U.S. Franchise Lodging Growth (Fool Plate Special) August 2, 1999

An Investment Opinion

U.S. Franchise Lodging Growth

By Warren Gump (TMF Gump)
August 2, 1999

Upstart lodging franchising company U.S. Franchise Systems (NYSE: USFS) posted its fourth consecutive profitable quarter today, with earnings hitting $0.08 per share, in line with First Call's consensus estimate. The company, which began in October 1995, franchises three brands: 159-unit Microtel Inn & Suites, an all new-build economy chain; 63-unit Hawthorn Suites, an extended-stay chain; and 80-unit Best Inn & Suites, an economy chain that accepts conversions from other brands.

Although Revenue Per Available Room (RevPAR), the hotel industry's equivalent to same-store sales, is usually a headline statistic, investors in an emerging franchising company should take a closer look at the number of new properties in the pipeline. Fees generated from new property growth will have a much more significant impact on royalty and fee income than changes in RevPAR. For the quarter, U.S. Franchise experienced solid growth across its brands, opening 24 Microtels, 9 Hawthorns, and 15 Best Inns. Indicating that growth is accelerating, the number of properties under construction in the Best and Hawthorn brands has risen dramatically from last year. The number of Microtel's being built is flat with the same time last year.

One of the key selling points of U.S. Franchise Systems is its franchisee-focused management team. Led by industry veteran Mike Leven, who previously served as President and COO of both Days Inn and Holiday Inn, the company strives to be more responsive to franchisee needs than the bigger companies that often ignore requests from their direct customers. Based on the number of units opened to date -- in particular, conversions from other brands into Best and Hawthorn -- U.S. Franchise seems to have struck the right cord.

From a financial perspective, you have to be careful looking at the current profit being reported. While it is certainly real, the company incurred a nominal tax rate of only 5%, a rate that will likely jump to 30%-40% once all tax loss carryforwards are utilized. In addition, almost half of the company's pre-tax income is derived from interest on cash and marketable securities. Over the long haul, equity investors tend to find that an emphasis on operating earnings proves more beneficial than income from cash sitting at the bank.

U.S. Franchise has made tremendous progress developing its brands over the past four years. With a quickly rising unit base for each concept, the company will have more dollars to invest in marketing and advertising to further increase brand equity. That higher awareness should result in more units being built, continuing the cycle and yielding hefty royalty fee profits to U.S. Franchise. Now trading around $20, up from a 52-week low of $4, and considering earnings estimates of $0.45 for the current year, I can't help but think the stock may have gone a little too far, too fast. Don't fall asleep, though, because this company seems to be one worth keeping your eyes on.