Intercontinental Hotels Group Management Discusses 2012 Results - Earnings Call Transcript

| About: InterContinental Hotels (IHG)

Intercontinental Hotels Group (NYSE:IHG)

2012 Earnings Call

February 19, 2013 9:00 am ET

Executives

Catherine Dolton

Richard Solomons - Chief Executive Officer, Executive Director, Member of Executive Committee and Member of Corporate Responsibility Committee

Thomas D. Singer - Chief Financial Officer, Director and Member of Executive Committee

Analysts

Charles Patrick Scholes - SunTrust Robinson Humphrey, Inc., Research Division

Robin Byde - Cantor Fitzgerald Europe, Research Division

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

Steven E. Kent - Goldman Sachs Group Inc., Research Division

Operator

Good afternoon, ladies and gentlemen, and welcome to the Intercontinental Hotel Group Conference Call. My name is James, and I'll be your coordinator for today's conference. [Operator Instructions] I will now hand over to Catherine Dolton to begin today's conference. Thank you.

Catherine Dolton

Thanks. Good morning, everyone. This is Catherine Dolton, Head of Investor Relations, IHG. I'm joined this morning by Richard Solomons, Chief Executive; and Tom Singer, Chief Financial Officer.

Before I hand over to them for discussion of our results, I need to remind you that in the following discussion, the company may make certain forward-looking statements as defined under U.S. law. Please check this morning's press release and the company's SEC filings for factors that could lead actual results to differ materially from any such forward-looking statement.

I will now turn the call over to Richard Solomons.

Richard Solomons

Thank you, Catherine. Good morning, everybody. Thanks for joining us. Certainly in a moment, Tom will take you through the financial results in detail. But first, let me just cover the highlights.

2013 (sic) [ 2012 ] is another strong year for IHG, with our preferred brands driving RevPAR up 5.2%. Together with 2.7% net rooms growth, which is fueled increasingly by our expansion in developing markets, this drove up fees almost 7%.

We see significant opportunities to add to our already strong position in many parts of the world, making great progress developing our existing brands. We extended our portfolio in the year by adding the innovative HUALUXE Hotels & Resorts and EVEN Hotels brands.

At the same time, we continually look to be efficient in our cost management. Combined with our success in leveraging our scale, it allowed us to reinvest in the business and simultaneously grow our margins over number of years, once again, demonstrating the ability of this business to drive powerful cash flows, providing us with the flexibility to invest in growth opportunities at the same time as being able to generate significant and consistent shareholder returns. The $1 billion return of capital, which we announced in August, combined with a 16% growth in the 2012 total dividend announced today, demonstrates our commitment to this outstanding strategy.

I'll now hand over to Tom to talk in more detail about the financial progress IHG's achieved in 2012, and I'll return later to look a little into the future and discuss our strategy and business development.

Thomas D. Singer

Thanks, Richard, and good morning, everyone. Revenue and operating profits were up 4% and 10%, respectively, in the year. On an underlying basis, operating profits were up 13%. This is at constant currency and excludes the impact of $16 million of significant liquidation damages received in 2011 and $3 million in 2012. Profits after tax grew 8% to $407 million and adjusting -- adjusted earnings per share were up 9% to $1.415.

One of the most important metrics for an asset-light cash-generative business such as ours is growth in fee revenues, on which the key drivers are RevPAR, room growth and royalty rates. Our strong rooms and RevPAR growth in the year drove up fee revenues by 6.8% with the royalty rate growth, being more of a long-term driver, than with small fluctuations from year-to-year.

Looking at the key 2 drivers in more detail, starting with RevPAR. In the Americas, RevPAR grew 6.1%, including 6.3% in the U.S., while trading remained strong in the fourth quarter, despite uncertainty around the presidential elections and the fiscal cliff. We continue to outperform the industry in the U.S. with total RevPAR growth of 7%, which is on the same basis as the Smith Travel Research data.

Europe grew 1.7%, consistently robust performance for the year, and 4.9% in AMEA reflects strength in Southeast Asia and Japan, partly offset by tougher conditions in some parts of the Middle East. Greater China RevPAR grew 5.4%, significantly outperforming the industry, with a slowdown in the second half, primarily due to the impact of the political leadership change, which impacted the whole industry. That system growth of 2.7% was at the top end of our guidance and a notable step-up compared to the previous 2 years.

We opened 34,000 rooms, up almost 5% on 2011 on an underlying basis, and over 1/3 of these rooms where in our fast-growing AMEA and Greater China regions. Room removals have reduced to a more normal level now. We've completed the Holiday Inn relaunch. And with our ongoing focus on the quality of our estate, we would expect to continue to exit around 2% to 3% of the system each year.

