Choice Hotels CHH
October 08, 2008 - 9:29pm EST by
fatman174
2008 2009
Price: 22.49 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,382 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

It’s no surprise that a hotel company is at its 52-week low, but Choice Hotels (CHH) is differentiated enough to merit consideration by longer term investors. The company achieves high ROIC a franchisor of various lower-end/lower-service concepts, notably Econo Lodge and Comfort Inn. While the traditional metrics/drivers hotel investors concern themselves with (namely ADR and RevPAR) may indeed flag over the medium term, CHH’s history has shown that unpleasantness in the hotel space causes independents to seek the safety of a franchise system. Therefore the lagged effect of a downturn may well be significant growth in operating income as independents sign on (straight growth plus operating leverage as incremental royalty fees drop down the income statement without proportionate incremental overhead).
The company is simple and members are likely pressed for time in such a target-rich environment. Mindful of this, I’ll keep things brief and will try to elaborate if a Q&A develops.
 
The company aims to provide franchisees the highest possible return on investment. While independents may focus on increasing ADR to maximize revenue (increasing occupancy carries variable costs), CHH helps its franchisees maximize occupancy via brand awareness, booking systems and loyalty programs. It helps them lower costs through scale buying, provision of yield management systems and consultations with a dedicated team of field services staff. Franchisee retention has averaged ~95%. Meanwhile, the proposition to the end-user, the guest, is “consistency, quality and guest satisfaction.”
 
A helpful presentation gives the business’ key drivers and their recent earnings release has management’s estimates for 2008. Between the two you can build a simple model for the year ahead that will leave you not particularly excited, especially with the Bargain Meter almost pegged and several of Buffett’s stocks on the 52-week low list.
 
More important is the longer term picture, which the below table hopefully illustrates.
 
 
1999
2000
2001
2002
2003
2004
2005
2006
2007
 
Industry
Gross Rooms Added
143,148
121,476
101,279
86,366
65,876
55,245
65,900
73,308
94,541
CAGR
Profit ($BB)
      23.00
      24.00
       16.70
        16.10
        15.00
      17.00
     21.00
      26.30
    26.90
1.98%
RevPAR ($)
       51.44
       54.13
      50.99
      49.22
      49.20
     52.93
     57.34
       61.69
     65.50
3.07%
ADR ($)
       81.27
      85.24
      84.85
       83.15
       83.19
      86.41
    90.84
       97.31
   103.64
3.09%
Occupancy Rate (%)
63.3%
63.5%
60.1%
59.2%
59.1%
61.3%
63.1%
63.4%
63.2%
 
Change in ADR (%)
3.4%
4.9%
-0.5%
-2.0%
1.0%
3.9%
5.1%
7.1%
6.5%
 
Change in CPI (%)
2.7%
3.4%
2.9%
16.9%
2.3%
2.7%
3.4%
3.2%
2.8%
 
Cumulative ADR (%)
103.4%
108.5%
107.9%
105.8%
106.8%
111.0%
116.7%
124.9%
133.1%
 
Cumulative CPI (%)
102.7%
106.2%
109.3%
127.7%
130.7%
134.2%
138.8%
143.2%
147.2%
4.60%
CHH
 
# of Properties
3,123
3,244
3,327
3,482
3,636
3,834
4,048
4,211
4,445
4.51%
# of Rooms
258,120
265,962
270,514
282,423
294,268
309,586
329,353
339,441
354,139
4.03%
Royalty Fees ($MM)
  120,932
   131,702
  133,244
   135,381
     141,150
   155,915
  175,588
  194,333
  212,519
7.30%
Average Royalty Rate
3.72%
3.85%
3.95%
3.97%
4.01%
4.04%
4.08%
4.09%
4.14%
1.35%
RevPAR ($)
      35.33
      36.72
      35.83
      34.48
       34.21
      35.95
      38.15
       40.13
      41.75
2.11%
ADR ($)
      58.42
       61.45
       62.31
       61.96
       62.53
     63.56
    66.24
       68.71
     72.07
2.66%
Occupancy Rate (%)
60.50%
59.80%
57.50%
55.60%
54.70%
56.60%
57.60%
58.40%
57.90%
 
