In the cyclical lodging industry, companies often fear an economic downturn that will affect personal and travel spending, therefore causing revenue declines. This is especially true for firms with an ownership-business model, instead of a franchised model like Marriott International Inc. (MAR, Financial), because owned or leased properties have larger fixed costs. Hyatt Hotels Corporation (H, Financial) operates 496 luxury-owned, managed and franchised hotels in over 40 countries. However, in 2012 the company stated that 70% of its cash flow derived from owned hotels, while other hotel operators reported less than 50%. Investment gurus Steven Cohen (Trades, Portfolio) and Jim Simons (Trades, Portfolio) recently reduced their company shares by more than 25% each, but remain active investors. So, let’s see what factors may have caused some doubts regarding this hotel operator's profitability.
The Pritzker’s Business Model
Hyatt Hotels Corporation is managed largely by the Pritzker family, which owns 60% of the company’s stock, as well as 77% voting power given the dual class stock structure. Thus, the family can easily stomp any takeover threat from the board, while simultaneously holding the potential to create an overhang for the stock. Furthermore, the management team has little to say about the firm’s ownership-based business model, which is capital intensive and more vulnerable to the dangers of a recession than its competitors' franchise structures are. The nature of this business also affects the firm’s returns on invested capital, which has averaged approximately 3.5% over the past five years (3.7% in 2013), significantly below the industry average of 12.10%. Also, since owned hotels have minimum switching costs for travellers, these are prone to choose another brand if it has more competitive prices.
Nevertheless, the Hyatt brands still remain popular among business and leisure travelers in the U.S. upscale luxury segment. With the Hyatt Regency, Grand Hyatt and Hyatt branded hotels serving this upscale market, and the Park Hyatt’s focus on luxury service, this company has a stable brand portfolio. Additionally, after the AmeriSuites acquisition, the firm launched its Hyatt Place and Summerfield Suite brands, in order to cater to the select service and extended-stay market. This diversity leaves the company well-positioned to outperform the industry in 2014, due to larger domestic growth of the upscale and luxury market, compared to the midscale segments. However, in the long term, the threat of a recession remains and could easily repeat 2009’s 13% revenue decline.
Valuation
What remains clear about Hyatt’s balance sheet is that the firm is still well on its recovery path from 2009’s economic crisis. Despite North America’s positive results in fiscal 2013, international market growth was weak, offsetting some of the company’s final metrics. While revenue growth remains sluggish at 2.8%, this is expected to change over the next decade, with an annual increase rate of 4.9% in revenue per room and 9% unit growth per year in the international market, due to a strong pipeline of hotels in emerging markets. The current EBITDA growth of 21.80% has also lifted some investors spirits, but I would advise caution when it comes to holding a long-term position in this stock.
Not only is Hyatt behind its competitors in terms of returns on equity (1.80%) and operating margins (4.0%), but the stock is also currently overvalued. Trading at 41.30x trailing earnings, compared to the industry average of 22.60x, the 82% seems somewhat high considering the firm’s lower than average financial results. Therefore, investors looking for short-term profits may not do wrong in turning to this company, but I feel bearish about the sustainability of a hotel ownership model and believe other industry players will achieve better long-term results.
Disclosure: Vanina Egea holds no position in any stocks mentioned.