Signings of 54,000 rooms, or almost one hotel a day, shows the demand for our brands, despite the significance of the difficult financing environment, which still exists in many markets. Our pipeline continues to be at the highest quality with 40% under construction.

So that's what's driving our fee revenue today. I now want to spend a few minutes talking about the shape of our fee growth going forward. The geographical mix of our business is changing, reflecting faster demand growth in developing markets. This accounted for almost 30% of our openings in 2012 with a proportion of our system and pipeline at 19% and 50%, respectively.

In these locations, hotels are often opening at the same time as the sources of demand for rooms are being developed, which means that they generally achieve a lower absolute RevPAR, particularly in their early years. The best way to think about this is that in year one, these hotels will have RevPARs around 30% of the level of an average mature hotel in that region.

Now let me turn to our financial performance in the year by business model. Underlying franchise profits grew 8% in the year to $547 million with high absolute margin levels of 84%, demonstrating the scalability of this part of the business, which is dominated by our strong presence in the U.S. In our managed business, we converted 7% underlying revenue growth into 15% underlying operating profit growth, with a proportion of managed hotels now earning incenting fees at 59%. Our owned and leased hotels have performed very well in the year, with strong RevPAR driving a 20% increase in underlying EBIT to $125 million.

At the group level, our fee-based margin expansion was better than expected, up 2 percentage points to 42.6%. This was helped in part, though, by some one-off items that are individually small, but collectively added around half a percentage point in margin. We've reported strong margin progression over the last few years, particularly in China where sustainable margin growth over time remains a key focus.

However, in 2013, we are increasing the level of reinvestments, particularly in fast developing markets, as well as support in our brands to drive continued outperformance. Furthermore, you will remember that in January, we announced 8 FelCor hotels would be leaving our system, and these generated around $9 million of fees in 2012 and contributed about 50 bps to our fee-based margins. Therefore, we don't expect underlying 2013 margins to grow at the same level as in recent years.

Looking now at cash flows. EBITDA was up 8% to $708 million, translating into strong free cash flow up 10% to $463 million. Net debt of just over $1 billion includes $612 million of capital returns as we paid out the special dividend and commenced the share buyback in the fourth quarter. I've talked on separate occasions about our 3 uses of cash, investing for growth, growth in the ordinary dividend, with additional returns to shareholders.

We continue to expect to spend around $100 million to $200 million on growth CapEx each year into the medium term, with around half of this in 2013, bringing the EVEN brand up and running. As regards to maintenance CapEx, we expect this to be around $150 million per annum over the medium term as compared to $113 million spent in 2012.

We grew the ordinary dividend by 16% in 2013, as Richard mentioned, and we have just -- and we have completed just over $600 million to date of the $1 billion capital return we announced at the interims. This reflects our ongoing commitment to an efficient balance sheet whilst maintaining an investment-grade credit rating.

I'm sure you all have seen the change to our quarterly reporting disclosure that we announced in our release this morning. Having consulted with many different stakeholders but in order to focus attention on the longer-term performance of the business, we've made the decision to stop producing full quarterly financial statements for Q1 and Q3 results as of Q1 this year. We will instead provide a trailing update, supported by our usual supplementary data for RevPAR and system size. So you'll still be able to track our quarterly performance, and we will continue to hold the conference call with time for questions at the end.

I'll hand back to Richard in just a moment. But first, some comments on current trading and outlook. Although we can only look out to around a month with any certainty, forward indicators of lead times and travel intentions are encouraging. Supply in developed markets remains at historic lows whilst global demand is at record levels.

Group RevPAR grew 6.6% in January, with 7% growth in the Americas, reflecting improved business confidence. Greater China RevPAR grew by 21%, principally due to the change in the timing of Chinese New Year. Short-term visibility in this region continues to be limited and will probably remain so until at least March, when the leadership changeover competes. The long-term drivers in Greater China remain highly compelling and our market-leading position leaves us very well placed. AMEA was up 6% in the month, an improvement in Q4, also helped by the shift in timing of Chinese New Year. And in Europe, RevPAR held flat in challenging economic markets.

And with that, let me hand back to Richard.

Richard Solomons

Thanks, Tom. In April of this year, IHG will celebrate its 10th anniversary as a stand-alone company. Looking back over the time, it's fair to say we've consistently delivered against a clearly defined strategy. Our focus is on high-quality growth. This drive has led us to remove over 260,000 rooms. And in the same time frame, we've opened a remarkable 425,000 rooms, giving us one of the highest quality, freshest portfolio of hotels in the business.

