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Can You Profit From The Lodging Sector Even As Room Rates Fall? + Vic Wisemann’s Thoughts on: HOT, MAR, WYN, CHH, GET, WOLF, MCS, HPT

Vic Wisemann
InvestorsObserver
Featured Contributor

As the recession continues, business travel has fallen off as spending on travel has become a boardroom issue. A recent survey showed more than half of the managers surveyed were eliminating all non-essential corporate travel and encouraging less air travel, while more than 60% of the Association of Corporate Travel Executives said that their central goal is cost reduction. More than a third of the ACTE members said they would spend less on travel.

Leisure travel is not quite as bleak. Research showing Americans’ travel intentions, spending expectations are roughly the same as last year. Americans are expected to take 322 million domestic leisure person trips during the summer, according to the annual summer travel forecast by the U.S. Travel Association.

Although a decline of 2.2 percent from summer 2008, leisure travel remains resilient in the current economic climate. Consumers are expected to take an average of two trips this summer, stay approximately seven nights away from home, and spend more than $900 on their longest summer trip.

The lodging industry is facing significant challenges stemming from the economic recession, as both business and consumers are cutting back on travel expenditures. When evaluating hotel companies like Starwood (HOT), Marriott (MAR) and Wyndham Worldwide Corporation (WYN) during this down cycle, pay especially close attention to changes in average daily room rates as an indication of how quickly the sector may recover once the economy improves.

Read on to see how to make profits take an extended stay in your portfolio with lodging stocks

A key operating metric in the lodging industry is RevPAR (revenue per available room). This metric is derived by multiplying the occupancy percentage of a hotel over a given period by the average daily room rate (ADR) over that same period. Changes in either occupancy or ADR will impact RevPAR, but with different implications for bottom line profitability.

Given the current state of the U.S. economy, it is no surprise that hotel occupancy percentages have been down recently, and that additional deterioration is anticipated throughout 2009. In past downturns, some hotel owners have attempted to slash room rates in an attempt to fill beds. In most cases, this tactic will result in material long-term damage to the business, for two primary reasons.

First, increases in occupancy are accompanied by increases in operating expenses. For every room that is filled, there are additional costs such as housekeeping, laundry and utilities that must be paid. When room rates decline while variable operating expenses remain stable, margins are compressed. Changes in ADR, however, fall almost entirely to the bottom line.

Second, and more importantly, cuts to ADR are difficult to recoup when the operating environment eventually improves. After slashing room rates in an effort to fill a hotel, attempts to restore those rates to previous levels are likely to be met with significant resistance. As such, the ability to benefit from an improving economy will be delayed.

Ultimately, the ability of lodging companies to maintain room rates as much as possible should have the most significant impact on their ability to weather the downturn. By keeping an eye on changes in ADR, investors can gain some insight as to which companies are best poised to benefit when economic growth returns.

Going long on large cap lodging stocks may not be the best course of action at this particular time. Although share prices have fallen considerably, much uncertainty remains. When researching potential investments in the sector, however, investors should pay close attention to the ADR reported by lodging companies. Companies that are able to best maintain room rates through the downturn are expected to be best positioned to capitalize once economic conditions do improve.

RevPAR is expected to decline significantly throughout 2009. To this point, the majority of the declines have stemmed from occupancy losses. However, while occupancy declines have somewhat stabilized, the rate of decline in ADR has continued to increase. Given this trend, expect the downturn to be deeper and more prolonged than currently anticipated by many investors.

Through the first 22 weeks of 2009, weekly RevPAR in the U.S. fell by an average of 19.6% when compared to the same period last year. The majority of this decline was attributable to decline in occupancy, as average weekly occupancy rates fell by 12.3%, but ADR also fell, with an average weekly decline of 8.4% when compared to the same period last year. This pace of ADR deterioration has accelerated, from down 7.4% in the first quarter, to down 9.6% thus far in the second quarter.

Given the lower levels of room revenue, margins are expected to tighten materially during 2009, resulting in substantial year-over-year earnings declines.

Despite the bleak outlook, recent industry upgrades sent the hotel sector up recently. An analyst from FBR Capital Markets boosted its rating on Starwood to Market Perform from Underperform and lifted the stock's price target to $19 from $15. The same analyst showed optimism for the company's peers, lifting its view of the U.S. lodging sector to Overweight from Neutral.

Choice Hotels International (CHH) shares moved higher after the upgrade. The analyst upped the stock's rating to Outperform from Market Weight, and its price target to $32 from $29.

Gaylord Entertainment (GET) moved higher despite receiving a downgrade from FBR.

Other winners were Great Wolf Resorts (WOLF), The Marcus Corporation (MCS) and Hospitality Properties Trust (HPT), which owns 474 hotels and travel centers across 44 states, Canada, and Puerto Rico.

With earnings still to come for most of the industry and the outlook not that good, a bearish hedged trade could be the way to go to generate some nice returns from the hotel industry. The stocks have climbed along with the broad market over the last three months, and in light of expectation for weak operating fundamentals going forward, the shares are most likely due for a correction.

In addition, companies with weak balance sheets, or even limited financial flexibility, will likely have a harder time navigating the challenges created by the economic recession.

For a hedged trade in the Hotel Sector, consider an August 25/27 Bear Put spread on Starwood (HOT). In this trade you would sell the August 25 put while simultaneously buying the same number of August 27 puts for a 1.70 net debit (cost to you). If the stock closes below 25 at August expiration, the trade will net a 17.6% return and the stock could rise 15% and the position would still be profitable.

As with all investments, there are risks involved. Be sure you know and understand the risks involved in any trade before you put your money at risk. Do your homework, stay within your limits, and try to have a little fun.

If you have had any additional thoughts, ideas or hotel bargains, please e-mail me at vwisemann@InvestorsObserver.com.