Marriott: Capital-Light Growth With 11-15% EPS CAGR

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About: Marriott International, Inc. (MAR)
by: Blue Sky Capital
Summary

We review the Marriott investment case after disappointing results last Friday sent shares down 5.5% at one point.

Marriott has a 2019-21 financial model that delivers an 11-15% EPS CAGR, based on RevPAR growth, room growth and buybacks.

This is achievable, given Marriott's capital-light model, structural growth in travel, a consolidated US market and its multiple brands.

Management remains confident in U.S. RevPAR growth of 1-3% for 2019; the 19Q1 U.S. RevPAR miss (+0.8%) was due to one-offs.

At $131.71, Marriott shares have a 4.7% FCF yield and a 19.9x P/E, and can deliver 10-20% upside in 12 months. Buy.

Introduction

Marriott (MAR) shares fell as much as 5.5% on Friday (May 10th) after 19Q1 results, before closing 3.3% lower for the day. Marriott share price has more than doubled in the last 5 years, as has that of Hilton (HLT), its largest competitor. In this article, we review Marriott's investment case to demonstrate how its long-term compounding story remains intact.

Marriott Share Performance vs. Peers (Last 5 Years)

NB. All prices are in local currencies. Source: Bloomberg Markets (10-May-19).

Low-Teens EPS CAGR

Marriott's financial model for 2019-21 envisages an 11-15% EPS Compound Annual Growth Rate ("CAGR"), which would give investors a low-to-mid teens annual return, assuming no re-rating for the stock. EPS growth is to come from 1-3% in Revenue Per Available Room ("RevPAR") growth, 5.8% in room count CAGR (at mid-point), stable/rising EBITDA margins and share buybacks, as shown below:

Marriott 2019-21 Financial Model

Source: Marriott investor day presentation (Mar-19).

This article will demonstrate how each of the drivers for the EPS CAGR remains achievable.

Company Overview

Marriott is the largest hotel operator globally, with 1.32m rooms. It generates two thirds of its EBIT in North America (mostly in the U.S.). Most of its hotels are owned by third parties on franchise or management contracts, where Marriott receives fees. Most of the fees are based on each hotel's revenues, but part of the fees are incentive fees based on the profits of the hotel. (In 2018, 12% of group revenues are such incentive fees). A breakdown of Marriott's room count, revenue and EBIT by region is shown below:

Marriott Room Count, Revenue & EBIT by Region (2018A)

(a) Excludes 22k rooms in time share. (b) Excludes cost reimbursement revenues. Source: Marriott 10-K (2018).

Marriott operates a variety of brands, but its overall focus is on the high end, with 10% of rooms in the luxury segment, 41% in upper upscale and 35% in upscale. Marriott's customer base is tilted towards business travelers, responsible for 67% of its room nights; on a similar metric, 45% of room nights are from negotiated group, special corporate or contract customers, which give a more recurring and predictable revenue stream.

Marriott Room Count & RevPAR by Hotel Type

NB. Figures include signed pipeline rooms. Source: Marriott investor day presentation (Mar-19).

Marriott Global Room Night Mix by Customer Type

Source: Marriott investor day presentation (Mar-19).

Cost-Efficient & Capital-Light Model

Marriott (like its large cap hotel peers) operates an efficient model where revenue growth requires little CapEx and brings little incremental costs.

Costs such as sales and marketing are funded by hotel owners as “reimbursed expenses”, and only appear in Marriott's P&L as a pass-through. Marriott's cost base consists mostly of semi-fixed general & administrative costs and depreciation & amortization, which are expected to grow at CAGR of only 1-2% (while fees will likely grow at 7-9%), as shown below:

Marriott Cost Base & CAGR (2018-2012E)

Source: Marriott investor day presentation (Mar-19).

This operational leverage gives Marriott the ability to continue expanding its margin, allowing earnings to grow much faster than revenues. Marriott has an EBIT margin of 52.8% (in 2018) and, while it only has a short history after the Starwood acquisition in 2016, a sustained margin expansion can be seen at its peers Hilton and IHG, as shown below:

Hilton & IHG Profit Margins (2014-18A)

NB. Hilton spun off Hilton Grand Vacations (HGV) in Jan-17. Source: Hilton & IHG company filings.

