Hotel Investor

The Short Case on Home Inns & Hotels Management

I think the people that focus on occupancy as the major gain from the Olympics have really missed the boat when it comes to limited service hotels. Occupancy is only one factor when looking at hotel performance - and in high occupancy markets or high-occupancy segments (such as limited service hotels) it is highly irrelevant. A point or two in occupancy means little to the bottom line. This has to do with the fact that for every occupancy point gained, the associated revenues are subject to full operational expenses on owned and leased properties, and on the incentive fee portion of managed properties (incentive fees are subject to operational expenses). The only type of operation that can truly benefit 100% from occupancy gains are hotel companies that franchise their brands - as fees are paid on gross rooms revenue.

In comparison, every dollar gained on the average rate (i.e. the average price of a room night) flows through directly to the bottomline with the exception of deductions for credit card commissions and and revenue based management fees.

Thus, ADR or average daily rate is a lot more meaningful. When demand is high and occupancy is particularly strong (and this has to be across hotel classes) operators will significantly increase their rates in order to maximise profits. This means that for limited service hotels the price/value relationship is highly distorted during such periods, with limited service hotels benefitting from the price increases of higher-grade hotels. An example...try booking a limited service hotel such as the Howard Johnson Times Square during a sell-out night in New York City and you may end up paying $900 for standard room. People will still pay because they have to stay in New York City - and New Jersey is not an option. This is why a Hampton Inn in New York City is likely to run twice the average rate of an average Hampton Inn in suburban US.

Same applies to the Olympics - if there is anything we have learned from past Olympics it is that hotel operators harvest profits primarily from excessive price increases '''supported''' by strong occupancy rates. This applies to the extended Olympic period and as such I think it is foolish to not expect any upside from the Olympics (despite distribution of hotels throughout China). Look at performance of hotels in Olympic cities around the world during Olympic years and I think you will find the answer.

The real downside is what we call the fall-out after an Olympic year - which is the Olympic cities and countries becoming 'out of fashion' in the year after the Olympic Games, and lodging performance taking a hit based on year-over-year performance as you are comparing to an exceptional year. This could lead to sell-offs, with great opportunities for the value investors to move in and capitalize on the long-term prospects of the share.

I would not sell this share prior to the Olympics, in fact I just doubled my position in the recent dip at $18.00. However, I would monitor sell-offs due to the following reasons that have little to do with the actual long-term performance of the company:

- Olympic fall-out may cause year-over-year performance in 2009 to look disappointing, and thus cause downward movement in price.

- With 200 hotels to open in 2008 and similar growth expected in 2009, the company is virtually doubling in size. The portion of the additional properties that are new developments will not open 'full', and as such the ramp-up period until a stabilized performance is achieved may dillute company-wide RevPAR (Revenue per Available Room). This will result in analysts confusing real growth with growth pain (i.e. occupancy and/or RevPAR dillution on an aggregate basis) as we have already seen before with this share.

I think shorts will have a difficult time making money on this share in the near term, as this company does things right. When backing out share-based compensation charges, foreign exchange losses, and acquisition-related charges from the Top Star acquisition from the recent financial reporting, this is a pretty solid growth share with a good outlook.