U.S. Hotel Industry Outlook - June 2018

Stocks in the hotel industry are benefiting from growth in demand that supports increases in both occupancy and average daily rate (ADR). The momentum in the U.S. hotel industry continues in 2018 after moderate growth in 2017. In first-quarter 2018, the industry witnessed a better-than-expected rise in demand, with revenue per available room (RevPAR) increasing by 3.5%.

Consequently, stocks in the Hotels and Motels Industry have put on an impressive show in the past year, handily outperforming the broader market, as a reflection of this positive backdrop. The Zacks Hotels and Motels Industry has rallied 20.2%, surpassing the S&P 500 index’s gain of 14.5%.

The industry looks attractive, owing to rise in occupancy rate and gain in commercial transient demand. Further, we note that 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 are likely to continue.

The unemployment rate declined from 3.9% in April to 3.8% in May, the lowest in 18 years. The U6 unemployment rate, which includes people forced into part-time work and people sporadically looking for jobs, declined to 7.6%, the lowest level witnessed since May 2001.

Going forward, consumer and business spending are expected to keep the mood upbeat, suggesting that the U.S. economy will remain on solid footing in 2018. In fact, the Atlanta Federal Reserve’s GDPNow model forecasts healthy 4.8% (annualized rate) GDP growth in second-quarter 2018.

Numbers Look Impressive

A recent report by PricewaterhouseCoopers (PwC) shows that new supply is likely to rise 2% in 2018, up from 1.8% in 2017. This is likely to result in 0.3% increase in occupancy rates in 2018 to 66.3%. Moreover, ADR and RevPAR are projected to climb 2.6% and 3%, respectively this year. In 2019, the industry is likely to register ADR and RevPAR growth of 2.8% each.

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, rose 1.6% in April 2018. In fact, in a year, the index has gained 12.7%.

Additionally, according to Smith Travel Research (STR), a leading information and data provider for the lodging industry and Tourism Economics, U.S. hotels continue to witness robust improvement across all metrics. However, the report revealed that occupancy rate will decline in the fourth quarter of 2018 and in 2019 due to rise in demand post hurricane in 2017. Despite this, the industry will continue to report record performance due to robust industry fundamental.

Decline in International Travel a Concern

Fall in international travel in the recent times has been a major concern for the U.S. lodging industry. Moreover, negative sentiment related to traveling to and from the United States, given Trump administration’s stringent policies on immigration and tourism visas,is detrimental to hotels. If the U.S. dollar gains strength, this may keep industry growth in check, given its impact on inbound international travel.

Additionally, higher costs and increased supply along with pockets of geopolitical instability and economic slowdown are likely to be headwinds.

Meanwhile, hotel companies have been focusing on renovation, and digital and marketing initiatives to boost traffic and capitalize on growing tourism numbers. However, steep costs incurred by leading hotel companies to do so are taking a toll on profits. High labor costs will continue to be a major concern for hoteliers. In fact, online travel agents like Booking.com (BKNG), Expedia Inc (NASDAQ:EXPE). (EXPE) and TripAdvisor (TRIP) 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 Hilton Worldwide Holdings Inc. (HLT) and Marriott International, Inc. (MAR). Both companies currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Catalysts Driving Growth

The hotel industry is particularly vulnerable to the ebbs and flows of economic conditions. So the present solid economic fundamentals are likely to spur consumer spending in the remainder of 2018, raising optimism for hotel companies. Moreover, hotel companies will be able to counter any economic volatility better, if they keep moving from owning real estate to franchising their brands and services.

Also, these companies 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 (NYSE:HOT) Inc. was viewed as a move to combat the rising threat from online travel agents and home-sharing companies. Other hotel chains like Hyatt Hotels Corp. (H) and Wyndham Worldwide Corp (NYSE:WYND). (WYN) are also investing in home-sharing start-ups to combat Airbnb.

So far in 2018, the hotel industry has proved to be resilient amid marketplace shift. Going forward, the industry is likely to witness continued success.

Thus, as hotel companies 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 priorities. Focused investment in infrastructure to attract business and leisure travelers will also hold the key to growth.

Valuation Picture

Looking at the industry’s trailing 12-month EV/EBITDA ratio (Enterprise Value/Earnings before Interest Tax Depreciation and Amortization), the space’s valuation picture remains a bit stretched. The industry is currently trading at 16.81X trailing 12-month EV/EBITDA.

Over the last five years, the industry has traded as high as 22.62X and as low as 10.8X, with a median of 13.95X. The S&P 500 Index is currently at 11.54X trailing 12-month EV/EBITDA, with the broader index’s five-year high, low and median at 12.67X, 7.49X, and 9.8 X, respectively.

Zacks Industry Rank

Within the Zacks Industry classification, hotel companies are broadly grouped in the Consumer Discretionary sector (one of the 16 Zacks sectors).

We rank 255 industries into 16 Zacks sectors based on earnings outlook and fundamental strength of the constituent companies in each industry. We put our X industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).

In fact, our back-testing shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1. Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by more than twice as much. The Zacks Industry Rank for Hotels & Motels industry is currently #212 (Bottom 17%).

The ranking is available on the Zacks Industry Rank page.

Earnings Trends

The Hotels & Motels industry falls under the broader Consumer Discretionary sector.

If we look at the overall results of the sector, per the latest report, earnings have grown 15.2% in the first quarter while total revenues are up 6%.

Meanwhile, for the second quarter, revenues are expected to rise 6%, and earnings are projected to record a gain of 8.2%. For 2018, while revenues are expected to rise 5.8%, earnings are anticipated to increase 12%.

For more details about earnings for this sector and others, please read our Earnings Trend report.

Conclusion

The U.S. hotel industry has been benefiting from several factors like a strong economy, higher income, increased consumer confidence and a strong labor market. As people are steadfast on spending time with loved ones and keep looking for unique experiences at all price points, companies in the space believe that their diverse portfolio of offerings can continue to deliver on this growing demand.

The U.S. economy expanded at a pace of 2.3% in the first quarter, above the consensus estimate. However, it represents a decline from 3% witnessed in the last three quarters of 2017. While declines were felt across all components, consumer spending declined significantly after strong gains in the fourth quarter of 2017.

This may appear to be a concern at the first glance but first-quarter figures have been dismal in recent years due to statistical and weather-related issues. Other consumer-related indicators are on the rise, which means that consumer spending should pick up in the rest of the year. Investing in consumer discretionary stocks looks like a smart option at this point. Further, the U.S. economy is expected to expand at a 4% annualized rate in the second quarter, per the latest forecast by Atlanta Federal Reserve’s GDPNow.

Thus, we see no reason why the industry should not continue to enjoy gains on both the top and bottom lines in the near-to-middle term, especially when the unemployment rate is at a 18-year low and wages are growing at the quickest pace since the end of the last decade.

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