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Bear Stearns Introduces Major Lodging Industry Study: The 1997 U.S. Lodging Almanac
Major Findings of the 1997 U.S. Lodging Almanac
NEW YORK May 8, 1997 - In our opinion, there is still growth potential for the industry as supply/demand fundamentals remain positive, the trend toward consolidation continues, and the general economic outlook remains bright. And although we see the days when any lodging company could prosper as coming to an end, we also believe that the strongest companies with savvy management, a clear corporate vision, and an orientation toward growth (both through acquisitions and expanding existing business lines) will be positioned to prosper.
Major findings of the report are as follows:
Given Historical Trends in the Lodging Industry, We Advise Select Investing.
As we get deeper into the industry's recovery cycle, we think investors should begin to take a selective approach toward investing in this group that has performed so well in the past (a 93% two-year increase for the Bear Stearns' Lodging Index versus a 59% rise for the SP 500 over the same period). The lodging index showed very strong growth in 1995 (a 40% gain versus 31% for the SP), which was remarkable considering it declined by 11% in 1994 (compared to a 1% gain in the SP). We believe the winning strategy is to stick with the large companies having strong management, access to large amounts of low-cost capital, a solid track record of growing their companies internally through enhanced unit-level earnings and externally via accretive expansion or acquisition. Alternatively, we recommend companies who have competitive advantages in specific niches within the industry. To be effective, these smaller companies need savvy management and access to sufficient (though not necessarily large amounts of) capital to execute their specific growth strategies. Consistent with our view, we think companies like Host Marriott, La Quinta, Hilton, ITT, Marriott International, Extended Stay America, Promus, Bristol, and CapStar are well positioned to benefit from the current environment.
We expect industry revenue per available room (RevPar) growth in the 5%-7% range for the next two years, a slight moderation from the 6.4% increase recorded in 1996. While moderating slightly, RevPar growth is still very strong by historical standards, and industry profitability is expected to grow strongly in 1997 and 1998
Demand Continues to Outpace Supply in the Luxury and Deluxe Segments of the Full-Service Sector.
For 1996, demand in the deluxe segment of the full-service sector grew at 3.3%, compared to supply growth of only 1.1%. Likewise, demand in the luxury segment of the full-service sector grew at 4.0%, while supply grew at 1.2%. As a result, these segments were the only segments to record meaningful occupancy growth in 1996. Occupancy in the deluxe segment was 72.2%, up 190 basis points from 1995, whereas occupancy in the luxury segment was 74.1%, up 140 basis points year over year. Moreover, supply growth in this segment does not show any signs of significant acceleration over the next two years. At the end of 1996, there were only 4,400 rooms in the deluxe and luxury segments under construction in the top 110 metropolitan statistical areas (MSAs) throughout the United States. It is still difficult to secure the financing necessary to construct these hotels, which are larger and more costly than other hotel products. Such continued disparity between supply and demand will allow operators in these segments to continue to generate strong year-over-year RevPar growth. With the positive leverage inherent in the lodging industry, more and more of each incremental dollar in RevPar will fall to the bottom line, leading profits to grow at rates proportionally higher than RevPar. Operators that are focused in these segments, such as Host Marriott, Marriott Int'l, Hilton, and ITT, should continue to prosper through 1997 and 1998.
Supply/Demand Growth Equalize in Remaining Segments.
After five years of strong demand growth with limited supply growth, equilibrium hit most remaining segments of the lodging industry in 1996. Throughout the remaining segments, 1996 occupancy rates were essentially flat- to slightly-below 1995 levels. This trend is a direct result of increased new construction and/or net conversion gains in these sectors. As industry fundamentals improved, barriers to new development remained high in the full-service sector. This was not the case in the limited-service sectors, and those wishing to profit from the improved industry fundamentals could readily develop limited-service hotels. As supply and demand growth rates come to equalization, competitive pressures emerge throughout the sector and sector-wide RevPar growth rates will flatten. In our opinion, those limited-service operators whose product offers consumers new or like-new properties, modern brand images, good price/value perceptions, or specialty niche properties will fare better in a more competitive environment, while operators of older product with dated brand images will see their occupancy, average daily room rate (ADR), and, ultimately, profits decline.
Vulnerability to Economic Downturn.