Change in ADR (%)
3.89%
5.19%
1.40%
-0.56%
0.92%
1.65%
4.22%
3.73%
4.89%
 
Cumulative ADR (%)
103.89%
109.28%
110.81%
110.19%
111.20%
113.04%
117.80%
122.19%
128.17%
 
% Change # of Rooms
2.28%
3.04%
1.71%
4.40%
4.19%
5.21%
6.38%
3.06%
4.33%
 
EBIT ($MM)
94,170
92,427
73,577
104,700
113,946
124,983
143,750
166,625
185,199
8.82%
 
 
 
* $22.7MM charge
 
 
 
 
 
 
 
The story is simply that the company can grow at GDP+ rates for a long time with limited investment. Trading at roughly 8.5x EV/EBIT, I would argue that the company is cheap on a no-growth basis. Just getting to a 10x multiple (which comports with Goldman’s recently revised price target) implies a nearly 25% return. In this market and with this company, I will gladly take a 25% return.
 
 
RISKS/ITEMS OF CONCERN
 
- The economy is less than great, and given the targeted guests/price points, there is very limited visibility. People do not book $35 rooms at a Rodeway Inn alongside an interstate months in advance.
 
- Credit markets are less than great. While conversion of existing hotels can continue, and lessened credit availability keeps a lid on introduction of room supply, development of new hotels is severely crimped.
 
- Tied in with the above, the company is planning to drive growth by allocating $20-40MM in financing, investment and guaranty support to qualified franchisees in 2009. This is a departure of sorts from the company’s usual buyback/dividend-out use of cash.
 
- The above program is in aid of CHH’s new Cambria Suites concept. One could say that CHH may be pricing themselves outside their circle of competence, and that they are striking precisely when the iron is cold.
 
- Turnover in management.
 
 

Catalyst

Independents converting. Increase in royalty rates and fees. Share buybacks.
    sort by   Expand   New

    Description

    It’s no surprise that a hotel company is at its 52-week low, but Choice Hotels (CHH) is differentiated enough to merit consideration by longer term investors. The company achieves high ROIC a franchisor of various lower-end/lower-service concepts, notably Econo Lodge and Comfort Inn. While the traditional metrics/drivers hotel investors concern themselves with (namely ADR and RevPAR) may indeed flag over the medium term, CHH’s history has shown that unpleasantness in the hotel space causes independents to seek the safety of a franchise system. Therefore the lagged effect of a downturn may well be significant growth in operating income as independents sign on (straight growth plus operating leverage as incremental royalty fees drop down the income statement without proportionate incremental overhead).
    The company is simple and members are likely pressed for time in such a target-rich environment. Mindful of this, I’ll keep things brief and will try to elaborate if a Q&A develops.
     
    The company aims to provide franchisees the highest possible return on investment. While independents may focus on increasing ADR to maximize revenue (increasing occupancy carries variable costs), CHH helps its franchisees maximize occupancy via brand awareness, booking systems and loyalty programs. It helps them lower costs through scale buying, provision of yield management systems and consultations with a dedicated team of field services staff. Franchisee retention has averaged ~95%. Meanwhile, the proposition to the end-user, the guest, is “consistency, quality and guest satisfaction.”
     
    A helpful presentation gives the business’ key drivers and their recent earnings release has management’s estimates for 2008. Between the two you can build a simple model for the year ahead that will leave you not particularly excited, especially with the Bargain Meter almost pegged and several of Buffett’s stocks on the 52-week low list.
     
    More important is the longer term picture, which the below table hopefully illustrates.
     
