Is It Time to Buy Hotel Stocks?

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Did anyone notice that in 2009, hotel room service seemed to arrive a lot quicker than it used to? Maybe that's because occupancy rates had fallen off a cliff. While that was really bad for hotels, I did enjoy getting my grilled cheese sandwiches so quickly.

In fact, you don't really want to mention 2009 to a hotel owner. Industry occupancy fell 8.7%, and the average daily rate (ADR) fell 8.8%. RevPAR, or revenue per available room, fell almost 17%. The folks at industry guru Smith Travel Research called the environment "unprecedented" and "incomprehensible."

The combination of the recession and the credit crunch was especially hard on hotels, which carry high levels of debt and service it through the cash flow generated by customers. Obviously, consumers were more concerned about paying mortgages and keeping their jobs than going on vacation, so cash flow was a precious commodity.

Just how bad was it?
Numerous hotels defaulted on loans in 2009. Companies that owned them handed the keys to the special servicer. When the market was crashing early last year, it was devastating. The Baird/STR Hotel Stock Index, which began 2008 at around 2200, fell to 673 in March of 2009. Shares of Starwood Hotels Worldwide (NYSE: HOT  ) fell from a high of $75 in 2007 to $10. Ashford Hospitality Trust (NYSE: AHT  ) fell from $12 to $0.97. FelCor Lodging Trust (NYSE: FCH  ) dropped 96%, Host Hotels & Resorts (NYSE: HST  ) fell 87%, and LaSalle Hotel Properties (NYSE: LHO  ) suffered a 90% loss.

But a funny thing happened on the way to the concierge. Investors realized that the companies kept things together by cutting expenses. FelCor Lodging, for example, offset a 20% revenue drop by cutting the cost of sales by 16% and selling, general, and administrative expenses by 12%. Ashford Hospitality aggressively repurchased shares, extended loan maturities, and engaged in interest-rate swaps that added to its cash flow. Many of these stocks have increased fivefold.

So is it safe for investors to settle back into the salt water pool? Have the stocks gone up too far, too fast? The answers aren't straightforward, but there are guidelines to help figure out what's right for you.

Screening for potential
How do you feel about the economy? If you believe we're headed for a double dip, then the sector is not only a short, but a screaming one. Many companies survived by the skin of their teeth. Another year of RevPAR declines would be like inviting the vampire in for a second bite.

If you feel the economy is rebounding, then the sector is worth considering, but you must discriminate. The most important thing is a company's debt situation. LaSalle, for example, has staggered debt maturities so that it doesn't have to pay big chunks all at once in case things get bad again. Its interest coverage ratio is 4.4, meaning it has 4.4 times the cash flow it needs to service debt. If that number is too low, a company risks default. LaSalle is well within the ratios in its debt agreements.

Is a company diversified geographically and across hotel styles? Did it cut expenses aggressively during the downturn without sacrificing capital spending needed to keep hotels maintained? Does it have access to additional, cheap, credit facilities? That's important, because there are distressed properties to be purchased at a discount that can be turned around. Cash on hand? If the answer to all of these questions is yes, then you've got a candidate.

If the company cut its preferred dividend, cash was tight. Preferred dividends are often cumulative, which means that once they're reinstituted, all missed payments must be remitted. That could mean a surprise cash drain.

Has the company been able to raise capital? If it did it via debt, then lenders were comfortable with the company's situation. If it did it with equity, that's good as far as cash position, but bad as far as shareholder dilution.

In surveying the sector, my takeaway is that most stocks appear to be ahead of themselves and priced for optimism. I'm cautious about buying at these levels, but have my eye on FelCor Lodging and Host Hotels & Resorts. Also, check out all of the sector's preferred shares. They pay 7% to 9% dividends and most are trading below par, offering further value.

Meanwhile, if you love Hawaii, tie on those grass skirts, because hotel rates are as low as ever. Enjoy a mai tai for me.

Fool contributor Matthew Brown loves a deal, especially at hotels, but right now he does not hold shares in any company mentioned. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.

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Related Tickers

10/21/2016 4:02 PM
AHT $6.26 Down -0.03 -0.48%
Ashford Hospitalit… CAPS Rating: **
FCH $6.42 Down -0.05 -0.77%
FelCor Lodging Tru… CAPS Rating: *
HOT $0.00 Down +0.00 +0.00%
Starwood Hotels an… CAPS Rating: **
HST $15.47 Down -0.04 -0.26%
Host Hotels and Re… CAPS Rating: ***
LHO $24.47 Down -0.27 -1.09%
LaSalle Hotel Prop… CAPS Rating: *****