To an infrequent traveler, hotel chains can look pretty much the same, with their various rewards, loyalty programs, and more recently, virtual check-ins.
There is a credible investment case, however, that Hilton Worldwide Holdings (ticker: HLT) stands out among the chains for its ability to weather the pandemic and emerge in good shape—and that its shares should have more upside.
With a relatively small number of owned hotels in its portfolio, Hilton runs a so-called asset-light portfolio and relies heavily on recurring, long-term franchise fee agreements. The company is a little less tethered to luxury brands, overseas locations, and big cities than its rivals—and favorably positioned to ride out a storm. And its hotel development pipeline, though slowed by Covid-19, should fare well versus its peers.
“It’s an extraordinarily well-managed global franchise company with top-notch brands at the very, very early stages of what should be a multiyear recovery in the hotel industry,” says Bill Crow, managing director of real estate research at Raymond James.
Crow has rated Hilton a Buy for a while now, but in January he raised his price target to $125 from $105. Although Hilton’s stock has rallied recently to about $110, it is still roughly 5% below its 52-week high set in November, and down a bit over the past 12 months.
Still, the stock looks pricey compared with its historical valuation, and it has a lot of Hold ratings. Lodging fundamentals still remain weak, and business travel in particular.
While the company has taken a big hit from the pandemic—it’s expected to post a loss for 2020 of $1.92 a share based on generally accepted accounting principles, according to FactSet—the vast majority of its global hotel properties were open at year end.
Before the pandemic, Hilton was a fee-generating machine. But it’s the composition of those fees that sets it apart and bolsters the bull case for the stock.
In 2019, for example, Hilton generated some $2.2 billion in fees, with about three-quarters coming from franchising agreements. Franchisees pay a royalty fee that is generally based on a percentage of the hotel’s gross room revenues and, in some cases, gross food and beverage revenues.
Some 15% of that $2.2 billion are what’s known as base management fees, typically a percentage of the hotel’s monthly gross revenue. The remaining 10% are incentive management fees, which are usually calculated as a percentage of the hotel’s operating profits and can be more volatile, depending on the environment.
In contrast, Marriott International’s (MAR) 2019 fees totaled about $3.8 billion, roughly half from franchising. “The Street tends to put a greater multiple on franchise-fee income than it does on the management business,” says Crow. “Managing a hotel is a very difficult process.”
Hilton’s road to becoming an asset-light company—it owns only about 60 hotels worldwide—didn’t occur overnight. Blackstone Group (BX) took Hilton private in 2007, made changes, and spun it off in 2013. Although there continues to be demand for Hilton to manage properties, especially overseas, it has steadily expanded its franchise business.
In 2017, Hilton spun off Park Hotels & Resorts (PK) as a real estate investment trust, and its timeshare business, which now operates as Hilton Grand Vacations (HGV).
Jefferies analyst David Katz gives plaudits to Hilton Worldwide’s “management team just in terms of overall execution and of creating value,” avoiding unnecessary acquisitions, and “growing its footprint.”
As of Sept. 30, Hilton’s footprint consisted of 18 brands stretching across more than 6,300 properties with nearly one million rooms in 118 countries and territories. Marriott International recently said it had a portfolio of more than 7,500 properties under 30 brands in 132 countries and territories.
Despite a smaller footprint than Marriott’s, Hilton enjoys several marginal advantages, at least for now. One is that Hilton is less exposed to luxury properties than some of its peers.
As of Feb. 3, first-quarter revenue per available room, or revpar, for the U.S. luxury hotel segment was down 69.3% compared with a year earlier, versus a 35.5% decline for upper-midscale properties, according to hotel-industry tracker STR and Raymond James.
Although Hilton operates several luxury brands, including Waldorf Astoria Hotels & Resorts, it has greater exposure to upper-midscale brands, including Hampton by Hilton and Home2 Suites by Hilton, as well as other market tiers.
“We’re talking about subtleties between these companies, but globally right now I prefer the footprint that Hilton has,” says Crow.
“ We’re not that far away from break-even. We need occupancy to get up a little higher systemwide to generate a little bit more revenue. ”
Michael Bellisario, an analyst at Baird who has Hilton at Outperform, says the company is “a lot more exposed to Hilton Garden Inns [and] Hampton Inns” in smaller markets.
Another advantage, at least during a time of international travel restrictions stemming from the pandemic, is that Hilton is more domestically focused and less dependent on big cities. For the 12 months ended on Sept. 30, 84% of Hilton’s adjusted earnings before interest, taxes, depreciation, and amortization, or Ebitda, came from the U.S.
Hilton earned six cents a share on an adjusted basis in the third quarter, down from a profit of $1.05 a year earlier, as revenues fell about 60%, to $933 million. However, the company doesn’t have any big debt maturities until 2024 and no plans to add more debt, Chief Financial Officer Kevin Jacobs tells Barron’s.
As of Dec. 31, Hilton held nearly $3.3 billion in cash, providing what the company says is sufficient liquidity to get through the crisis. The company has had a junk rating on its debt since it returned to public markets, most recently BB from S&P Global Ratings. As of Sept. 30, its long-term debt totaled $10.4 billion.
One concern: As of Sept. 30, the company’s net debt to Ebitda ratio was a lofty 5.8 times. The company aims to get that ratio back to the prepandemic range of three to 3.5, a realistic goal once travel picks up.
Hilton also was burning cash last year, including about $100 million in the third quarter. But “we’re not that far away from break-even,” says Jacobs. “We need occupancy to get up a little higher systemwide to generate a little bit more revenue.”
Another plus for Hilton is its development pipeline, a key growth driver for hotel companies. Net unit growth, which measures the number of rooms added, minus any removals, grew by about 6.5% in 2019. But even as Covid-19 halted construction on some projects in the pipeline—many of them in growing overseas markets such as China—Hilton managed 5.1% last year.
The company has said that it can boost its net units by 4% to 5% for the next several years. Bellisario wrote recently that he expects Hilton’s 2020 net-unit growth and its forecast to lead the sector, supporting “our positive view of the shares.”
Perhaps the toughest part of the bull case for Hilton is valuation, which has to be viewed through the prism of a once-in-a-century pandemic and lower-than-normal earnings estimates over the next few years. Hilton recently traded at nearly 17 times enterprise value to estimated 2022 Ebitda, according to Bloomberg.
That’s expensive, but “we’ve never come through stuff like this,” says Crow. His price target of $125 assumes an enterprise value to Ebitda multiple that is stretched but uses “trough earnings,” as he puts it.
Then there’s business travel, which in more normal times accounts for about 70% of Hilton’s business. If that doesn’t start to claw back this year, the stock is likely to sell off sharply.
Still, Covid vaccines are being rolled out, and there are signs of pent-up demand for business travel.
Katz of Jefferies remains optimistic. Hilton, he says, is a “high-quality name” that “you can just own forever and you will continue to wind up in better and better places.”
Write to Lawrence C. Strauss at lawrence.strauss@barrons.com
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