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Is Choice Hotels Stock a Buy?

By Dave Kovaleski – Aug 23, 2020 at 7:45AM

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The hotel chain has some key advantages.

These past two financial quarters have been among the worst ever for the hotel industry, as travel has largely shut down due to the COVID-19 pandemic. Choice Hotels International (CHH 0.99%) has managed the downturn better than most with the stock price down 9.7% for the year compared to the industry average, which is down 15%.

While conditions have gradually improved, travel is still way down. So, what does that mean for the hotel chain moving forward? Is Choice Hotels a buy?

Some light poking through the dark earnings clouds

The numbers aren't pretty. Choice Hotels saw revenue in the second quarter drop 52% to $151 million compared to the second quarter of 2019. While the company cut operating expenses 32% to $141 million in the quarter, operating income was down 92% year over year to $7.8 million. Overall, the hotelier posted a net loss of $2.4 million in the quarter, down 103% from a year ago.

A couple checking into a hotel wearing masks.

Image source: Getty Images.

Revenue per available room, or RevPAR, a key metric for hoteliers that is calculated by multiplying the average daily room rate (ADR) by the occupancy rate, was $26.27, which was down 49.6% year over year. The ADR was $67.21, down 20% from a year ago, and the occupancy rate was just 39.1%, down from 62.1%. The extended-stay hotels fared the best, with average occupancy rates of 66% since the start of the pandemic, which is twice the industry average of 34%. The WoodSpring Suites brand was the top performer for Choice, with an occupancy rate of 69% and a RevPAR of $31.09.

Choice has awarded 151 new domestic franchise agreements this year through the second quarter, which is down 42% from the same period a year ago.

However, there were some shafts of light poking through all the dark clouds. First, almost 100% of its 5,917 hotels are open and 90% have been since April. Also, 96% of its roughly 1,200 international hotels are open. In terms of RevPAR, Choice outperformed the industry average by 670 basis points and steadily improved through June and July. In addition, domestic occupancy rates are 565 basis points higher, on average, than the industry per week through July. 

Is this the right Choice as an investment?

Choice is different from the typical hotel chain in that it has a franchise-only business model, meaning it doesn't own the various properties but licenses them to the owner. For a franchise fee, the owner gets to use the brand name, logo, operating practices, and reservations systems, and must operate the hotel in accordance with the brand standards. Franchisors also get a percentage of revenue through a royalty fee. So, Choice makes most of its revenue on the royalty fees, which is gauged through RevPAR, and new franchise agreements. The company saw improvements in both of these metrics in July.

This franchise model has several advantages, particularly in this difficult market, with lower capital expenditures due to the lack of assets, more stable earnings, and significant free cash flow. Choice is on pace to reduce expenses by 25% this year with a 15% reduction targeted for 2021. Through the second quarter, the company had over $725 million in cash and borrowing capacity through its revolving credit facility.

"Every action the company has taken since the beginning of the crisis was aimed at improving our cash position, bolstering liquidity, reducing discretionary costs and exercising discipline around capital allocation," Patrick Pacious, president and CEO, said on the second-quarter earnings call

Another advantage is that almost 90% of the company's hotels are in suburban areas, small towns, or off major highways. These are primarily in drive-to leisure markets, which have seen higher occupancy rates and lower RevPAR declines than other locations during the second quarter.

All that said, the outlook for the hotel industry is not expected to improve much -- if at all -- in the second half of the year. Choice Hotels may have to wait until 2021 to start seeing its stock price bounce back in a meaningful way, so there are certainly better options out there right now. But keep an eye on the stock as it may look better toward the end of the year if there is more visibility on a potential vaccine.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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