When investors think there may be global economic storm clouds on the horizon, as many seem to now, hotel-company shares are the last place they normally want to hide. Indeed, shares in InterContinental Hotels (IHG) have lost a fifth of their value since October’s market volatility began. However, IHG is different from traditional hotel groups in ways that we think make it a more defensive and attractive investment.
Asset-light approach
Special dividend
China expansion
Very cash-generative
Global growth worries
Soft third quarter
Since 2003, it has sold off almost all its hotel assets, which has stripped it of the high fixed-cost base and asset-heavy balance sheet that make the earnings of traditional hotel businesses so very cyclical. Meanwhile, it has used its operational skills, technology platforms and 15 international brands to create a capital-light franchise and hotel management business, which has hotel owners as clients. This model offers: more defensive earnings, with four-fifths of IHG's sales linked to the revenues at hotels that are much less cyclical than hotel profits; long-term growth potential based on the competitive advantage of IHG’s scale, tech and brands; and the scope to continue to cut its own running costs to boost the group’s already high fee margins.
The move to an asset-light model has helped underpin the return of a whopping $13bn (£10.3bn) to shareholders since 2003. While three-fifths of this reflects asset sales, the rest is a reflection of how cash-generative IHG has become, and a $500m special dividend was announced with half-year results, which is due to paid in early 2019.
Last year, 96 per cent of profit was generated from fees from franchisees and management contracts. Fee margin, which already sits at a heady 53.5 per cent, is expected to continue its historical 1.35-percentage-point-a-year climb thanks to a three-year $125m saving programme to 2020. The programme will cost $200m to implement, about half of which has already been booked. What's more, management is confident it can recycle much of the savings into growth – a hugely attractive proposition for a business that last year generated a return on average capital employed of 39 per cent.
Growth is heavily dependent on new hotels joining the IHG system as well as revenue and profit growth at hotels already in the system. The key draw IHG has to bring asset owners into its system is its ability to generate bookings for them and create efficiencies. Key ways it does this are through the pull of its brands, a centralised marketing effort, operational know-how, its IHG Concerto booking and management technology, and its IHG Rewards loyalty scheme.
Work is ongoing to improve what's on offer for hotel owners, which should help it build scale that should improve its advantage over the competition. For example, in Greater China, where IHG is keen to expand and currently generates 7 per cent of revenue, it is having success with a new franchise model. The group is also rolling out three new brands, including Regent Hotels and Resorts following the purchase of a 51 per cent stake for $39m. IHG plans to bring Regent into its luxury segment and grow the brand from six hotels today to over 40. Meanwhile, the new IHG Concerto system was rolled out across its hotels last year and a number of enhancements have also been made to the loyalty scheme to encourage more higher-value direct bookings.
Importantly, while an economic slump could reduce hotel openings, these efforts by IHG to enhance its offering appear to be paying off. On the release of half-year numbers in August, total rooms had grown by 4.1 per cent, an acceleration on 2017’s growth rate of 4 per cent and 2016’s rate of 3.1 per cent. Fast forward to the third quarter and net rooms grew by 5.1 per cent, with the 19,000 rooms opened during that time representing the strongest pace of new openings in 10 years. As of the end of September, the group had 826,000 rooms, with a further 267,000 waiting in the pipeline.
While news on room growth from the third quarter was encouraging, trading at hotels was slightly disappointing. Comparable revenue per available room (RevPAR) rose by 1 per cent globally, representing flat growth across the Americas (57 per cent of revenue) and a 2.5 per cent improvement across Europe, the Middle East, Asia and Africa (EMEAA – 28 per cent of revenue). Meanwhile, in Greater China, RevPAR jumped by 4.8 per cent, with a 4.5 per cent improvement across Mainland China thanks to “continued transient and corporate demand”. That might have fallen short of the growth rate recorded during the first half of the financial year, but it reflects strong comparable figures from the same time last year.
INTERCONTINENTAL HOTELS (IHG) | ||||
ORD PRICE: | 4,201p | MARKET VALUE: | £7.6bn | |
TOUCH: | 4,200-4,202p | 12-MONTH HIGH: | 5,050p | LOW: 3,850p |
FORWARD DIVIDEND YIELD: | 2.2% | FORWARD PE RATIO: | 17 | |
NET ASSET VALUE: | * | NET DEBT: | $1.8bn |
Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($m)* | Earnings per share (¢)* | Dividend per share (¢) |
2015 | 1.80 | 593 | 175 | 85.2 |
2016 | 1.73 | 687 | 233 | 94.0 |
2017 | 4.08 | 673 | 245 | 104 |
2018* | 4.22 | 724 | 293 | 109 |
2019* | 4.22 | 766 | 310 | 115 |
% change | - | +6 | +6 | +5 |
Normal market size: | 500 | |||
Beta: | 1.07 | |||
*Negative shareholders' funds | ||||
**Numis forecasts, adjusted PTP and EPS figures £1=$1.26 |