left in lodging is Starwood Hotels(HOT).

So today, I'm adding Starwood to the Bricks and Mortar mock portfolio as a company worth buying.

Starwood owns some of the best brands in the hotel industry -- including Sheraton, Westin and W Hotels -- that will provide a strong international growth platform for years to come. Meanwhile, the spinoff of many of its hotel assets last year has left the company with a business model weighted toward a high-margin management and franchise fee business, along with time-share sales.

In addition, Starwood's operations produce a ton of free cash flow, while the balance sheet has low debt levels. That combination makes the hotelier an attractive buyout candidate for private-equity firms, which continues to eye hotel assets because they're cheap relative to other real estate sectors.

My last hotel pick, Hilton, agreed to be acquired by Blackstone Group(BX) for $47.50 a share, a 37% premium to where the stock was trading when I added it to the Bricks & Mortar portfolio.

Starwood shares have climbed since the Hilton deal, so it doesn't offer as much upside. But I still expect the stock to rise more than 15% from the current $72 level -- and as much as 25% if a buyout company approaches.

Starwood's stock should perform well so long as lodging fundamentals remain strong over the next few years, which admittedly isn't a risk-free proposition. Rival Marriott (MAR) on Thursday tempered its revenue projections for 2007, signaling that the hot growth for the group may be cooling.

"Growth is slowing (in lodging), but it's still stronger than other sectors," says Dean Frankel, portfolio manager with Urdang Investment, which owns Starwood and other hotel stocks. Frankel says lodging is in a midcycle pause right now, but he expects growth to pick up next year, once the economy improves.