Analyse the global giant’s stellar results and you’ll see why the City is learning to love hotels, says David Stevenson
I’m still old and ugly enough to remember that the hotels sector was once as unpopular as the travel companies are today. Stockmarket analysts would constantly bemoan the heavy asset expenditure, the slow growth prospects and the poor branding and service.
In fact for a long period of time, many of the leading hotel companies traded at below their net asset value. Flash forward to 2010 and InterContinental Hotel’s recent results remind us of a number of profound changes.
The £4 billion global leviathan turned in some really very impressive numbers this week. Highlights included:
• Revenue up by 6% to $1,628m.
• Revenue per available room (RevPAR) up by 6.2%, driven by improved occupancy
• Operating margin expanding by 110 bps to 35.7%
• Free cash flow up, at $432m vs $377m for the previous year
• Net debt $349m lower than prior year at $743m
Obviously we shouldn’t get too carried away, especially as earnings per share were down 4% to 98.6c. But overall I’d say InterContinental looks increasingly like a role model for its London-listed travel sector peers.
So what has changed? The first key observation is that the mix of businesses has changed profoundly, with proper global diversification. EMEA and especially Europe looks okay and Germany in particular more than okay – operating profit increased by 5% while RevPAR was up – but it is massively overshadowed by North America and Asia.
The Americas business saw profits increase by 10% while Asia Pacific was up a staggering 67%, in part driven by RevPAR which increased by 12.4% – in China the equivalent figure was 25.8%.
InterContinental does report that asset financing remains tough in the USA (apparently funding for luxury hotels in the US is almost impossible to obtain) but these numbers are a reminder that the US is going to rebound strongly in 2011 and that Asia really is the future. On this point it’s worth noting that CEO Andrew Cosslett reckons that US RevPAR should grow by as much as 6% to 9% this year.
The next key observation is that despite InterContinental saying that it will increase system capacity by between 3 and 5% over the long term, it has actually kept capacity flat overall. The total room count at 647,161 (in 4,437 hotels) does include an extra 35,744 new rooms but these were more than offset by the removal of 35,262 rooms.
The travel sector also talks the good talk about removing capacity, but in recent months we’ve seen it start to creep back up in Northern Europe as the old growth mentality begins to take over again. InterContinental reminds us that you need to be incredibly disciplined with capacity.
The company – like many of its peers – has also been relentless in its pursuit of brand relaunches, overhauling products such as Holiday Inn and Crowne Plaza. Again I’d suggest that the travel sector hasn’t been as vigorous in its attempts to freshen up its image, making lots of superficial graphic changes but leaving much of the day-to-day, customer-touching infrastructure looking a bit samey.
Perhaps the most important change though has been the use and management of assets. InterConintental has ruthlessly followed an asset-light model, utilising franchise arrangements for most of its business (it is the manager or owner-operator in only 654 of its hotels). Like many of its peers, it shows no sign of wavering from this model and is currently trying to sell off some of its remaining US assets.
Clearly we have to accept that much of what happens at InterContinental is outside of its control. It’s a globally diversified player benefitting from a strong global upturn, especially in Asia – and that recovery looks like it’s strengthening in January, with global RevPAR up 8.4% driven by returning business travellers.
InterContinental is also benefitting from a more structural hotel sector cycle. A few years ago the whole sector was mired in over-capacity and struggling to control debts. Now that cycle is slowly turning upwards and well-diversified groups like InterContinental (and Whitbread for that matter) should be net beneficiaries.
But the successful hotel giants also tell us that they’ve got their balance sheet dynamics right, with proper global diversification allowing them to ride lots of exceptional events, and rigorous capital-light models letting them focus on the brand and marketing. Both the travel and aviation sectors could learn a great deal from this model – InterConinental currently trades at a lofty 21 times earnings, while most travel companies are in single figures.
Who cares about debt?
I couldn’t help but notice one small press release that came out this week from a debt management company. The report by GfK NOP was commissioned by the Debt Advisory Line and involved polling 1,000 adults about whether they’d consider cutting their summer holiday in order to control the family budgets and cut debt.
Only 25% of respondents said they would, with consumers in Yorkshire least likely to – just 15% said they would do the ‘sensible’ thing. Consumers in Northern Ireland were a little more savvy, with nearly half of respondents “keen to forego their family summer holiday to pocket the pennies”.
We shouldn’t read too much into what is essentially a marketing-driven piece of research, but I do think these numbers tell us a fascinating story.
One of the big narratives of the last few years has been the idea that the debt binge of the last two decades is about to grind to a halt. Consumer and mortgage debt levels are now unprecedented, and most economists have argued that over the next five to 10 years we will see a process of ‘de-leveraging’, where consumers wean themselves off debt and increase savings.
The corollary of this is that discretionary consumer spending in the UK and the US would remain depressed as the animal spirits unleashed by debt-fuelled capitalism are put back in the bottle and replaced by a more Teutonic (or maybe Northern Irish) thrift. These numbers confirm what I think is a dirty secret amongst economists: that we are in fact addicted to debt as a society, especially with interest rates so low. That addiction is stronger the poorer you are, with obvious consequences on financial literacy.
This analysis confirms that once some confidence returns to the economy, consumers will start spending again with renewed vigour, chasing large discretionary items like nice summer holidays – purchases that make them feel happier and offer some respite from a dismal wider economy.
The policy implications are dire. If the central bankers in the UK and the US really want to wean us off debt there’s only one solution: drastically raise the long-term rate of interest, to 6% or even 7%. At these levels saving might actually become attractive and ordinary consumer debt penurious. Sadly it would also push the UK economy into a decades-long recession.