Nick Ennis, Bill Geist, Allen Miller, Mike Mongiardini, Tom Walker & Ryan Williams December 6 th 2014 Investment Analysis: Starwood Hotels & Resorts (NYSE: HOT) EXECUTIVE SUMMARY We believe that Starwood Hotels & Resorts Worldwide (HOT) is an interesting company with sustainable advantages in the Lodging sector and feel that current market sentiment underestimates the true earnings potential for the firm over the next two years. We believe that HOT has positioned itself to benefit from optimistic industry growth prospects and have set a December 2015 price target of $85.00. We are bullish on the long term trajectory of Chinese consumer discretionary spending growth and encouraged by HOT’s increased focus on the region as a prominent source of future revenue. Additionally, we believe that the company’s timely transition to an asset-light business model capitalizes on increasing real estate prices, enables ROA improvement, and decreases the firm’s debt burden, which ultimately leads to decreased risk associated with the business and in turn, justification for multiple expansion. Below are the four main points behind our argument: Macro trends in the Lodging Industry should support HOT’s growth initiatives. Growth in consumer discretionary spending in China continues to outperform global averages. The company has stated that it views Asia as the next source of revenue growth and intends to invest heavily in the region. Discretionary spending in China has increased from 9100 CNY to 3100 CNY since 2004. Furthermore, revenue per available room (RevPAR) in North America has increased at an 8% CAGR since 2009. Currently, North America accounts for roughly 45% of reported revenue for HOT broken out by geography. HOT’s divestiture of real estate assets takes advantage of current market conditions. Data on real estate trends suggest that we are entering a seller’s market as prices for commercial real estate have increased roughly 40% since 2009. An asset-light strategy in the Lodging segment allows for multiple expansion in stock value. By adopting such a model, HOT has proven that it can leverage the high reputation of its brand to support revenue and improve efficiency metrics along the
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Nick Ennis, Bill Geist, Allen Miller, Mike Mongiardini, Tom Walker & Ryan Williams December 6th 2014
We believe that Starwood Hotels & Resorts Worldwide (HOT) is an interesting company with
sustainable advantages in the Lodging sector and feel that current market sentiment
underestimates the true earnings potential for the firm over the next two years. We believe
that HOT has positioned itself to benefit from optimistic industry growth prospects and have set
a December 2015 price target of $85.00.
We are bullish on the long term trajectory of Chinese consumer discretionary spending
growth and encouraged by HOT’s increased focus on the region as a prominent source of future
revenue. Additionally, we believe that the company’s timely transition to an asset-light
business model capitalizes on increasing real estate prices, enables ROA improvement, and
decreases the firm’s debt burden, which ultimately leads to decreased risk associated with the
business and in turn, justification for multiple expansion. Below are the four main points behind
our argument:
Macro trends in the Lodging Industry should support HOT’s growth initiatives. Growth in consumer discretionary spending in China continues to outperform global averages. The company has stated that it views Asia as the next source of revenue growth and intends to invest heavily in the region. Discretionary spending in China has increased from 9100 CNY to 3100 CNY since 2004. Furthermore, revenue per available room (RevPAR) in North America has increased at an 8% CAGR since 2009. Currently, North America accounts for roughly 45% of reported revenue for HOT broken out by geography.
HOT’s divestiture of real estate assets takes advantage of current market conditions. Data on real estate trends suggest that we are entering a seller’s market as prices for commercial real estate have increased roughly 40% since 2009.
An asset-light strategy in the Lodging segment allows for multiple expansion in stock value. By adopting such a model, HOT has proven that it can leverage the high reputation of its brand to support revenue and improve efficiency metrics along the
way. Since 2010, HOT’s return on assets has grown from 5.2% to 7.3% and the company’s debt burden has decreased from $3.4 to $2.4 billion. We believe that these developments represent strong arguments for a multiple expansion of 5.3% (from its current 13.1x to our estimated 13.8x) as the risk associated with the firm’s business have lessened.
2015 FCF should improve for the firm, as the company continues to rely less on a capital-intensive model. We believe that capital expenditure decreases will accelerate through 2015 as the firm continues to wind down its development capital expenditure from $160 million in 2014 to $135 million in 2015. The benefit to FCF will ultimately be a boon for shareholders of HOT as the company has shown a desire to return significant value to them through stock repurchases, dividends, and debt reduction.