     
    1999
    2000
    2001
    2002
    2003
    2004
    2005
    2006
    2007
     
    Industry
    Gross Rooms Added
    143,148
    121,476
    101,279
    86,366
    65,876
    55,245
    65,900
    73,308
    94,541
    CAGR
    Profit ($BB)
          23.00
          24.00
           16.70
            16.10
            15.00
          17.00
         21.00
          26.30
        26.90
    1.98%
    RevPAR ($)
           51.44
           54.13
          50.99
          49.22
          49.20
         52.93
         57.34
           61.69
         65.50
    3.07%
    ADR ($)
           81.27
          85.24
          84.85
           83.15
           83.19
          86.41
        90.84
           97.31
       103.64
    3.09%
    Occupancy Rate (%)
    63.3%
    63.5%
    60.1%
    59.2%
    59.1%
    61.3%
    63.1%
    63.4%
    63.2%
     
    Change in ADR (%)
    3.4%
    4.9%
    -0.5%
    -2.0%
    1.0%
    3.9%
    5.1%
    7.1%
    6.5%
     
    Change in CPI (%)
    2.7%
    3.4%
    2.9%
    16.9%
    2.3%
    2.7%
    3.4%
    3.2%
    2.8%
     
    Cumulative ADR (%)
    103.4%
    108.5%
    107.9%
    105.8%
    106.8%
    111.0%
    116.7%
    124.9%
    133.1%
     
    Cumulative CPI (%)
    102.7%
    106.2%
    109.3%
    127.7%
    130.7%
    134.2%
    138.8%
    143.2%
    147.2%
    4.60%
    CHH
     
    # of Properties
    3,123
    3,244
    3,327
    3,482
    3,636
    3,834
    4,048
    4,211
    4,445
    4.51%
    # of Rooms
    258,120
    265,962
    270,514
    282,423
    294,268
    309,586
    329,353
    339,441
    354,139
    4.03%
    Royalty Fees ($MM)
      120,932
       131,702
      133,244
       135,381
         141,150
       155,915
      175,588
      194,333
      212,519
    7.30%
    Average Royalty Rate
    3.72%
    3.85%
    3.95%
    3.97%
    4.01%
    4.04%
    4.08%
    4.09%
    4.14%
    1.35%
    RevPAR ($)
          35.33
          36.72
          35.83
          34.48
           34.21
          35.95
          38.15
           40.13
          41.75
    2.11%
    ADR ($)
          58.42
           61.45
           62.31
           61.96
           62.53
         63.56
        66.24
           68.71
         72.07
    2.66%
    Occupancy Rate (%)
    60.50%
    59.80%
    57.50%
    55.60%
    54.70%
    56.60%
    57.60%
    58.40%
    57.90%
     
    Change in ADR (%)
    3.89%
    5.19%
    1.40%
    -0.56%
    0.92%
    1.65%
    4.22%
    3.73%
    4.89%
     
    Cumulative ADR (%)
    103.89%
    109.28%
    110.81%
    110.19%
    111.20%
    113.04%
    117.80%
    122.19%
    128.17%
     
    % Change # of Rooms
    2.28%
    3.04%
    1.71%
    4.40%
    4.19%
    5.21%
    6.38%
    3.06%
    4.33%
     
    EBIT ($MM)
    94,170
    92,427
    73,577
    104,700
    113,946
    124,983
    143,750
    166,625
    185,199
    8.82%
     
     
     
    * $22.7MM charge
     
     
     
     
     
     
     
    The story is simply that the company can grow at GDP+ rates for a long time with limited investment. Trading at roughly 8.5x EV/EBIT, I would argue that the company is cheap on a no-growth basis. Just getting to a 10x multiple (which comports with Goldman’s recently revised price target) implies a nearly 25% return. In this market and with this company, I will gladly take a 25% return.
     
     
    RISKS/ITEMS OF CONCERN
     
    - The economy is less than great, and given the targeted guests/price points, there is very limited visibility. People do not book $35 rooms at a Rodeway Inn alongside an interstate months in advance.
     
    - Credit markets are less than great. While conversion of existing hotels can continue, and lessened credit availability keeps a lid on introduction of room supply, development of new hotels is severely crimped.
     
    - Tied in with the above, the company is planning to drive growth by allocating $20-40MM in financing, investment and guaranty support to qualified franchisees in 2009. This is a departure of sorts from the company’s usual buyback/dividend-out use of cash.
     
    - The above program is in aid of CHH’s new Cambria Suites concept. One could say that CHH may be pricing themselves outside their circle of competence, and that they are striking precisely when the iron is cold.
     
    - Turnover in management.
     
     

    Catalyst

    Independents converting. Increase in royalty rates and fees. Share buybacks.

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