Most of us live in cities, so we take them for granted. But around the world, it is a relatively new phenomenon. By the end of next year, 3.3 billion people -- slightly more than half of humanity -- will be living in an urban environment. And the United Nations says that 5 billion people will live in cities by 2030.As you might expect, China is the main story in this major change in global social organization. City dwellers there earn an average of $1,500 per year, which is four times the amount that rural dwellers earn, according to Jim Williams of the Williams Inference Center, a Massachusetts think tank. So as farmers decide to give up their plows and head to cities to find better-paying work, you can bet that there must be major changes in the way the country is organized. You have heard all about the infrastructure plays in emerging markets, ranging from steel and copper to cement and airports. But another angle you may not be so familiar with is the rising need for more hotels as people travel more than ever before. The industry worldwide is so hot that
Surprising? Well, one thing that we know for sure about business is that much of it needs to be done in person, no matter how efficient wireless phone and broadband systems are. If you're a sales rep for an electronics manufacturer, or an account executive for a steelmaker, you need to go out of town to meet your customers, check inventories and write orders. If you're Chinese and are the first in your family to see all these cities, as you accumulate wealth you'll naturally also want to take your family on vacation to see these cities as well. Domestic tourism is growing at 10.4% per year and will amount to 8% of China's national GDP by 2017, according to government statistics, compared with 5.4% today. Like middle-class tourists and business people in the West, most of these people are not staying in four-star hotels. Or even three-star hotels. They are staying at budget hotels owned by new chains that have risen to the challenge with awesome facilities. Analysts say that 90% of Chinese travelers stay at budget inns where they can find standardized rooms, comfy beds, great locations near business centers, free Internet access, hair dryers and ironing boards for the equivalent of $22 per night. Imagine the Chinese roadsides dotted with the equivalent of brand-new Super 8, Motel 6 and Best Western motels, and you'll get the picture.
Well, that's not exactly how it will look, because those are not the main brands of hotel chains in China. The leading brand for inexpensive digs on the road is Home Inns and Hotels Management ( HMIN), which listed its shares on the Nasdaq about a year ago and now sports a $1.3 billion market cap. It reported $95 million in revenue in the past 12 months and $5.4 million in income. Earnings growth should clock in at around 60% compounded annually over the next four years, yet shares are demanding a relatively modest 45 times
price-to-earnings multiple. Deutsche Bank analysts report that HMIN is enjoying "exceptionally strong pricing power" in virtually all of its markets because travelers don't seem to mind paying a little bit more for its high-quality rooms, especially in second-tier cities. And the nice thing about an investment in HMIN today is that it has more than just a rise in domestic business travel and vacationers on the horizon. It also has the Olympic Games in August next year, which are hosted in Beijing but will spur traveling to many other nearby cities as well. As the leading budget hotel chain in China, HMIN should profit nicely from this boost in traveling despite the rising competition. Analysts report that the number of budget hotels has grown from fewer than 100 in 2003 to around 1,300 this year.
Yet, as you can imagine, that is hardly excess supply in a country the size of China. HMIN executives, several of whom were founders of the successful travel agency Ctrip.com International ( CTRP), say that they plan to add 100 hotels a year to achieve that 60% annualized growth rate. And its business model is what you might call "asset light": Since the land and building costs are not excessive, the company does not need a lot of capital, and each hotel earns its costs back pretty rapidly. At the moment, HMIN is believed to own about 18% of the market, a percentage point above its older but slower-growing arch-rival, the Jin Jiang Inn chain. More competition is coming for HMIN, as the French chain Accor has announced plans to open 20 of its Ibis budget hotels over the next year, Morgan Stanley is backing a slightly more upscale chain called Motel 168, Warburg Pincus is backing a chain called 7 Days Inn, and the Super 8 hotel chain already has 49 budget hotels in China. These are all paltry numbers, if you think about it, as the industry is still in its infancy. It wasn't too long ago that budget-minded travelers had to stay in un-standardized, low-quality "guesthouses," so customers are relishing all the choices as they travel to attend an increasing number of what the industry calls MICE, or meetings, incentives, conventions and exhibitions. As a leader in the budget hotel business and huge growth plans in the works, HMIN should come out on top as Chinese business travel and tourism increase and the Olympic Games near. I expect HMIN to report as much as 13 cents per share in earnings when it reports third-quarter results in November, on the basis of preliminary results reported earlier this week. My calculations also suggest that 2008 and 2009 earnings could come in as high as 68 cents and $1.08, respectively; these figures are above consensus. At the slightly higher 50 times P/E that it deserves for solid growth in a young industry, that means HMIN could trade as high as $55-plus late next year, which would be 40% higher than the current quote.