We've created an advanced position through the great work we've been doing to strengthen our existing brand and create new ones, as well as the unique partnership we enjoy with our owners and especially through the IHG Owners Association. We've all but completed our move to an asset-light business model, disposing of 190 hotels to some $5.7 billion in proceeds.

In more recent years, we've demonstrated the resilience of our business through the recession, successfully relaunching Holiday Inn and maintaining our dividend while continuing to invest in growth. And in the process, we proved that IHG has one of the highest quality income streams in the industry. Of course, we remain committed to continuing to reduce the capital intensity of IHG and our asset-light strategy, which has helped us drive up return on capital employed from 7% in 2003 to some 44% last year.

We delivered significant value to shareholders over that time, returning around $9 billion, almost twice the market capital group when we enlisted as a stand-alone company. We've grown the ordinary dividend by 11% compound since 2003. All of this has resulted in total shareholder returns in the last 10 years higher than any of our major competitors, and we're very proud of that.

So the question on your minds and definitely on ours is how we continue this track record for the next 10 years and beyond. And the answer is more of the same. We've talked on several occasions about generating steady, sustainable growth in market share through driving RevPAR and adding the right hotels in the right locations with the right owners. We're making this happen through our 3 clearly stated priorities of brands, people and delivery, underpinned by responsible business practices.

Looking at where we are today on a couple of these priorities, let's start with our brands. Our brands already deliver superior and consistent experiences, which drive RevPAR premiums and deliver better return of investment for us and for our owners. But we have to keep it contemporary and relevant and meet changing guest needs.

We've recently enhanced our understanding of our guest through an industry-leading piece of research. The hotel industry has relatively unsophisticated in this area. We used to focus on industry classification price points, which mean nothing to guests. Definitions such as upper upscale or mid-scale are categories our guests just don't buy or think about. Our research in the latter has identified the choices guests make as a function of who they are, the occasion they're traveling for and their need when traveling. The detail segmentation analysis we produced are now integral to all our brand management processes, including the proposition for our 2 new brands, and it has been fundamental to our plans for Crowne Plaza.

I'll share some of the details on Crowne Plaza now. We'll be providing more insight on the work we've been doing on our other brands at an analyst investor educational event that we plan for Q4 of this year.

Crowne Plaza is a well-established brand and has been a big success for us. There is a significant opportunity for us to close the performance gap that exists between the brand in the Americas and the rest of the world, and we've got a plan to achieve this. We've made good progress against phase 1 of this plan, improving the overall quality of the estate. We've exited 18 substandard hotels with around another 22 to leave over the next couple of years. Full-quality action plans are scheduled to be completed in the Americas by the end of quarter 2, and we've rolled out a new guest service training program into all of our regions. And we're on track to complete the rollout of the new brand hallmarks by the end of 2015.

In developing these, we leveraged our guest segmentation work to help us better meet the needs of our target guest. For Crowne Plaza's target guest, business productivity is their primary need. As a result, we designed Hallmarks to enhance 4 key areas of the guest experience: arrival, food and beverage, guest room and fitness and recreation. The team has done a great job. The Hallmarks are being tested and piloted now, and we'll start to roll them out later in the year. We'll talk about them in more detail once we've communicated to the owners and the rollout has commenced.

Moving now on to Holiday Inn, and our efforts to drive awareness for this brand family continued to pay off. Holiday Inn is being named J.D. Power Award winner for best guest satisfaction in the mid-scale full-service category for the second consecutive year. Holiday Inn has enjoyed a fantastic 2012, celebrating its 60th anniversary and being official hotel provider London Olympics.

Looking forward into 2013, we won't be standing still. We'll be launching a new advertising campaign for Holiday Inn across several media channels. Testament to the power and longevity of the brand, according to Smith Travel, it was the fastest-growing brand in the segment in the world last year, with more rooms added than any other brand family, pretty impressive for a 60-year-old brand and evidence of the success of our relaunch.

Our 2 new brands tap into the growing global demand for hotel rooms and the rising consumer trends for greater segmentation and differentiation. We signed 15 HUALUXE Hotels in Greater China in the year and have a further 15 letters of intent. A great result for a brand that's not even a year old, also making good progress at our EVEN Hotels brand in the U.S., with one in the pipeline and several more close to signing.

We continue to leverage our global scale with the power of our systems to drive a greater share of industry demand into our hotels. In 2012, 69% of total rooms revenue is booked through IHG channels and direct to our hotels now [indiscernible]. We deployed these systems and platforms in a coordinated way around 4 fundamental strategies: creating, converting, yielding and retaining demand.

