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Is Choice Hotels Stock a Buy?

By Dave Kovaleski – Dec 6, 2020 at 2:58PM

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The hotel chain has some key differentiators that set it apart from competitors.

As we head into these long dark days of winter, optimism is starting to build for a better 2021. Three vaccines have been proven highly effective in trials and could see early distribution by the end of the year. 

These vaccines will not only save lives but hopefully bring back a sense of normalcy once they are rolled out broadly in 2021. For the economy, particularly those businesses and industries that have been decimated by the pandemic, the vaccines may serve as the light at the end of a long, dark tunnel.

One of the industries most affected has been hospitality as travel has dropped off dramatically during the pandemic. Will this industry bounce back next year? Let's take a look at one of the largest chains, Choice Hotels (CHH -0.43%).

Not a bad Choice

I don't need to tell you how bad the last year has been for hotels -- you already know because of the vacations and weekend getaways you may have had to cancel. But Choice Hotels has been slightly less affected than many of its competitors. Its stock price is up about 5% year to date as of this writing, while many other hotel chains are down double digits.

Two people, wearing masks, checking into a hotel while being helped by the hotel clerk, wearing a mask.

Image source: Getty Images.

In its third-quarter earnings report, net income was down 81% year over year to $14.5 million, or $0.26 per share, while revenue dropped 33% to $210.8 million. But there were some positive signs. The company's revenue per available room (RevPAR) was down 28% in the quarter compared to a year ago, but that decline was 20 percentage points better than the industry average, according to management. The RevPAR deficit has continued to shrink through October. Also, occupancy rates have been steadily rising, up to an estimated 52% in October from a low of 28% in April. The company's extended stay properties enjoyed the highest occupancy rates at 74%.

Choice awarded 81 domestic franchise agreements in the third quarter, down 19% from a year ago, but 40% came in September, signaling an upward trend. The number of domestic hotels and rooms is up 0.7% and 1.9%, respectively, from a year ago, led by increases in domestic upscale, extended stay, and midscale segments. Currently, there are 945 domestic hotels in the pipeline awaiting conversion, under construction, or approved for development, representing more than 76,000 rooms.

Also, the number of international hotels and rooms increased 0.9% and 10.7%, respectively, in the quarter. Overall, Choice has about 7,100 hotels with nearly 600,000 rooms in roughly 40 countries and territories.

A good Choice?

Choice has been able to outperform its peers during the pandemic for a few reasons. One major differentiator is its franchise-focused business model, meaning the company doesn't own very many properties. It franchises out the name, logo, operations, and systems for a fee. Choice also collects a royalty fee that gives the chain a percentage of revenue, so the higher the RevPAR and the more franchisees it licenses with, the more revenue the company generates.

Another advantage is the geographic locations of its hotels. Almost 90% of the domestic hotels are in "suburban, small towns, and interstate" locations," catering to leisure, drive-to travelers -- a segment that has seen higher occupancy rates this year.

Choice CEO Patrick Pacious sees this trend continuing. "We believe that in uncertain times, as in previous down cycles, consumers will be looking for more moderately priced, limited service hotel offerings, presenting an opportunity for our portfolio to capture this demand," Pacious said on the third-quarter earnings call. Pacious indicated the strategy is to grow its limited service brands "in the right segments and the right locations" to increase market share.

Because of its franchise model, Choice also doesn't have as much overhead, because it doesn't own the properties. That has led to lower expenses than its competitors, leaving the company with a strong cash position.

The company expects to achieve its selling, general, and administrative expense reduction goal of 25% in 2020 with plans to save another 15% in 2021. It increased its cash and borrowing capacity in the third quarter by $40 million to $790 million and reduced its net debt by $50 million. This should help it get through these next few difficult quarters.

Despite these strengths, the stock is still not a buy as the earnings aren't there, and the valuation is too high. The stock trades at 32 times earnings estimates for 2021, and there's just too much uncertainty for this industry overall. But keep an eye on the company over the next few quarters as it may be a good long-term play once there's more visibility into a sustainable recovery.

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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