Analysts see opportunities as industry gains momentum

Hotel & Motel Management, Jan 12, 2004 by Bruce Adams

National Report--Wall Street lodging analysts are looking favorably at the hotel industry because of expected improvement in the economy, inexpensive debt and equity capital, and the resiliency of the industry.

"Everybody believes the economy is turning, and as it turns, lodging stocks are poised for a recovery," said Greg Wolkom, managing director and head of lodging and leisure, Banc of America Securities LLC. "Investors are trying to get in now as they look at 2004 and 2005, based on increased demand and lack of new supply."

Because the industry is coming out of a down cycle, improved performance is expected.

"We've seen strong performance at our hotels the last several months and are positive about [2004]," said Jon D. Kline, executive v.p. and c.f.o. of Sunstone Hotel Investors LLC.

Until April 2003, Kline ran the hospitality practice at Merrill Lynch.

The industry's performance is based on supply and demand, according to Jackson Hsieh, global head of real estate, lodging and leisure group at UBS Investment Bank.

"When the economy improves, business travel will pick up, the airlines will offer more flights and hotels can charge more," Hsieh said.

Jack Vissicchio, managing director of Merrill Lynch, agreed.

"When the economy improves, the hotel market will improve," he said. "With 8-percent growth rates expected in the economy, it makes sense that hotels can expect revenue growth."

Paul Whyte, managing director, Deutsche Bank Securities, said the supply and demand dynamics are as attractive as they have been in a long time.

"Demand is expected to pick up, and there is little new supply in the pipeline compared to previous years," he said. "Operators should be able to push average daily rate when occupancy rebounds. As advance bookings increase, that will provide operators greater pricing power."

The hotel industry is proving its flexibility as it recovers from the "perfect storm," according to Michael Levy, executive director of Morgan Stanley.

"There have been no massive disasters, primarily due to low-cost debt," Levy said. "Flexible hotel operating structures resulted in better operating performance. The industry has proved to be more flexible than many people thought it would be."

Equity valuations grow

Hotel-equity valuations are at near-record high levels, and real-estate investment trusts are raising large amounts of equity capital, analysts said. The equity markets are encouraging lodging companies to make accretive deals.

"Investors are voting with their wallets by driving up lodging equities to significant levels relative to company performance," said Rich Weissmann, managing director for Goldman Sachs & Co. "There is confidence in the investor community that we are at the beginning of a turnaround, and there is significant upside in stocks and/or in [earnings before interest, taxes, depreciation and amortization."]

Public hotel companies are trading at near historic highs from a valuation multiple perspective.

"The public companies are trading at 12 [times] to 13 times EBITDA and are able to issue equity at 12 [times] to 13 times EBITDA and buy assets at 10 [times] to 11 times EBITDA, and therefore make acquisitions that are accretive to earnings," Whyte said.

Whyte cited Host Marriott, which raised $250 million in equity and bought the Hyatt Maui in Hawaii at 10 times EBITDA. "They added a strategic asset, and the transaction was accretive to earnings; and they deleveraged their balance sheet," he said.

There were 12 public equity offerings in the public lodging sector from June 25 through Dec. 2, according to Levy. They raised more than $1.2 billion in public equity.

"This allows companies to get growth capital to buy more assets," Levy said. "Private REITs are raising huge amounts of equity capital."

In addition to private REITs, other potential hotel buyers are dedicated sector funds and local hotel owner/operators who have relationships with lenders.

"The capital markets are strong, and assets will become available to match up with this capital," Levy said. "There are funds out there that have owned billions in hotels that will use this window to sell."

As long as investors see high growth rates, multiples will remain at or above the current levels, Kline said.

"The multiples are important because they grease the wheels of the capital flow," he said. "Public companies can use stock as currency or issue new stock to fund growth through acquisitions. On the private side, there is a tremendous amount of capital chasing transactions. It is likely there will be more sales of hotel assets in 2004."

Investors who got hurt in the stock market now are looking more favorably at real-estate. "It used to be if you bought real-estate, you missed out on your money tripling from a dot-com stock," Kline said. "That's not the case anymore."

Bond interest rates are so low that institutional investors also are looking at real-estate because they offer higher yields than bonds, plus offer equity upside, he said.

Meeting expectations

Many of these favorable conditions are based on expectations that hotels will be able to improve their earnings.