Marriott is also capital-light because it expansion CapEx is funded by hotel owners, and CapEx in IT systems is also mostly reimbursed over time. Maintenance CapEx is expected to be a modest $225m in 2019, less than 10% of its 2018 EBITDA.

Structural Growth in Travel

Marriott's ability to deliver continuing RevPAR and room growth has been helped by the structural growth in travel globally, especially in APAC. The rise in air travel has been a strong secular trend since 1945, with people flying more as they become more affluent. GDP and air travel per capita in countries like China, India and Brazil remain significantly below Western norms today:

Annual Air Passengers Since 1945

Source: Boeing (BA) Commercial Market Outlook (2018).

Air Passenger Per Capita vs. GDP Per Capita (2017)

Source: Boeing Commercial Market Outlook (2018).

Personal and business travel spend in each region is expected to grow at CAGR of 5-10%, fastest in APAC but at a solid 5% even in North America, as shown below. The number of hotel rooms in key economies such as China, India and Brazil is far lower than in the U.S., also shown below:

Personal & Business Travel Spend (2017-27E)

Source: Marriott investor day presentation (Mar-19).

Hotel Rooms Per 1,000 People

Source: Hilton investor presentation (May-19).

Marriott's 2019-21 pipeline envisages a net addition of 230,000-255,000 rooms, or 18-20% of the 2018 year-end room count (implying a 5.8% CAGR at mid-point). This includes significant expansion outside the U.S. – non-US markets are 33% of the 2018 room count, but represent 56% of the 2019-21 pipeline. Rooms already under construction represent 2.5 years of embedded gross rooms growth.

Consolidated, Disciplined US Market

Marriott's continuing RevPAR and room growth are also supported by a consolidated U.S. market, where there is good capacity and pricing discipline.

70% of U.S. hotel rooms are operated by branded operators, including 46% by the top 4 operators. The share by Marriott and Hilton is even larger in the pipeline, at a third and a quarter of rooms under construction respectively. Details are shown below:

Top 4 Operators' Room Share by Region

NB. Figures include signed pipeline rooms. Source: Marriott investor day presentation (Mar-19).

North America Pipeline Room Count by Operator

Source: Marriott investor day presentation (Mar-19).

The discipline exercised by U.S operators means industry room growth has been within a 2-3% p.a. range in the last few years, in line or below demand growth. This has in turn allowed Marriott to keep its North America RevPAR growth in a stable 1-3% range in the last few years, driven by daily rate growth, after occupancy has reached an optimal 74% level in 2016. Details of Marriott North America's RevPAR, daily rate and occupancy is below:

Marriott North America RevPAR Growth

Marriott North America Daily Rate Growth

Marriott North America Occupancy Rate

NB. 2014-15 figures exclude Starwood (acquired Sep-16); 2016-18 figures are pro forma. Source: Marriott results press releases.

19Q1 Miss from One-Offs

Marriott's U.S. RevPAR growth in 19Q1 was +0.8% , below guidance of 1-3%. The miss was due to a number of one-offs, as stated by the CEO:

“System-wide RevPAR in North America rose nearly 1% in the first quarter. RevPAR was constrained by the partial federal government shutdown in January, tough comparisons to hurricane recovery in Florida and Houston, and the lingering impact from the fourth quarter labor strike in Hawaii. Excluding these factors, we estimate our system-wide RevPAR growth would have been roughly 70 basis points better than the reported number, our RevPAR index in the U.S. increased nearly 100 basis points in the first quarter.”

Arne Sorenson, Marriott CEO (19Q1 earnings call)

Moreover, a reduction in Online Travel Agency revenues (as intended by management; more below) also impacted RevPAR by "a few tenths of a percentage point". Marriott reaffirmed its guidance for an 1-3% RevPAR growth in 2019, partly based on a “surge” of group bookings in April.

Lower RevPAR growth in 19Q1 was also largely confined to the Limited Service segment, where occupancy fell; the Full Service segment performed well:

Marriott Hotel KPIs - North America Full Service

Marriott Hotel KPIs - North America Limited Service

NB. 2014-15 figures exclude Starwood (acquired Sep-16); 2016-18 figures are pro forma. KPI = Key Performance Indicators. Source: Marriott results press releases.

