I laid out the long-term threat posed by Airbnb to the large hotel chains in a MorningWord post last week, with the following conclusion:
The hotel industry is still in the early days of dealing with the disruptive threat, with the big cash cows of business and high-end travel still secure from Airbnb’s reach at the moment.
In my mind though, Airbnb is a serious threat to the largest incumbents. Given the elevated valuations and still robust growth projections of the traditional hotel names, investors might want to consider the risk that the rental market poses to their long-term growth and profits. Those slow to adapt could be looking back 5 years from now and wondering where they went wrong.
With that in mind, I wanted to take a closer look at one of the largest hotel chains, Starwood (ticker: HOT). Starwood is a $16 billion market cap, only slightly smaller than Marriott, which is the sector leader at a $20 billion market cap. HOT recently made a new all-time high, rising above the prior high from 2007:
The company’s earnings and sales were hit hard by the financial crisis, but Starwood has gradually grown back to its prior size. Its expected 2014 sales of around $6.1 billion and its expected EPS of $2.84 are quite similar to its 2007 sales figure of $6.15 billion and its 2007 EPS of $2.76.
While HOT did hit a new all-time high, the stock has underperformed its hotel industry peers over the past couple of years. Analysts who cover Starwood stock have been badgering Starwood management on the past 2 conference calls, voicing to management that the stock is underperforming because of a smaller buyback program relative to peers. A good portion of the recent conference call in late July was devoted to capital returns as a result.
The capital return strategy is relatively benign, and the more important issue in my mind is the overall business growth. HOT has been unable to grow revenues or earnings since 2007, and the rental market threat from Airbnb could be a long-term problem. The one positive for Starwood is that it is focused on the high end of the market, which has been less impacted by Airbnb’s rise so far. Most of Starwood’s planned expansion is in high-end, international markets. From the conference call:
I should remind you that the quality of our pipeline remains strong about 60% in luxury and upper upscale, about 80% managed and over 80% outside the U.S.
In response to an analyst question about management’s expectation for a potential pickup in lower-end hotel room growth, which has lagged the high end in the U.S., Chief Executive Frits van Paasschen did not mention the possibility that Airbnb was posing competition (REVPAR = revenues per average room):
So certainly earlier in this recovery we saw a much more significant bounce back and higher growth rate as you moved up markets to luxury and upper upscale and so forth and so clearly at some point in the cycle, some of the growth in REVPAR and occupancies is going to percolate down to other segments of the market and then I think as you also right pointed out, decent part of our business geographically is skewed to the North East or at least the North and Hawaii where growth was a bit slower and in particular in New York where more suppliers come on stream.
Given the enormous growth in Airbnb rooms available, I think the hotel market in the largest cities in the world are going to be impacted. Perhaps that is already happening on the lower end of the hotel market, but even a 5-10% market share for Airbnb over time is going to hit Starwood’s and other operators’ expected growth.
Having said all that, the geographically diverse nature of the largest hotel companies shields them somewhat from Airbnb’s growing threat. Here is the breakdown of HOT’s revenues and earnings by region:
The Americas (drive by the U.S.) still accounts for about half of total earnings for the company. The main hit in the first half of 2014 was the decline in the vacation ownership and residential division, which was due to the end of sales from a long-term project earlier this year.
However, Airbnb is rapidly expanding abroad as well. While the high end remains somewhat protected, the risk to the hotel market is serious. Managements seem to be going about business as usual despite the approaching threat.
As for Starwood in particular, the stock has underperformed because the business has underperformed. The stock is valued at around a 27x P/E, with analysts projecting EPS growth of 10-15% over the next 2 years. That hardly looks like a bargain, especially since the hotel industry has had the wind at its back in the past few years, and HOT has still struggled.
The stock has stalled near $85 for the second time in the past couple of months, even as the broader market has continued higher:[caption id="attachment_44726" align="aligncenter" width="600"] HOT daily chart, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
The $75 level is the long-term breakout above the 2007 high, and the 200 day ma is around $78.50, and has acted as support on several occasions in the past year.
As with most stocks in the market, 30 day implied volatility is near a 2 year low:[caption id="attachment_44727" align="aligncenter" width="600"] 30 day implied volatility in HOT, Courtesy of Bloomberg[/caption]
Add it all up, and the trade that I considered was the Sept 85 put for around $1.90. If the broader market starts to sell off, HOT is likely to come under pressure given its inability to break out to a new high this month. One risk is decay, though I think the stock is either likely to breakout or sell off away from $85 in the next few weeks. The stock has sold off on the last 3 earnings reports, but has found a bid with the rallies in the broader market. As a result, a move higher is possible if the stock market overall remains strong. That’s why I’m going to hold off on a HOT trade here. But I think the long-term prospects for HOT are unfavorable.