Taking each of these in turn, we need to ensure our brands are top of mind in potential guest search for a hotel. We do this through mass marketing campaigns, such as those around for our Intercontinental and Crowne Plaza brands in Greater China last year. These drove great results, helping us to more than double brand awareness and the preference scores in the year. In 2012, we generated $1.4 billion of revenue through online marketing, purchasing or managing more than 8 million keywords, another example of what we can do due to our scale.

In the area of sales, IHG lead the way for innovation with our focus remaining growing our overall share of corporate business through our successful dynamic pricing initiative. We now have 43% of our centrally negotiated rates on the system, and we're seeing significant success. In 2012, these accounts achieved nearly double the growth in revenue of our traditional accounts and meaningful share gain.

Consumers are comparing and shopping like never before, so we have clear strategies to convert more browsers into buyers. In 2012, our website has experienced more than a 0.25 billion visits, generating $3.4 billion of revenue, which put IHG among the top 10 Internet retailers in the west.

Our mobile strategy is at the forefront of the industry. We were the first to have apps across all major platforms. In just 3 years, we've grown bookings made by our mobile websites and apps from $3 million to $330 million.

We continue to innovate to maximize bookings through our direct channels the cheapest and most effective way. Not only do we have our powerful Best Price Guarantee, but also a founding member of roomkey.com, the first industry hotel search engine launched last year. Another industry first is our collaboration with China's B&C commerce platform, Taobao Travel, which would enable us to reach many more Chinese guests.

Effective yield management is essential to maximize owner returns. Our industry-leading price optimization tool supports hotels to make the best pricing decisions based on sophisticated algorithms that consider a combination of historic demand, pricing and economic indicators.

Our Priority Club Rewards program cultivates our guests into loyal IHG customers and advocates of our brands. We offer members a vast array of point redemption and recognition opportunities. Now this great customer value proposition means we now have 71 million members around the world who deliver 41% of revenues to our hotels.

So why am I going into what might've seem like a lot of preparation of the details today? I wanted to make it clear how we've driven growth and outperformed over the past 10 years and to explain how the delivery will continue to drive the growth of IHG in the years to come.

We built a strong business over the past decade, established a leading position and good momentum in the global industry with compelling, long-term future demand drivers. However, it's also a very competitive industry, which makes it vital to have a clearly defined strategy to deliver results, not just for us, but also for our hotel owners.

At the heart of this is our brands, which is some of the biggest and best in the world. Through our industry-leading consumer insight work, we're making our portfolio even stronger, refining propositions for our existing brand, as well as launching new ones, which have captured the growing demand for hotels around the globe.

We're also leveraging the scale of our systems, along with the expertise of our people, to drive a greater share of demand into hotels in the most cost-effective way. Continued innovation and investment in this area is vital in order to ensure we deliver value to our owners and building our competitive advantage. And remember that the sheer scale and expertise that we have here is a considerable barrier to entry too.

So we're taking a lot of actions to ensure we deliver high-quality growth, and this requires investment in our brand, infrastructure, people and technology. Developing markets is, of course, a key area of focus. This is especially so in China, where we need to further build our infrastructure. We bought our 187th open hotel and the 160 hotels we will open to manage that is actually doubling the size of that business over the next few years.

As Tom touched upon, our fee-based margin growth will revert to more normal levels in 2013 as we strive to provide balance between current profits and investing for the longer-term future. We do, however, continue to remain very focused on driving long-term, sustainable growth in margins.

The wider economy continues to be uncertain in many parts of the world, as you know, but we remain confident in our outlook. We have an excellent record of driving superior returns for investors, and we're focused on continuing to do so.

Thank you. Now Tom and I will now be very happy to take your questions.

Thomas D. Singer

Operator, if we could...

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Patrick Scholes from SunTrust.

Charles Patrick Scholes - SunTrust Robinson Humphrey, Inc., Research Division

I'm wondering if you can just give us any more color on the -- those loss of the Holiday Inns with the FelCor. I'm wondering if you folks tried to counteroffer, or was the $31 million just too enticing?

Richard Solomons

Yes. Look, this happened, as you know. 260,000 rooms were taken out and 425,000 new ones we've added. So I think we've always seen in this business that some brands that are struggling to grow will have issues and will often put big financial incentives out there to take some assets. But we've had a relationship with FelCor for many years. These were 8 assets in our portfolio of, I guess, say, average quality. And certainly, from our perspective, the financial incentives that were offered were way above and beyond anything they could have made sensibly on their return. And our Holiday Inn brand is very successful, as you know. As I said, it's the fastest-growing brand in the segment in the world, and we can do deals with owners who want to invest behind that brand and bring new products in. So wasn't something we lost a lot of sleep over or spent too much time trying to counter, to be honest.

