Innovation With Expansion Separates Choice Hotels From Rivals

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 |  About: Choice Hotels International, Inc. (CHH)
by: InvestAlike

Summary

Choice's latest quarter was a success as every element, ranging from revenue to earnings, exhibited growth.

On the basis of rising RevPAR, expansion is the most likely way to earn greater profits.

Innovation is a less focused area in the hospitality sector, which Choice is monetizing ahead of rivals.

Choice Hotels International (NYSE:CHH) has given its investors a price return of 17% in one year. The company is now among those stocks that investors seek because they outperform in earnings season. This is partially due to the company's brand, Ascend Hotel Collection, which is a group of unique, posh and independent hotels. These hotels reflect the character of the place in which they are located. Last year, the brand nearly doubled in size and is still expanding rapidly.

Choice reported its second-quarter earnings last week and gave good news to its investors. In this article, I will briefly go through the major events, highlighting the important details of the impressive performance. Later, I will talk about the future potential of this fast-growing hotel chain.

Second Quarter

During this period, Choice's total revenue climbed by 350 bps to reach $198 million from the same quarter a year ago. While expansions continued, the domestic system-wide revenue per available room (RevPAR) showed an increase of 7.6% mainly due to higher occupancy and rate charges, which increased by 280 bps and 290 bps, respectively. Clearly, it can be seen that adding more hotels wasn't the actual reason behind revenue growth; other qualitative factors prevailed.

These factors are important for the long-term health of the company; as opening new hotels isn't justified as long as RevPAR grows too. Think of it as a comparable store sales figure that we see in the retail industry. Even franchising margins were seen climbing 270 bps to 68.8% for Choice. I would like to focus more on the numbers to see how they have been performing relative to the industry.

Gross profit margin came in at 47.5%, which I believe was very strong. It has increased since the previous year's quarter and along with it, the net profit margin of 17.9% beat the industry average. Also, the operating cash flow significantly increased by 123% to $60.6 million, greatly surpassing the peer average growth rate of negative 22%. There wasn't a single element which can materially be considered a danger to the future success of Choice. The net result was diluted earnings growing by 11% to 60 cents due to a combination of lower costs and margin expansion.

Talking about the future, the company hasn't settled down yet on the expansion front. It executed 125 new domestic hotel franchise contracts during the latest period. These contracts were 20% more than what Choice had last year. The increment is explained by both strong conversion deals and growing new construction activity. New construction for Choice is picking up, post-improvement of the financing environment. As a result, Choice has more than doubled its new construction franchise agreements, with 29 new contracts last quarter as compared to only 14 during 2013's quarter.

Franchises are a profitable way to earn money not just for the parent company, but for those who buy them as well. A growing base of contracts explains the tourist appeal the company's hotels possess. In other words, there seems to be an element of good brand loyalty. This appeal is being monetized by franchise owners and in return is benefiting Choice.

Choice's success lies not only in making better hotels, but also in improving the accessibility of their locations. Recently, the company unveiled a partnership with Ford Motors (NYSE:F) in which it will become the world's first hotel chain to offer drivers of Ford vehicles the ability to search for and make hotel reservations hands-free in their car. Also, Choice has been working hard to engage tourists through online activity. It was recently recognized as having the top mobile websites in the industry. The Search Agency reviewed the 100 most-visited mobile travel destination and accommodation sites, and named Choice and five of its brands sites as the top six sites for customer mobile experience.

I believe this to be an area ignored by rivals because hotel chains normally work on improving their hotels more from the inside, while paying less attention to how customers might reach their premises. Investments in making hotels more accessible through engaging websites and innovations, such as the car-related one Choice recently introduced, will push the company's topline further in the future. This will provide Choice with a competitive advantage since rivals will be late in understanding what additional benefits this extra expenditure on innovation could have brought to them.

Bottom Line

The company's cloud system for hotels, SkyTouch, has secured contracts for nearly 50 third-party hotels. The small venture is another revenue earning product of Choice. This and the above portfolio of hotels have allowed the company to provide a dividend of 18.5 cents. The upside for Choice is huge, despite the fact that its share value has already grown in the past. For all these reasons, the company has a strong buy rating.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.