Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Hotel chain Marriott International (NASDAQ:MAR) reported strong earnings last week, exceeding expectations and proving investors were right to have been bidding shares up all year long. Over the past 52 weeks, Marriott stock is up a very respectable 20% versus the S&P 500, which is up only 14%. And yet, since reporting those earnings, Marriott shares have actually retreated.
In this, investment banker Raymond James sees an opportunity.
Upgrading Marriott International
This morning, analysts at Raymond James announced they're upgrading Marriott stock to outperform and assigning a $140 price target -- roughly $20 higher than where it trades today. With Marriott paying its shareholders a 1.4% dividend yield, and RJ promising 16.6% price appreciation, that works out to an expected return of roughly 18% over the next 12 months, which could very well continue the stock's streak of outperforming the S&P.
But why, exactly, does Raymond James think Marriott will outperform?
What Marriott said last week
Let's begin by recapping last week's news. On Monday, Aug. 6, Marriott released Q2 earnings that showed its profits surging 34% to $1.71 per share despite growing sales only 2.5%. What's more, it's been nearly two years now since Marriott closed on its purchase of Starwood Hotels, so the vast majority of this earnings growth is of the organic variety, not inflated by simply adding one company's business to the other's.
Marriott continued growing its business, adding 23,000 rooms to its stable of offerings. It's got a further 466,000 rooms in its "development pipeline" -- enough to grow its existing accommodations by more than one third.
What Raymond James said about that
In short, Marriott is set to continue growing steadily and profitably. As Raymond James explained in its note this morning (subscription required), Marriott already has "unmatched scale" in the hotel industry, with roughly 1.3 million rooms available for rent around the world. It's a "global brand powerhouse" with "30+ brands" under the Marriott corporate umbrella, and its pipeline of new hotels in progress is "industry-leading."
Most importantly, Marriott is doing all of this growing quite profitably. According to S&P Global Market Intelligence data, Marriott International earned more than $1.5 billion in profit over the last 12 months. Even better, it's a "free cash flow-generating machine," says Raymond James. Free cash flow at the company -- operating cash flow minus capital spending -- surpassed reported earnings by 20% at $1.8 billion. And if you add in the cash Marriott freed up by selling off unwanted assets -- $1.4 billion over the past year -- you could argue Marriott actually generated something more like $3.2 billion in free cash flow.
(To be clear, I personally would not argue that, because even with a company as big as Marriott, there's only a limited amount of assets it can sell. I don't think those asset sales should be counted as part of the company's sustainable free cash flow.)
The upshot for investors
Despite all these positives, though, investors sold off Marriott stock -- it's down 6% since the company reported earnings last week. Raymond James thinks this is a mistake.
Marriott is on the right road to "deliver low to mid-teens EPS growth for the next several years," argues the analyst, and should easily produce "15%+ total returns" for investors "over the next year." (As you'll recall from above, between dividends and earnings growth, I calculated a likely 18% return myself.)
Whether these returns are enough, however, to justify the price investors are being asked to pay for Marriott stock is another question. Marriott shares sell for about 28 times GAAP earnings, which seems to me a bit much to pay for an 18% total return. The stock is cheaper when valued on its traditional free cash flow of $1.8 billion (its P/FCF ratio is 23.3), and cheaper still if you give Marriott credit for the full amount of the cash it's been generating from asset sales (valued on $3.2 billion in putative free cash flow, the stock could be said to cost as little as 13.1 times FCF). But as I noted above, I don't think that last valuation is a safe one to assume, given that Marriott has only a limited amount of assets available to sell for cash -- and the more assets it sells, the fewer assets remain with which to generate cash in the future.
By and large, I agree with Raymond James' evaluation of the health of Marriott's business, and I agree that the stock is getting more attractive after last week's sell-off. I just don't agree that, at this price, it's quite cheap enough to buy just yet.