As the national economy appears to be on solid footing at this time, we remind investors that the performance of the lodging industry has been highly correlated to the performance of the general economy. For the past 25 years, the percentage increase in the number of rooms sold each year has closely tracked the year-to-year percentage change in gross domestic product (GDP). Although economic trends are a good industry barometer, they don't track each other precisely. Historically, contractions in the lodging industry have been longer and deeper than economic contractions, while expansions have been shorter than the overall economy's. Troughs in hotel rooms demand growth lead downturns in the economy and lag recoveries. For example, recovery from the last national recession began in 1991, lodging's worst year in a generation. Now that current economic fundamentals appear strong, we caution investors that negative trends are likely to develop in the lodging industry first, long before they become apparent in the general economy. Therefore, the investor who waits for signs of an economic downturn before cashing out of his lodging stocks will find that the smart guests have already "checked out of the inn."
Consolidation Wave Expected to Continue.
We expect the wave of industry consolidations begun in 1996 to continue into 1997. Major industry mergers such as Doubletree/Red Lion, ITT/Hilton, Marriott/Renaissance, and Extended Stay America/Studio Plus occurred because the acquirers saw an opportunity to create added economic value in the acquired companies. Through these acquisitions, companies saw the opportunity to generate earnings growth at rates higher than their internal cost of capital. For example, Extended Stay America had the internal resources to roll out the successful Studio Plus brand much faster than its existing management could. Through Marriott International's demonstrated ability to increase occupancy, ADR, and operating profits, it knew it would be able to create economic value with the Renaissance acquisition that other potential acquirers could not. We believe there are many more opportunities to create economic value through strategic acquisitions in the lodging industry today. For the past five years, most of these value-added transactions were being made at the single-asset or portfolio level, as lodging companies acquired properties at below-replacement-cost prices and enhanced their value through renovations, repositionings, or rebrandings. As the acquisition prices of single assets or portfolios have risen closer to replacement cost, the opportunities to make these economic value-added transactions have diminished. We believe that corporate-level acquisitions are the next logical step in this process, as acquiring companies seek opportunities to add value for their shareholders.
Low Risk of Widescale Overbuilding.
Even though supply and demand growth equilibrium will increase competitive pressures and flatten RevPar growth rates in certain segments, we do not believe this signals an imminent, sustained, industry downturn. It merely means that the current industry cycle is plateauing. We believe there are differences between the current state of the lodging industry and the state of the industry prior to the debacle of the late 1980s and early 1990s. The 1991 bottoming-out of the hotel industry occurred through the convergence of three devastating events: 1) ten years of noneconomically justified hotel construction, 2) a national recession, and 3) the Persian Gulf War. None of these items appear to loom on the horizon today. Moreover, we believe the industry is more closely monitored than it has been in the past, and that early warning signs will arise and be heeded long before the industry could do irreparable damage to itself again. First, the statistical data available on lodging industry trends is now much more comprehensive and widely distributed than in the past. Data on supply, demand, occupancy, ADR, and RevPar - by segment, by property type, by region, and by individual market - are monitored on a monthly basis, making trends, both positive and negative, quickly apparent. Second, public market involvement with the lodging industry is at an all-time high. Analysts are constantly scrutinizing the industry on behalf of investors, a degree of oversight previously unseen in the industry. Finally, capital remains cautious. Lenders have not forgotten the recent past and they have maintained conservative underwriting standards for the industry, even in light of its strong economic performance. Substantial equity commitments are still required on projects, and financing for large-scale developments is still hard to come by. We are not foolish enough to believe that the industry is now immune to the business cycle, but we do believe that new circumstances are likely to moderate the depths of the next trough in the cycle.
The 225-page 1997 U.S. Lodging Almanac is one of the most comprehensive studies of the lodging industry ever conducted. As a reference tool, the almanac provides investors with detailed information about current and historical market conditions, lodging and economic cycles, supply and demand information, and construction outlooks. The document is a unique national perspective of the lodging industry for investors who wish to understand the dynamics behind the existing markets and potential new markets. The almanac also includes summary reports, income statement trends, and financial information and earnings projections for 22 publicly traded lodging companies. This report also details the Bear, Stearns' brand segmentation analysis. Lastly this report provides a detailed guide to lodging expansion and development in the U.S.
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