The U.S. hotel industry started 2017 on a strong note with solid demand supporting modest growth in both occupancy and average daily rate (ADR) in first-quarter 2017. Revenue per available room (RevPAR) also increased 3.4%.
This is reflected in the industry’s stock-price performance. Over the past six months, the Zacks Hotels and Motels industry has fared better than the broader S&P 500 index. While the industry has gained 12.5%, the broader index has added only 6.9%.
Despite moderate first-quarter GDP growth of 1.2%, low oil prices, rising employment, higher real income, and increased household net worth reinforced consumer confidence and sentiment. This has resulted in a steady rise in business and leisure travel, and higher transaction volumes, which is likely to continue.
Positive economic outlook (GDP projected to rise 2.2% in 2017) is also expected to keep the mood upbeat, supporting continued albeit decelerating growth for the U.S. hotel industry for the rest of the year. Even then, peaking supply growth is expected to put pressure on pricing power, thereby tempering the performance somewhat.
What Do Numbers Say?
Statistics underscore the expectation of moderating but positive performance by the hotel industry. A recent report by PricewaterhouseCoopers (PwC) shows that new supply is likely to rise 2% in 2017, slightly below the anticipated demand growth of 2.1%. This is likely to result in a 0.1% rise in occupancy rates in 2017 to 65.5%.
Though both ADR and RevPAR are projected to climb 2.3% in 2017, the rate of increase will likely be less than the average growth recorded in the past few years.
Additionally, as per CBRE Hotels' Americas Research, ADR and RevPAR are expected to rise 2.9% year over year in 2017, while occupancy is projected to inch up 0.1%.
Meanwhile, the Baird/STR Hotel Stock Index, which comprises 20 of the largest market capitalization hotel companies publicly traded on a U.S. exchange and attempts to characterize the performance of hotel stocks, fell 2.4% in Jun 2017. However, in the first six months of the year, the index rose 25.4%, much higher than its 19.6% rise in the same period last year.
Thus, while overall demand in the U.S. is likely to remain strong, driven in part by firming group travel, increasing supply growth is anticipated to lead to stabilizing occupancy levels. ADR and RevPAR are expected to continue to increase, but at a slower pace than earlier expected, impacted in part by comparatively lower growth in the overall economy.
What’s Hurting the Hoteliers?
Uncertainty, both international and domestic, continues to weigh on the performance of the U.S. lodging industry.
On the one hand, the strengthening U.S. dollar and its impact on inbound, international travel is expected to keep the industry’s growth at check.On the other hand, negative sentiment related to traveling to and from the U.S. given the Trump administration’s stringent policies on immigration and tourism visasis bad for hotels.
Additionally, higher costs, increased supply along with pockets of geopolitical instability and economic slowdown are likely to continue to pose headwinds.
Though prospects of lower taxes, reduced regulations and updated trade policies proposed by the Trump administration should contribute to economic improvement, capital market surge and rising business and consumer confidence, the majority of these changes are unlikely to take effect until at least 2018.
Meanwhile, hoteliers have been focusing on renovation and digital and marketing initiatives to boost traffic and capitalize on growing tourism numbers. However, to do so, steep costs incurred by leading hoteliers are taking a toll on profits. Moreover, high labor costs will continue to be a major concern for hoteliers, and as they won’t be able to boost ADRs as much as they would like, their profits may be dented further. In fact, online travel agents like Expedia Inc. (EXPE), TripAdvisor (TRIP) and The Priceline Group Inc. (PCLN) are also limiting the pricing power of these brands.
Another major threat comes from home sharing companies, like Airbnb, Inc., which offer digital service allowing travelers to book homes at holiday destinations. With lower overhead costs and far less regulations than what hotel companies have to comply with, these firms have made steady inroads into the industry and are grabbing share from giants like Marriott International, Inc. (MAR) and Hilton Worldwide Holdings Inc. (HLT).
What Can Drive Growth?
The hotel industry is particularly vulnerable to the ebbs and flows of economic conditions. So the present solid economic fundamentals that should spur consumer spending in 2017 raises optimism for hoteliers.
Moreover, hoteliers will be able to counter any economic volatility better, if they keep moving from owning real estate to franchising their brands and services.
Particularly, hoteliers must look for ways to sustain their growth as online private accommodation aggregators flood the marketplace with new inventory. In fact, Marriott’s acquisition of Starwood Hotels & Resorts Worldwide Inc. is being viewed as a move to combat the rising threat from online travel agents and homesharing companies. Other hoteliers like Hyatt Hotels Corp. (H) and Wyndham Worldwide Corp. (WYN) are also investing in home sharing start-ups to combat Airbnb.
So far, the hotel industry has proved to be resilient during this marketplace shift. In 2017, too, the industry is estimated to witness continued success.
Thus, as hoteliers strive to enhance value and competitiveness, industry-best practices such as sustainability, brand refreshment and increased visibility through technological innovation and social networking – especially among millennials – will remain the priorities. Acute, focused investment in infrastructure to attract more business and leisure travelers will also hold the key to growth.
Why Hotel Stocks Still Have Some Upside Left
While the industry has outperformed the broader market over the last five years, it seems there is still a value-oriented path ahead. Looking at the industry’s EV/EBITDA ratio (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization), which is the best multiple for valuing hotels as they are highly capital intensive, investors might still want to pay more.
The industry currently has a trailing 12-month EV/EBITDA ratio of 10.51, which compares favorably with what it saw in the last five years. The ratio is lower than the average of 12.72 and the high of 17.45 over the last five years.
Moreover, it compares somewhat favorably with the market at large, as the current EV/EBITDA for the S&P 500 is 10.83.
Overall, the valuation of the industry from an EV/EBITDA perspective looks attractive when compared with its own range in the same time period. Moreover, its somewhat lower-than-market positioning calls for some more upside in the quarters ahead.