As the recession continues, hotel companies that are able to limit the degree to which room rates are discounted will be in the best position to benefit once the economic environment improves.
OUTLOOK
The lodging industry is facing significant challenges stemming from the economic recession, as both business and consumers are cutting back on travel expenditures. When evaluating hotel companies like Starwood Hotels (HOT) and Marriott International (MAR) during this down-cycle, we will be paying especially close attention to changes in average daily room rates as an indication of how quickly the sector may recover once the economy improves.
A key operating metric in the lodging industry is RevPAR (revenue per available room). This metric is derived by multiplying the occupancy percentage of a hotel over a given period by the average daily room rate (ADR) over that same period. Changes in either occupancy or ADR will impact RevPAR, but with different implications for bottom-line profitability.
Given the current state of the U.S. economy, it is no surprise that hotel occupancy percentages have been down recently, and that additional deterioration is anticipated throughout 2009. In past downturns, some hotel owners have attempted to slash room rates in an attempt to fill beds. In most cases, this tactic will result in material long-term damage to the business, for two primary reasons.
First, increases in occupancy are accompanied by increases in operating expenses. For every room that is filled, there are additional costs such as housekeeping, laundry and utilities that must be paid. When room rates decline while variable operating expenses remain stable, margins are compressed. Changes in ADR, however, fall almost entirely to the bottom line.
Second, and most importantly, cuts to ADR are difficult to recoup when the operating environment eventually improves. After slashing room rates in an effort to fill a hotel, attempts to restore those rates to previous levels are likely to be met with significant resistance. As such, the ability to benefit from an improving economy will be delayed.
Ultimately, the ability of lodging companies to maintain room rates as much as possible should have the most significant impact on their ability to weather the downturn. Cutting rates meaningfully should be an absolute last-ditch effort to survive, because changes in rate have the biggest impact on the bottom line, and are hardest to recoup when the operating environment improves. By keeping an eye on changes in ADR, investors can gain some insight as to which companies are best poised to benefit when economic growth returns.
OPPORTUNITIES
We are not currently recommending the purchase of any large-cap lodging stocks. Although share prices have fallen considerably, much uncertainty remains. When researching potential investments in the sector, however, we would advise investors to pay close attention to the ADR reported by lodging companies. We expect that companies that are able to best maintain room rates through the downturn will be best positioned to capitalize once economic conditions do improve.
WEAKNESSES
We expect RevPAR to decline meaningfully in 2009, with the majority of the declines stemming from occupancy losses, while the companies attempt to hold ADR as steady as possible. If, however, we see room rates declining significantly, we would then expect the downturn to be deeper and more prolonged than currently anticipated.
Even for the firms that are able to maintain room rates, however, it will likely be some time before the operating environment improves. Margins are expected to tighten during 2009, and earnings are projected to decline year-over-year.
We would avoid lodging companies such as Marriott International (MAR) that have both exposure to lower-end hotel chains and significant exposure to the time-share industry, given the poor fundamentals in residential real estate.
In addition, companies with weak balance sheets, or even limited financial flexibility, will likely have a harder time navigating the challenges created by the recession.