Multi-brand Strategy

Marriott's ability to continue its room growth is helped by its expansion into new addressable customer segments. Marriott operates a variety of brands with different price points, as shown below; average daily rate varies from $416 for Ritz-Carlton on the left to $143 for Courtyard on the right. The brands also have different identities, and can suit different needs (for example, business vs. leisure) of the same customer.

Selected Marriott Brands

Source: Marriott investor day presentation (Mar-19).

Some of the brands are new, like the Moxy economy brand launched in 2013; others have been acquired, like the formerly mainly Canadian Delta brand acquired in 2015. Marriott is uniquely able to operate multiple brands successfully because of its scale, including its large loyalty program.

Good International Track Record

Marriott's ability to expand outside the U.S. can be seen in its continuing good RevPAR and occupancy performance in non-U.S. markets, apart from a dip in 2016, as shown below. The 2016 dip was due to downturn in APAC, primarily China, and region has recovered strongly since.

Marriott Hotel KPIs – International

Marriott Hotel KPIs – APAC

NB. 2014-15 figures exclude Starwood (acquired Sep-16); 2016-18 figures are pro forma. Source: Marriott results press releases.

Proven Resilience Against Disruptors

There were investor concerns about the impact from Online Travel Agencies ("OTAs") and Airbnb; but Marriott and other large operators have proven their resilience in the last few years, as seen in their continuing strong growth.

Large operators have advantages in their economies of scale, direct digital capabilities, brands and loyalty programs. They are now able to offer customers better rooms/prices on their direct channels than available with OTAs, thanks to regulatory changes. OTAs’ high fees for independents in fact helped large operators sign up new franchisees or gain market share.

Marriott has been successful in reducing its use of OTAs, keeping its percentage of bookings from OTAs flat in 2018 (after several years of 100 bps+ increases) and reducing OTA revenues by 4% y/y in 19Q1. Direct digital channels grew revenues +20% in Q1, and reached 30% of room nights.

Similarly, Airbnb has not had a real impact on large operators like Marriott since being founded in 2008. There are many reasons for this: Airbnb is targeting different customers, their properties tend to be in residential neighbourhoods away from hotel hotspots, business travelers tend to prefer hotels, some governments have started cracking down on Airbnb listings, etc.

Marriott has in fact recently announced its own homes/villas rental program, which (having completed a pilot) will launch in 100 destinations across multiple regions. This will further protect its business against Airbnb.

Shareholder-Friendly Capital Returns

Marriott has consistently returned more than 100% of its earnings to shareholders, helped by property disposals and debt, as shown below:

Marriott Return of Capital (2014-18A)

Source: Marriott company filings.

Marriott targets a Net Debt / Adjusted EBITDAR ratio of 3.0-3.5x (3.2x at 18Q4), taking on more debt in line with EBITDAR growth. 2019-21 capital returns are expected to be $9.5-11.0bn, equivalent to 21-24% of current market capitalisation, including “at least $3bn” in 2019, and will mostly be in buybacks, as shown below:

Marriott Sources of Cash (2019-21E)

Source: Marriott investor day presentation (Mar-19).

Marriott Uses of Cash (2019-21E)

Source: Marriott investor day presentation (Mar-19).

Valuation

Marriott generated $2.05bn of Free Cash Flow in 2018 on an adjusted basis, excluding growth CapEx and disposal proceeds. At $131.71, shares have a 4.7% FCF yield and are on a P/E of 19.9x:

Marriott Free Cash Flow & Valuation Multiples

Source: Marriott company filings.

Conclusion

Marriott has a 2019-21 model that targets an 11-15% EPS CAGR, which would generate a low-teens annual return for investors. The target appears achievable, given Marriott's capital-light model, the structural growth in travel, a consolidated U.S. market and Marriott's multiple brands. The 19Q1 miss o U.S. RevPAR growth is likely a dip caused by one-offs, and Marriott's long-term investment case remains intact. At $131.71, shares are on a 4.7% FCF yield and a P/E of 19.9x, and can deliver 10-20% upside in 12 months. Our recommendation on the stock is Buy.

Disclosure: I am/we are long MAR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.