InterContinental Hotels has reported impressive trading recently and, with its first-half results last month, its bosses said they saw little reason to change their confident view of the future. So, maybe, it's churlish of us to turn negative on the shares. However, volatile stock markets and movements in InterContinental's own share price are telling a different story, and these signals need to be heeded.
- Recent trading strong
- Tight supply of new hotels
- Highly cyclical business
- Exposure to low-growth US and Europe
- Trading comparatives demanding
- Downturn may hit future supply
At its heart, InterContinental is a cyclical business with a significant focus on slow growth developed economies, particularly the US (though management wants to expand the presence in emerging markets, such as China). The Americas accounted for half of the revenues and 63 per cent of underlying profit in 2010, while a further quarter of revenues and just over a fifth of profit came from the European, Middle East and African regions. So, given the torrid economic data coming from the US and Europe, there are solid grounds for concern about InterContinental's outlook, however bright things looked at the time of the results.
| InterContinental Hotels (IHG) | ||||
|---|---|---|---|---|
| ORD PRICE: | 990p | MARKET VALUE: | £2.87bn | |
| TOUCH: | 990-992p | 12-MONTH HIGH/LOW: | 1,440p | 939p |
| DIVIDEND YIELD: | 3.3% | PE RATIO: | 14 | |
| NET ASSET VALUE: | 75p | NET DEBT: | 228% | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2007 | 1.77 | 444 | 131 | 40.7 |
| 2008 | 1.90 | 316 | 91 | 41.4 |
| 2009 | 1.54 | -64 | 73 | 41.4 |
| 2010 | 1.63 | 397 | 101 | 48.0 |
| 2011* | 1.78 | 462 | 112 | 53.0 |
| % change | +9 | – | – | +10 |
Normal market size: 4,000 Matched bargain trading Beta: 1.3 *Numis Securities' forecasts (Profits & earnings not comparable with earlier figures) £1=$1.61 | ||||
The group beat City expectations by some margin in the first half, reporting a 26 per cent jump in underlying EPS on the back of growth in revenue per available room of 6.7 per cent. Performance benefited the rebranding of Holiday Inn as well as strong trading in developed markets, which benefited from a limited supply of new hotels at a time of reviving demand. Performance was also strong in emerging markets, with profits in the Asia Pacific region up 31 per cent.
But even that presents problems because the group will go into any downturn facing comparison with strong trading, given the pace of its recovery since 2009. Management has also been making the business less sensitive to the ups and downs of the economy by selling hotel buildings over a number of years, and a thawing of real estate markets has aided this process recently. The group has 12 hotels left to sell, which broker Evolution values at about $1.9bn.
The move away from owning bricks and mortar means InterContinental is focused on managing its hotels and its brands. New rooms are now added to its "system" either by asset managers, who want to build hotels to be operated by InterContinental, or under franchise agreements. Tougher economic conditions will most likely hit the supply of new rooms and therefore the potential for growth.
Limited supply is a benefit when demand is strong because it adds to the upward pressure on room rates. That said, hotels are always vulnerable when economic activity is weak - not only do occupancy rates fall, but room rates drop, too. This double whammy can lead to a fast deterioration in performance. While the likelihood of a full-blown recession remains a matter of conjecture, InterContinental's performance during 2007 to 2009 shows why shareholders have reasons for concern. The share price fell from a peak of 1,420p in 2007 to a low of 446p - a 69 per cent fall - while EPS fell sharply too, as our table shows.
