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FelCor Lodging Trust'sundefined properties are just now hitting the sweet spot of the hotel recovery, and the company is poised to see the best fundamentals in the lodging group over the next year.

But for the long haul, the question remains whether the real estate investment trust's new management and recent initiatives can reverse the tendencies of the past, when value generally sputtered after a temporary window of outperformance.

FelCor's upscale hotels, which are mostly located in secondary markets like Texas, Georgia and Florida, are just now hitting the sweet spot of the hotel recovery.

Such markets typically take longer to recover from downturns than the major cities, and so FelCor -- whose hotels are operated under brands such as Embassy Suites, Holiday Inn and Sheraton -- has historically lagged the recovery of fellow hotel companies by 12 to 18 months.

While markets like New York City and Washington, D.C., have shown sharp growth following the 2001 downturn, FelCor hasn't benefited from the recovery because the company doesn't own properties in these big-city markets.

"This is the best part of the cycle for them," says Dean Frankel, a portfolio manager with Urdang Securities Management, which invests in hotel stocks but doesn't own FelCor. "The recovery is behind everyone else. In 2006,

FelCor should have the best growth of anyone. That may occur in 2007 too."

The issue, however, is whether FelCor's growth over the next two years is already priced into the stock. In the past, the company has outperformed the industry for a short period only to become one of the worst performers after the short-term bump.

FelCor's current recovery has been underway since the third quarter of last year, when the company posted healthy gains in revenue per available room, or RevPAR, a key operating performance metric for the industry. At the time, FelCor also reinstated its dividend, which was suspended in 2003. Its dividend yield currently stands at 4%.

For the first quarter of this year, FelCor led the industry with a 15% RevPAR increase. In comparison,

Host Hotels

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, one of the largest hotel owners, posted a 7.6% RevPAR rise. Last year, FelCor generally followed the industry with a 10.8% gain, most of it in the second half of the year.

But going back to 2004, FelCor posted just a 4.9% RevPAR increase, compared with 7.3% at Host Hotels and 9% at

LaSalle Hotel Properties


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Over the next year, JP Morgan analyst Harry Curtis expects FelCor to have the best RevPAR growth in the industry, along with a 23% increase in earnings before interest, taxes, depreciation and amortization.

Management has forecast 9% RevPAR growth this year, but several analysts believe that number is conservative.

FelCor is nearing the end of a $550 million asset sale process, and the funds will be used to reduce debt levels and spruce up its assets, which have been neglected.

All told, the company plans to spend $400 million over the next few years to fully renovate every hotel in its portfolio, which will eventually be pared down to 90 from 128.

Much of the capital expenditures will be spent on adding spas, meeting space and other features that represent a high return on capital.

"We think that we have some internal growth opportunities relative to our peers that are very, very good," said FelCor Chief Executive Richard Smith in an interview.

As an example of how the capital spending translates into earnings, Smith points to the 16 hotels the company spent renovating in 2004 and 2005 at a cost of $2 million each. Those assets saw 40% EBITDA growth in the first quarter, compared with 20% growth at the other hotels, Smith says.

The company also has beefed up its asset management business, reducing the number of hotels per manager from between 30 to 40 down to 15.

This helped FelCor post a 270-basis-point-margin improvement in the quarter (excluding benefits from hurricane recovery settlements), which was among the best in the industry.

It remains to be seen whether these improvements will last for the long-term or only the next 12 to 18 months.

Curtis remains bullish on the stock and told the audience at the NYU Hospitality Conference in early June that FelCor would be the best-performing stock in the sector over the next year.

Frankel admits this might be true, but argues that the company's strong RevPAR growth is already priced into the stock, since after that growth, FelCor should trade at a lower multiple than anyone else.

FelCor's stock is up 35% since it reported strong third-quarter results. Currently, the company trades at 8.7 times the consensus estimate for 2007 funds from operations (a REIT proxy for earnings), compared to 11.4 at Host Hotels. Some of that discount comes from the fact that FelCor has a history of outperforming during short windows and then eventually lagging the group again.

"After 18 months of outperformance, I don't expect those assets in those markets that they're in to outperform the group from that point forward," Frankel says. "I expect them to underperform."

Some analysts have said FelCor is cheap on an EBITDA basis, but on an adjusted EBITDA basis (which subtracts recurring capital expenditures), the stock looks expensive, Frankel says.

On such a basis, he continues, FelCor is trading in line with competitors like

Sunstone Hotel Investors

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Strategic Hotels


, and Host -- all of which Frankel prefers.

Frankel admits FelCor could be a short-term buy, but one risk to the valuation is that the stock has been trading on buyout rumors -- and if the company isn't sold, the stock could suffer.

Curtis says there was unsolicited buyout interest, but the company decided instead to harvest value through its own portfolio. Smith, FelCor's CEO, declined to comment on any potential deals.

The biggest sign that the buyout is likely dead for now may be the approximately $9.2 million in stock sold by directors and other insiders since the beginning of May.

Another risk to FelCor is that it has an unproven chief executive, and the jury remains out on whether he will steer the ship better than management did in the past.

Smith took over the CEO post this February after joining the company as financial chief in 2004. Previously he was chief financial officer at Wyndham International and a senior vice president with

Starwood Hotels



Smith says the improvements in asset management and the proceeds from the asset sales put the company on a different track than it was on in the past. "The capital puts us into a position to be extremely competitive in our core assets going forward," he says.