COMPANY OVERVIEW
Starwood Hotel & Resorts Worldwide is a global hotel and leisure company that owns,
operates, and franchises luxury and upscale hotels, resorts, residences, and extended stay
hotels under the St. Regis, The Luxury Collection, W, Westin, Le Meridien, Sheraton, Four Points,
Aloft, and Element brands. In addition, the company markets vacation ownership resorts and
residential units for purchase at mixed use hotel projects. Starwood owns and/or manages over
1,200 properties in 100 countries and is headquartered in Stamford, Connecticut. It is listed on
NYSE in the S&P 500 stock price index under the ticker, HOT.
Figure 1: HOT Brands by Total # of Hotels
3185
45
198
95
432
85 7911
0
100
200
300
400
HOT Brands
The company segments its hotels business into Branded Hotel Management, Managed
Hotels, Brand Franchising and Licensing, and Owned, Leased, and Consolidated Joint Venture
Hotels. Its vacation ownership and residential sales operates separately from the hotels
business. Revenue by unit is broken down as follows:
Figure 2: Total Revenue by Unit
Business Unit 2012 2013 2014E 2015E Owned, Leased and Consolidated Joint Venture Hotels 1,698 1,692
Management Fees, Franchise Fees and Other Income 888 965 Vacation Ownership and Residential 1,287 924 Other Revenues from Managed and Franchised
Properties 2,448 2,614
Total Revenues 6,321 6,115
INVESTMENT THESIS HOT is positioned well to benefit from trends that suggest the Lodging Industry is rebounding from historical lows in 2008-2009 in existing markets and prepared to accelerate growth in new markets like China.
Chinese discretionary spending per capita is expected to grow beyond 30,000 CNY in
2015. That figure is expected to grow to over 42,000 within the next five years according to
estimates by Trading Economics which tracks nearly 300 economic indicators for 196 countries
worldwide. We believe that the nearly 10% CAGR in discretionary spending since 2004 indicates
a maturation of the Chinese consumer’s increasing demand of discretionary products and
services following overall economic expansion.
Figure 3: Chinese Discretionary Spending
In addition, we believe that the relaxation of visa restrictions between China and several major
economies, notably the United States and England, will increase inbound tourism demand
within China and serve as a further tailwind for the industry in the region.
Due to the continued development of the Chinese economy and therefore the increased
necessity of business travel to the region, paired with the relaxation of travel restrictions, we
feel that the Global Business Travel Association’s estimation that 55% of the increase in global
corporate travel over the next ten years stemming from Asia as a fair assumption and one that
supports the lodging sector’s growth in the region.
The North American lodging sector’s growth prospects, where HOT receives 45% of its
revenue, should also support our revenue projections for the firm over the next several
quarters. Figure 4 details the recovery of the North American luxury tourism sector. As can be
seen, the industry has rebounded from its lows following the financial crisis in 2008-09. We
believe that Average Daily Rate (ADR) will continue to outperform overall economic
development in the US (as measured by GDP growth) and believe this will have a positive effect
on RevPar.
Figure 4: Luxury Tourism Growth
9000
14000
19000
24000
29000
34000China Discretionary Spending per
Capita
Another effect of the financial crisis was the sudden decrease in business travel
expenditures. Many detractors cited the gross excess of company budgets that allocated
exorbitant levels to conventions and perks associated with business travel. In the last three
years, those expenditures have rebounded as well. In 2014, the cost of business travel is
expected to grow to over $290 billion, a 6.8% increase over 2013. Within that total,
expenditures on group meetings or conventions are expected to grow 7.1%.
Furthermore, Smith Travel Research estimates that supply growth for the travel and
tourism industry to grow by 0.9% through 2015. We believe that the overall GDP projections
over that time, and the historic premium that travel and tourism growth has had relative to that
metric, indicate that demand for travel and tourism will increase around 4-5% overall in 2015.
The roughly 1% increase in supply will not be sufficient to satisfy the growing demand and
should serve as an additional tailwind to ADR looking forward.
EXPLANATION OF MODEL We used conservative projections for the company to approximate a reasonable
scenario for HOT over the next 5 years. We broke down our hotels into owned, managed and
franchised hotels. Consistent with management’s plan to limit growth in the owned segment we
have forecasted no growth in the number of rooms in that segment. For the franchised and
managed segments we assumed a modest growth rate of 0.5% in the number of rooms across