Hotels are segmented into six categories, ranging from "economy" to "luxury." I toured the low end while I attended the recent Berkshire Hathaway (NYSE:BRKa) (NYSE:BRKb) annual meeting, opting for a Motel 6. If, however, you enjoy a high-speed Internet connection and a complimentary shoeshine, try a hotel owned by Host Marriott (NYSE:HMT). This 1993 spinoff of Marriott International (NYSE:MAR) now operates as a real estate investment trust, or REIT, and boasts a portfolio of 107 "upper-upscale" and "luxury" hotels.
Host Marriott was organized as a REIT in 1999 and operates alongside Hospitality Properties (NYSE:HPT), Equity Inns (NYSE:ENN), and other lodging-focused property owners. After a slump that began in the aftermath of the Sept. 11 attacks, these and other members of the hotel industry have just recently begun ramping back up. And Host Marriott's second-quarter numbers, released yesterday, suggest that its business is picking up quite briskly.
Before digging any further into the company's second quarter, let's look at the fundamentals of REITs. First off, they don't usually pay federal income tax and are required to return 90% of their net income to shareholders. To value a REIT, skim over its earnings and concentrate more on funds from operations -- basically, net income from continuing operations with depreciation added back in, since the company's assets (hotels in this case) shouldn't lose value over time. Another useful metric is the trust's liquidation value, or how much the company could reasonably net after selling its properties and paying its debt.
If we look at Host Marriott's basic numbers from the Q2 report, we see a 10.6% jump in revenues from the previous quarter and a 48% increase in funds from operations per diluted share. Average revenue generated per available room was up 9.8%, marking the company's largest increase since 1997.
But while the company's operations show every indication of continued growth, its market cap of more than $6.4 billion seems high. And cash flows, after netting out renewal and replacement expenses, have been unimpressive over the past three years. Management's estimate of asset-replacement costs of $15 billion to $16.5 billion is also speculative. With the current returns generated by those assets, it's unlikely they can achieve such a high sale price.
Since assets and profits don't measure up, investors should forgo this high-scale hotel owner for something more economy-priced. Luxury isn't always better.
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Fool contributor Matt Thurmond owns one Class B share of Berkshire Hathaway; otherwise, he holds no financial position in any company mentioned in this article. The Motley Fool has a disclosure policy.
