Last week, both Hyatt Hotels Co (NYSE:H) and Hilton Worldwide Holdings (NYSE:HLT) were upgraded by analysts at Macquarie and SunTrust, respectively. Price targets of $65 for Hyatt and $26 on Hilton shares indicate upside of 19% for each stock from Thursday’s closing price. In addition, Hilton was moved to “Top Pick” by JMP Securities on October 14, 2014 with a $30 target price.
The upgrades are interesting because they came from two different firms on two different stocks that are both in the same sector. This could indicate hotels along with travel & leisure stocks may have fundamentals shifting in their favor despite the larger selloff of stocks. This is a quick look at the reasoning behind each upgrade and any implications the rationale behind the upgrades may have for other stocks in the sector.
Hyatt’s stock is attractive based on its valuation relative to its peers and its better than average growth outlook. Hyatt is a US based hotel and resort operator. It has 71% of its rooms and receives 69% of its EBITDA from rooms in the United States. Management at Hyatt believes its geographic footprint is more favorable right now compared to other hotel operators. While the NYC hotel market was slow in 3Q up just 3.8%, other markets like Atlanta and San Francisco were strong which is important to Hyatt. In addition to its core Hyatt brand, Park Hyatt and Andaz are improving. That helps to increase exposure to higher quality assets and become less dependent on its Group business.
Hyatt has not capitalized on franchising the brand to the same degree other major operators have. International Hotels Group (NYSE:IHG), and Marriott (NYSE:MAR) franchise 73% and 55% of rooms, respectively. Hyatt currently has just 22% of its rooms franchised. Along these lines, the company recently sold and then franchised 4,950 rooms for $590 million. Franchising more rooms will improve the balance sheet and allow Hyatt to finance its growth in a less capital intensive manner.
Hyatt has accelerated its planned growth rate for its properties and plans to add 45,000 rooms to its existing room base of 135,000. Macquarie noted that it expects the number of rooms to grow at a CAGR of 6-8% versus 3-5% for competitors. It will also focus expansion on its luxury and higher end hotel brands, which should generate higher margins.
The opportunity is there for Hyatt to outpace the growth rates of this industry. It has a compelling secular story in an improving hotel market. With 3Q14, North American Rev up 9.1%, fundamentals are improving. Hyatt is in the unique position to benefit from its owned assets, finance the addition of new hotels/rooms, and expand margins back to prior peak level. Its plans should result in an industry leading growth rate, especially in 2016 when the number of rooms it brings onto the markets accelerates.
Hilton Worldwide Holdings
Hilton is well positioned to benefit from an improving outlook for 2015. RevPAR is expected to improve in 2015, a key industry metric, and SunTrust believes it will improve even more than expected industry wide. Hilton’s positioning should make it one of the primary beneficiaries of this trend according to SunTrust. While this has been the case for some time, the valuation of Hilton was standing in the way.
The 15% decline in the share price of Hilton has made the valuation more attractive and created a buying opportunity for investors. Prior to the decline, a target price with enough upside to warrant owning the stock would have required a multiple in excess of what Blackstone paid in 2007. Multiples paid for buyouts in 2007 were historically high, so unless you could argue that estimates were far too low, it would be hard to recommend Hilton. This is no longer an issue after the recent pullback. The target price of $26 is based on 13x FY15 EV/EBITDA.
Sector Sell-off – Ebola Fears Playing a Role
The sector sold off since mid-September which only accelerated over the past 10 days. Concerns around the global economy, and more recently ebola fears play a role. Historically, threats like SARS in the past, did lead to a temporary slowdown in global travel, around two months, before returning to normal levels. Depending on the how significant ebola becomes in the U.S. could change the impact. If the crisis passes over the next month, the stocks have probably oversold on this news.
Global Slowdown Impacts Global Players
The fears around a slowing global economy have driven most of the sector sell-off since mid-September. The big global players like MAR and HOT have the most at risk. Hilton gets about 78% of EBITDA from the US and Hyatt 69%, which makes both of these safer plays. The U.S. remains the strongest among the big global economies and still has a steady outlook for 2015.
Conclusion – Hyatt for Long-term, Hilton for 2015 Upside
Both Hilton and Hyatt are interesting plays right now. Between the two, we would view Hyatt as the better play. It can benefit from both cyclical trends and a secular growth story. In addition, its balance sheet and leverage towards owned versus leased assets is more attractive right now and justifies a higher multiple. That said, Hyatt’s growth story is longer term with growth accelerating in 2015. If investors are looking for a direct play on 2015 RevPAR in the U.S., Hilton may be the best stock to play.