Bigger Is Better When It Comes to Hotel Investing

The largest hotel operator in the US is a great investment for its size and growth.

Apr 25, 2014 at 3:49PM

If there's one name in hotels that everyone knows, it's Hilton Worldwide Holdings (NYSE:HLT). Hilton is now the largest publicly traded hotel company in the U.S. after its IPO earlier this year. But shares are flat since the company's debut. However, with a potential turnaround in the domestic lodging cycle, Hilton could be worth a closer look.

Why Hilton still reigns supreme
Hilton has a strong brand name with worldwide recognition. It has a portfolio of 10 brands, including Hilton, DoubleTree, Embassy Suites, and Hampton Inn. Hilton was taken private in 2007, and since then it has managed to lighten its debt load while also increasing the number of its locations by more than 40%. The hotel operator also has a strong international presence. About 60% of its pipeline is international compared to only 20% in 2007.

But more than three-quarters of Hilton's earnings before interest, taxes, depreciation, and amortization are generated in the U.S. The U.S. remains one of the more stable markets for hotel operators. It's also already seeing a more meaningful rebound than Europe and other markets. So, Hilton's exposure to the U.S. is a net positive. The other positive for Hilton is that it has a broad range of mid- and upper-tier brands; Hilton's mid-tier brands should see increasing demand as the economy continues to rebound.

One of the more exciting opportunities for Hilton is to shift towards an asset-light model. This involves moving more to a franchise model versus a hotel-ownership model. And with Hilton's strong rewards program (HHonors), which is quickly approaching 40 million members, Hilton has been able to raise its franchise fees with virtually no push back from franchisees.

Ultimately, the shift to an asset-light model will permit Hilton to generate a higher return on capital while also allowing the company to carry lower debt. This type of shift should allow Hilton to continue trading at a premium valuation to peers.

Is there value to be found in other hoteliers?
Despite its size, Hilton is still one of the growth stories of the industry. Analysts expect earnings to grow at an impressive 22.5% annually over the next five years. However, a couple of other hotel operators might appeal to income-seeking investors (Hilton doesn't pay a dividend). Starwood Hotels & Resorts Worldwide (NYSE:HOT) offers a 1.8% dividend yield. And Wyndham Worldwide (NYSE:WYN) pays a dividend yielding 1.9%.

As far as Starwood Hotels goes, it's right there with Hilton when it comes to size. Starwood Hotels has more than 1,000 hotels spread across 100 countries. The nice thing about Starwood Hotels is that it's positioned nicely to benefit from a turnaround in international markets.

Wyndham is a bit different. It not only has hotels but also manages vacation properties. With its exposure to the vacation market, Wyndham has even more leverage to the rebounding economy than Hilton and Starwood.

How shares stack up
Hilton trades with a premium valuation to its peers, trading at a P/E of 28 based on next year's earnings estimates. Wyndham trades at a 15 P/E and Starwood at 24. This points to Hilton as one of the better growth stores in the industry. Of the 22 Wall Street analysts following Hilton, none have a sell rating.

As far as Wyndham's steep discount to Hilton and Starwood, it's for a reason. Wyndham has inherently more risk given its exposure to the vacation and exchange & rental market, especially in Europe, where this part of the market remains very weak.

Bottom line
Hilton is making the shift toward an asset-light business model, which should help reduce the amount of debt the company carries as well as boost margins. For investors who would like to play the rebounding economy, hotels are a great way to do so. And in this space, Hilton's worth considering on a pullback.  

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