Over the past year the short interest in Morgans Hotel Group Co (NASDAQ:MHGC) has grown from 1.4 million shares to 2.4 million shares. Short interest peak at 3 million in September. It is currently down from that peak. However, there is still good reason to be wary of this stock. And perhaps there is further downside to be realized. An examination of the company's balance sheet and income statement reveal significant problems. Also, when compared with MHGC's peers, the comparison sheds further light on the company's problems.
Poor Quality Balance Sheet
The hotel industry has had a difficult time during the global recession. Occupancy rates have fallen, and average dollar rate earned has also fallen. The impact this macro trend has had on MHGC is not good. Morgans has not posted an annual profit since 2005. Thus the company has a negative net worth and negative retained earnings. The amount of the company's current liabilities exceeds total assets. The picture looks even worse when just the company's liquid assets are considered. Selling off properties can be a difficult process. Since the company is currently not profitable, the company will need to increase its liabilities (i.e. obtain funding from the market) in order to cover continued operating losses.
Income Sheet Deteriorating
Viewing the top-line revenue trend since 2005 reveals deteriorating revenue. There has been price competition at its resorts and competition for occupancy. This has led to declining revenue. Current revenue in 2010 is below the 2005 revenue. In addition to top-line weakness, there is weakness at the bottom line of the income statement as well. The company has yet to post a profitable year. While these losses can be carried on the balance sheet as a tax asset, the company must begin to earn a profit to realize those tax benefits.
Fad Quality Properties
The company prides itself on having hip hotels in trendy markets. Its hotels are often in exclusive markets and appeal young upwardly mobile travelers. Unfortunately to maintain this sheik and posh image requires significant periodic capital investment. Given the luxurious nature of the hotels, maintenance costs are most likely higher than for traditional hotels.
Comparison with Competitors
It is interesting to compare Morgans Hotel Group with four of its competitors. These are Starwood Hotel and Resorts Worldwide (HOT), Marriott International (NYSE:MAR), Red Lion Hotels (NYSE:RLH), and Great Wolf Resorts (NASDAQ:WOLF). When compared against each of these hotel operators, MHGC consistently is the weakest of the operators.
MHGC is clearly the most highly leveraged hotel operator of the group. Since most of its liabilities are short-term, the company is heavily dependent on the market for continued financing. The other companies such as Marriott and Starwood seem better positioned to manage this less liquid period of time.
In terms of profitability, the MHGC is losing money. Again, Starwood and Marriott are earning profits and are better positioned. It is not known how long MHGC can sustain these loses without liquidating assets and trimming the number of its hotels. Even the weaker players in the market, WOLF and RLH, are not losing as much on a percentage basis.
On the two most important metrics, profitability and financial leverage, MHGC appears weak. It is clear why the short interest in this company has been large. When seeking to invest in the hotel sector, it is better to consider Marriott and Starwood than their less financially stable counterparts. Whether or not MHGC is worth shorting depends upon an investors risk tolerance. The company share price has already fallen substantially. Yet if MHGC doesn't turn things around, the current share might not be the floor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.