Operator

And our next question comes from the line of Robin Byde from Cantor Fitzgerald.

Robin Byde - Cantor Fitzgerald Europe, Research Division

Just 2 questions for me, please. Firstly, on the cost of debt. You just issued a medium-term note at a fairly attractive coupon. So I guess, your average cost of debt is now coming down. Can you provide any metrics on that movement? And then secondly, you just mentioned system exits a bit earlier of about 2% to 3% each year. Just to clarify, was that system-wide, or was that just relating to the Holiday Inns? And is that rate of churn increasing or decreasing at the current time?

Richard Solomons

Robin, thanks. On the exits, so that's been decreasing because we had a very big quality drive when we went to the relaunch of Holiday Inn. We're down -- we're running now at much more normal level. We saw 2% to 3% system growth, which was net of those exits across the brands across the world.

Robin Byde - Cantor Fitzgerald Europe, Research Division

Okay. And, Tom, just pick up on the interest?

Thomas D. Singer

Yes. I mean, on the debt we issued, as you said, they're GBP 400 million selling bonds at a coupon of 3 7/8%. That was a great deal for us to do to put a piece of long-term debt into the balance sheets. In fact, the majority of our debt now is, actually, at fixed interest rates. And you can work out from the blended average of those fixed interest rates on the 2 bonds and the [indiscernible] what we're paying. It's roughly on the order of 5.5%. In the rounds, and obviously any drawings that we might make on our bank facilities, which remained undrawn at the year end, we will have to factor that in as well in terms of coming out with a blended rate for the full year.

Operator

We now have one further question that comes from the line of Jonathan Pong from Robert W. Baird.

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

I just wanted to follow up on the EVEN Hotel that's near Grand Central. I just want to get an update on when you guys envision that opening. Are you still on track for late 2014, or is that potentially getting pushed out to a little bit later?

Richard Solomons

Yes. We haven't been absolutely specific on that lead times, as you know what these things are like, but of that order. The thing to think right now is we've got the hotel. We're working very much on the experience and making sure that that's absolutely right in developing the brand. So that's the key focus. But we'll get it open, and we're looking forward to signing a few more.

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

And one question on share repurchases. You guys did $107 million in the fourth quarter. What do you see for the timing for the rough -- for the balance of that program? Do you see that dragging on throughout?

Thomas D. Singer

We're not going to be specific about timing. But we are very committed to returning the full $500 million through share buybacks, and we'll complete the program in due course.

Operator

And we currently have no further questions coming through. [Operator Instructions] We now have one further question that comes from the line of Steven Kent from Goldman Sachs.

Steven E. Kent - Goldman Sachs Group Inc., Research Division

So can we just talk about the asset sales? I missed a little bit at the beginning of the call. But do you have to start all over in New York? And sort what's the timing in London? And how do we -- how should we start to think about that? Is it brand-new bidders? Just explain the process a little bit.

Thomas D. Singer

Sure. Well, Steve, it's Tom Singer here. Well, as you know, we've been on the market with the New York Barclay for some time now. And through the third quarter of last year, we thought we were getting closer. We've gone to the exclusivity to one party, which then subsequently wasn't able to consummate the deal, so the exclusivity dropped away. But we've actually taken the additional time to do a lot more work in terms of figuring out what we want to do with the assets. And as you might recall, there's a significant refurbishment plan that goes with the Barclay, and a new owner is going to have to spend probably upwards of $100 million to improve the hotel. And we've put together extensive plans and cost estimates now that we're able to share with people who are interested in taking conversations forward. So we shortly hope to be back out in the market, talking to people about the Barclay. The good thing is that the asset continues to trade extremely well. And ultimately, we're confident that we'll do a good deal that's in the interest of shareholders in terms of maximizing value through this disposal. In terms of the other asset that we just started to market here in London, the InterCon Park Lane, again, it's very early days. But again, the asset is trading well. And given the quality of that real estate, there's going to be a lot of interested parties around the world, who, I'm sure, will come in and bid for it. So the main thing to really take out of the update, I think, is that both assets continue to trade well, not for sellers. And actually, we've been very focused on doing the best deal we possibly can for shareholders.

Operator

We now have no further questions coming through. [Operator Instructions]

Richard Solomons

Okay. Thanks, operator, and we'll call that a day. Thank you, everybody, very much for listening. We appreciate that. And obviously, if you have any more further questions, please give us a call.

Have a good day. Thank you.

Operator

Ladies and gentlemen, thank you for joining today's conference. You may now replace your handsets.

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