This week, Hilton Worldwide Holdings Inc. (NYSE:HLT) announced that it would likely be selling all, or at least a stake, of its world-famous Waldorf Astoria hotel in Manhattan, New York. While CEO Christopher Nassetta is unsure about the exact details, he said the company was considering residential, office, and retail use for the property, as it has become increasingly difficult to charge premium rates on the rooms, due to the hotel’s magnitude. The hotel itself will still exist, with Hilton as its operator, but it will extend its use to other areas. This may very well be the first of several future asset spin-offs in the next few years, in line with the firm’s new asset-light strategy.
New Strategy for More Profits
As the world’s largest hotel company, Hilton operates over 4,000 properties and 665,000 rooms, spread out in 90 countries. While company-owned hotels currently generate 43% of revenue, the remainder earned through managed and franchised hotels, high fixed costs and the firm’s debt load make it more vulnerable to an economic downturn than other industry peers. Thus, management has declared a strategic shift towards hotel management and franchising, with 99% of the company’s new hotel pipeline in this segment, and 80% of the hotels under construction outside the domestic market. The new hotels will operate under Hilton brands, such as Conrad, Waldorf Astoria, Embassy Suites, and Hampton, with revenue from the franchised branch expected to increase at a 8.5% compound annual growth rate until 2018. Additionally, the leveraging of fixed costs should help improve returns on invested capital over the next five years, boosting the current 11% to a solid 18%.
In the competitive lodging industry, holding brand power can go a long way amongst customers, a trait from which Hilton benefits. The company’s loyalty program, Hilton HHonors, has successfully retained customers over time, with 50% of total rooms booked by the program’s members. Furthermore, brand power will continue to enable premium pricing, which in 2013 resulted in the hotel operator’s industry leading 15% average revenue per available room, well above competitors Marriott International Inc. (NASDAQ:MAR) and Starwood Hotels & Resorts Worldwide Inc. (NYSE:HOT). This factor, combined with the asset-light strategy, will increase Hilton’s network effect looking forward, thereby reducing cyclicality and enabling faster unit growth. Therefore, investors can expect free cash flow to jump from 2012’s $700 million to an average $1 billion per year until 2018, in addition to 16% EBITDA growth.
Although Hilton is still working on paying off its debt, acquired by the 2007 buy-out, 2013’s substantial increase in cash flow has helped lower this level by over $3 billion, leaving it currently at $12.6 billion. Nonetheless, investors should not be aroused by this scenario, as management’s pull towards growth via managed and franchised hotels is a smart choice that will relieve the firm from its usual capital expenditures. Moreover, while many franchised hotel operators face the risk of losing customer satisfaction, due to a lack of control over quality standards, Hilton’s possession of 32 awards in the J.D. Power’s North American Guest Satisfaction rankings is a compelling argument in favour of the company’s service quality.
However, I must point out that many analysts consider Hilton to currently be overvalued, a fair opinion when comparing the stock’s trading price of 49.6x trailing earnings to the industry average of 29.9x. So, although I feel very bullish that this hotel operator will continue to deliver strong results and profits for shareholders, I think investors should wait until the price drops before purchasing shares.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.