Filling empty beds

"Hotels are directly correlated to economic growth and GDP, but GDP leads hotel performance into a downturn and trails it on the way out. And everything is amplified," says David Mongeau, chairman and founder of leisure-sector investment bank Avington Financial. "From the hotel groups we're talking to, from mid-summer things started to stabilise. It looks like the market has flattened out but there's nothing to bring it back to where it was… and [stability] is not across the world."

Checking in

Mr Mongeau's anecdotal evidence is supported by recent key industry data, which suggests that at the very least, things are getting worse less quickly. There have also been signs of life in the hotel-property market following a drop in hotel investment from $122bn (£76bn) in 2007 to $25bn last year, according to commercial property consultancy Jones Lang LaSalle Hotels. Spanish hotel giant Accor recently sealed a $400m budget-hotel sale-and-lease-back deal, and Avington Financial has raised money for a fund aimed at buying up hotel assets from financially-distressed owners.

In the stock market, these positive signs have created a consensus that trading in the hotel sector is now bumping along the bottom and establishing a base from which it will recover, even though fortunes between regions remained very mixed. What's more, from this month onwards, hoteliers will be comparing their performance with post-Lehman's trading levels last year, so it will become much easier to show year-on-year improvement.

But the run-up in the share prices of major UK-listed hotel groups may well have already got ahead of events, especially as any recovery may prove faltering. Shares in the big three UK-listed hotel groups InterContinental Hotels, Millennium & Copthorne and Whitbread are respectively 74 per cent, 120 per cent and 73 per cent above their 52-week lows.

"The public markets have brought these stocks back to where they were before Lehman and we think this may prove a bit premature," says Mr Mongeau, "The movements are not because of what we're seeing in the fundamentals."

Room service

Although the recent decline in the market has not been as bad as some had feared, it has nevertheless been pretty savage. For example, according to hotel consultancy STR Global, revenue per available room (RevPAR) - the key industry performance measure - was down 19 per cent in the year to the end of August in the US and it fell 15.3 per cent in Europe.

The decline in the corporate market was particularly sudden and acute following the collapse of Lehman Brothers. The drop-off in leisure travel has also been painful, and rising joblessness will do little to help recovery prospects.

"There is the fear that people have been living off the good times and the bonuses they got from earlier on," says Arthur de Haast, global chief executive of Jones Lang LaSalle Hotels, "As unemployment continues to rise I think quite a few people are feeling more nervous about 2010. It's the leisure market that has actually held up relatively well and that may well weaken now, but we may see some recovery in corporate travel offsetting that."

Another issue facing the industry is the that leisure travellers are doing a lot more price comparison than they used to, due to the popularity of price comparison and customer rating websites. So while overall hotel occupancy levels have been a pleasant surprise for some, the amount being charged for rooms has really felt the strain, which has been reflected in steep declines in RevPAR.

The relative strength of occupancy gives some grounds for optimism about the sector's recovery potential, though. That's because the general rule in the hotel industry is that occupancy levels rebuild themselves first and rates follow quickly after that. So if occupancy has not been totally decimated to begin with, hoteliers are closer to achieving those illusive rate rises.

The earnings and cash flows being reported by hotel groups is also being aided by aggressive cost cutting in the sector, although, only time will tell whether anyone has cut too far and damaged their brand. There is optimism though that management teams have got the cuts right. "It's easier for mid-market operators to take out costs," says Panmure analyst Simon French, "Generally I think hotel groups have responded well with their cuts."

Check-out time?

Despite the slowdown, the hotel industry is still having to cope with the pre-credit-crunch hotel-development boom. New rooms will continue to be churned out for some time yet, often in regions that have suddenly become undesirable, such as Eastern Europe. The US also continues to see new hotels arrive on the market at quite an impressive rate.

So, exacerbated by a 2.4 per cent increase in supply this year in the US, Jones Lang LaSalles Hotels expects RevPAR in the country to decline by a massive 17.4 per cent in 2009. For 2010 the property consultancy is forecasting a 1.3 per cent increase in US hotel room supply, which will contribute to another 2.4 per cent decline in RevPAR, before the supply tap runs almost dry in 2011 and a RevPAR revival kicks in, with 7.3 per cent growth predicted.

But with financing tight, future hotel development is likely to be constrained, which is bad news for the growth prospects of hotel groups that manage, but don't own or develop physical hotel assets, such as InterContinental.

Tighter financing conditions are also an issue for some hotel owners. Law firm Freshfield has identified $76bn worth of debt globally that matures by 2014. Of that, $5bn is due to mature this year and $12bn by the end of 2010. If banks put pressure on companies that are struggling to refinance to sell up, this would indirectly hit the value of similar hotels.

Totting up the bill

The budget hotel sector is often considered the place to ride out a recession, but even this market is not without its challenges. While UK-listed budget hotel player Whitbread has attracted many more corporate guests, it has found the leisure market tougher as three- and four-star hotels have begun to compete more aggressively on price. What's more, budget hotels are unlikely to benefit as much from a recovery as higher-end operators. While corporate frugality may be the watch-word of the current tough economic environment, it would be surprising if the attractions of opulence didn't reassert themselves pretty quickly as a recovery sets in.

In fact, luxury hotels could prove especially well positioned to benefit from an upturn due to the length of time they take to develop - about five years, in Avington's experience. Given that most developments have now been pulled unless they were at an advanced stage when the credit crunch hit, competition should be pretty thin when a recovery sets in - and that should further magnify the benefit of an economic upturn.

However, even though there are encouraging signs coming from the hotel sector, they're only encouraging in light of the severity of the preceding fall. And with much uncertainty remaining we believe caution should remain the order of the day and retain a negative on the sector given the strength of this year's recovery rally.