Should You Stay the Course With This Select-Service Hotel?

Source: La Quinta.

More doesn't mean better, and select-service hotels are equally, if not more attractive than their full-service counterparts, minus the bells and whistles. La Quinta (NYSE: LQ), one of the largest owners, operators, and franchisers of select-service hotels in the U.S., is a potential play on this select-service hotel theme. It also shares elements of the winning formula for hotels with its larger peers like InterContinental Hotels Group (IHG 1.89%) and Hilton Worldwide Holdings (HLT 0.97%).

Select-service
While InterContinental Hotels is better known for its flagship luxury brand InterContinental Hotels & Resorts and upscale brand Crowne Plaza Hotels & Resorts, it also owns Holiday Inn Express, one of La Quinta's competitors in the limited service segment. Holiday Inn Express is part of the Holiday Inn brand family, the largest midscale hotel brand globally. In the notoriously volatile hospitality industry, Holiday Inn has been a pillar of resilience for InterContinental Hotels.

According to Smith Travel Research, Holiday Inn has suffered a relatively smaller decline in revenues relative to the overall hotel industry during the Global Financial Crisis. Holiday Inn Express, as a select-service hotel brand, was one of the key contributing factors to this stable demand.

This is because budget-conscious vacationers staying at limited service hotels are more likely to maintain their travel plans in both good and bad times, as they are already used to travelling on shoe-string budgets. In contrast, leisure travelers, who prefer full-service hotels, have a higher propensity to cut back on discretionary travel in economically difficult periods. Furthermore, there is a trade-down effect when travelers seek cheaper accommodation.

La Quinta boasts a portfolio of more than 800 select-service hotels primarily serving the midscale and upper-midscale segments as of December 2013. Similar to Holiday Inn, La Quinta's hotels are more resilient in any downturn, because travelers are likely to move down the scale to more affordable lodging in the event of economic uncertainty.

Furthermore, select-service hotels are generally more profitable than full-service hotels. La Quinta's 2013 operating margins of 47% are significantly higher than the industry average operating margins of full-service hotels of about 30%, based on its own internal estimates. As select-service hotels provide less services and amenities, their operators such as La Quinta generates substantial cost savings from reduced operating costs and capital expenditures.

The statistics provided by both InterContinental Hotels (Holiday Inn) and La Quinta show that select-service hotels boast relatively stable revenue streams and higher margins, making them superior investments than their full-service peers.

Source: La Quinta.

Asset light growth
Since it is proven now that that select-service hotels have better economics, the next step is to grow the hotel footprint as fast as possible in a capital-efficient manner.

In the past decade, La Quinta has increased its number of franchised hotels by more than five-fold from 89 in 2003 to 477 in 2013, which represented more than half of its hotel portfolio. Notwithstanding, La Quinta still has a long growth runway.

Separating the U.S. into 628 market tracts, La Quinta has a presence in 63% of these tracts with an average of two hotels in each of these areas. In contrast, its competitors are represented in 92% of these tracts, averaging three hotels in each area. Furthermore, La Quinta has a strong pipeline of 187 franchised hotels as of December 2013, which will increase its number of franchised hotels by 39% when completed.

Hilton Worldwide, the world's largest hotel group, has also shifted toward a franchising strategy in recent years to accelerate its growth. It has added approximately 207,000 hotel rooms to its Management and Franchise segment since 2007 and grew EBITDA contribution from $945 million in 2007 to $1.2 billion in 2013.

This impressive rate of growth will have been impossible with the classic hotel owner-operator model, which demands huge capital investments. In addition, Hilton Worldwide's Management and Franchise segment is a source of stability for the company. Franchise contracts are typically long, at around 20 years, and cash flows also tend to be more stable because of recurring fees.

Franchising has become the default growth strategies for all hotel operators, big and small.

Foolish final thoughts
Hotels and hotel operators come in different shapes and sizes. Select-service hotel operator La Quinta is my top pick in the hospitality sector, because of its higher profitability, more defensive revenue streams and franchised growth strategy.