Hotel stocks have been on a tear for the past six months, with some rising more than 30% amid waning terrorism and war fears. So what's in store for the rest of the year?
It depends on the business traveler, analysts say. If signs of an economic recovery persist, then business travelers will hit the road and hotels will raise room rates to finance growth. If not, the next quarter -- which generally sees a seasonal dip in vacationers -- could be disappointing.
"More than anything else, the big driver is some sense that the business traveler is picking up," said Jake Fuller, analyst at Thomas Weisel Partners. "The third quarter is going to be a strange quarter because we're out of the peak for leisure travel, and business travel is going to have to pick up."
As a result,
-- all of which have gained 30% or more this year -- find themselves in the same boat, looking to business travelers to offset the fall slump in vacationers.
The third quarter "is less company-specific" and will be driven by broader trends, like the economic recovery, Fuller noted.
Three months ago, back in July, hotels weren't so optimistic about the business-travel recovery, with Marriott telling investors, "We have not yet seen clear indications of a meaningful rebound in
revenue per available room and profits." Starwood was slightly more positive, telling investors it was "cautiously optimistic" that business would recover through the fall and into 2004.
"I think that Marriott and Hilton and Starwood have been a bit overly cautious, with good reason. When we got guidance for the third quarter, we were in a second quarter impacted by SARS and the war," said Fuller. "It turns out the summer was better than we thought, leisure demand was high ... and that translates into positive earnings for Marriott, Hilton and Starwood."
Indeed, analysts say the strong summer travel season has carried over into the fall. In August, Starwood beat its own internal forecasts regarding business travelers, prompting Chief Executive Barry Sternlicht to remark on
that he felt the industry recovery was already here. Early signals from September confirm that business travel is starting to come back.
In the first week of September, Jay Cogan, analyst at Banc of America Securities, toured 20 of the most important hotels in New York City, Boston, San Francisco and Chicago, and found that bookings were ahead of plan.
"After touring that week in those four key cities, it became clear to us that business travel was ramping up at a faster-than-expected pace for September," said Cogan, noting that New York and Chicago were especially strong. "Group activity was showing well, and this was all coming on short-term booking. A number of hotels were expecting to beat targets."
Through the first week of September, third-quarter industry revenue per available room, or revpar, was up 2.1%, beating even the most optimistic expectations of hotel management, which call for zero growth to revpar in the third quarter.
As a result, industry watchers are optimistic heading into the third-quarter earnings season, which begins next week. But valuations are also high, with the price-to-EBITDA ratio (the metric analysts prefer) on the trio of big-name hotels up 33% or more since March, as the chart below shows.
An Eye on 2005
With the industry expected to show no gains in profit in 2003, investors must keep an eye on 2005, when analysts expect a strong return to profit growth. In the near term, upside could be limited, but analysts argue that the third quarter will be stronger than expected and that stocks are attractive on a long-term basis.
"Part of the problem is that when you look at historical valuations you only tend to go back four to five years," said Rod Petrik, analyst at Legg Mason. "I was looking at Starwood the other day and in the early 1990s, it would trade at 20 times EBITDA. We're not forecasting that, but there's no reason to think that it can't trade at the upper end of a range in a recovery. It doesn't concern me. I think we can see a 10% revpar increase in 2005."
Petrik admits that investors with a deep discount value bias won't find hotel stocks all that compelling at these levels. But he said he'd be a buyer of stocks, even at these levels, to get in before a cyclical recovery takes hold. "A year from now fundamentals will be better, and why would we have a pullback in the face of improving fundamentals? Can it happen? Yes, but I'm not hopeful of that," he said, adding, "Yes, I would buy here."
Cogan isn't as convinced. In his view, even though revpar is showing signs of improvement and business travel is doing better, stocks are fairly valued at these levels. And given the risks to the recovery scenario, such as a spotty or stalled recovery and another terrorist attack on American soil, buying shares now might not be such a wise choice.
"We've been calling for a softer-shaped recovery in 2004 and maybe in 2005 for them to see outsized gains in revpar and earnings," said Cogan. "But this is a market that can't afford to wait for the recovery and the market caps on these companies aren't that large ... Maybe there will be more upside, but the reality is that even on the higher numbers, these stocks aren't that cheap, trading at 11 to 13 times EBITDA."