Today there are more expensive hotels and resorts offering exotic pampering, fawning service, fantastic food, and eye-popping prices than at any time in the history of the world. Islands once barely habitable are now clogged with private yachts and belly-button-revealing beauties temporarily in search of paradise. City blocks that had formerly housed factories have become home to hedonistic high-rises that welcome American Express' favorite customers on a regular basis. If you're willing to pay for it, it's almost impossible to travel far without being able to find a luxury hotel that offers beds swathed in Egyptian cotton, aromatherapy spas, or four-star restaurants serving French premier crus and caviar.
Beginning in 2003, the hospitality industry began what turned out to be a four-year surge. Share prices of hotel chains with significant luxury holdings have soared. Last year alone, nine luxury chain-affiliated hotels were built in the U.S., adding more than 2,000 rooms to an increasingly crowded field. Overseas, construction is equally aggressive, especially in burgeoning markets such as China and India.
But are there too many hotel rooms? Some analysts are beginning to think so.
The reason is that there soon could be more luxury hotel rooms than guests to fill them on a regular basis. While the potential of a glut would be spread across the entire hospitality industry, it could be even more worrisome for large operators such as Marriott (MAR), Starwood (HOT), InterContinental (IHG), and Fairmont (FHG) that have a strong presence in the luxury sector.
While they make up only 2.6% of the overall market room supply, luxury hotels account for 5.5% of room revenue. According to Smith Travel Research in Hendersonville, Tenn., rates for all U.S. hotels rose 7.1% in 2006, but luxury hotels increased 9%. For the most part, luxury hotels don't generate higher returns cash on cash but will often generate higher returns based on appreciation of the cost. A decline in revenue from their luxury subsidiaries would have an equally disproportionate impact on the parent companies' bottom lines.
"The U.S.-wide slowdown in room demand and ADR growth is evident across all sectors of the hotel industry," says Bjorn Hanson of PriceWaterhouseCoopers. (ADR is an acronym for Average Daily Rate, a metric that determines a hotel's pricing scale by dividing actual daily revenue by the total number of available rooms.) "This is a cyclical industry, you see, and we could be coming to the top of the cycle."
But Hanson believes the luxury sector will be reasonably well buffered, even if it won't see the same kind of gains it has enjoyed recently. He predicts that for the luxury lodging segment, revenue per available room (RevPAR) will only grow by 7.3% on the strength of a 7.4% increase in ADR as occupancy declines by 0.1%. By contrast, in 2006 RevPAR was up 11.6% on a 9.1% rise in ADR and an occupancy growth rate of 1.6%. And don't look for any rapid rebound. Hanson further forecasts that the numbers will continue their downward trend over the next few years.
That doesn't mean the sector is in trouble, however. It just means that shareholders won't witness the kind of growth they've become accustomed to seeing.
Deals Still Brewing
The warning signs have been out there for a while. Last October, analyst Steven Kent at Goldman Sachs (GS) was one of the first to raise concerns about the industry's near-term future when he downgraded the lodging sector overall to neutral from attractive. He admits he was a little early, because rumors of private equity takeovers and better-than-expected top-line guidance for 2007 continued to buoy share price.
Nevertheless, he continues to believe that the persistence of such rumors is keeping prices artificially high. Without these, investors would be able to see that the supply chain for new hotels is overextended, and that the recent runup is coming to an end.
"I'm generally more concerned about the broad hotel industry, and ultimately think that luxury hotels will be in better shape over the next couple of years. But at some point, a deceleration in RevPAR will be felt even at the high end of the sector," Kent adds.
Not everyone is so gloomy. InterContinental Chief Executive Andrew Cosslett believes that his company, the world's largest hotel operator with more than 3,700 properties in more than 100 countries, is well-positioned for growth in the near future. InterContinental operates seven hotel brands, including the flagship InterContinental luxury chain, but also Holiday Inn, which operates more than 1,300 hotels worldwide and is investing heavily in developing markets like India and China. He believes that his company's diversified portfolio and a business model based on managing hotels, not owning them, will benefit IHG if the cycle turns down.
"As long as you are opening more hotels when the bad times come, you won't be as adversely affected because overall revenue continues to rise," says Cosslett. "So it's a model that offers predictable cash-flow generation." (For an interview with Cosslett, see BusinessWeek.com, 5/21/07, "How Andy Cosslett Restyled IHG")
Cosslett is not the only one who thinks there might be some gas left in hotel stocks, though. Between 2004 and 2006, for example, Blackstone Group was involved in six lodging deals, acquiring assets that totaled more than $14 billion. In April of this year, Isadore Sharp, founder and chairman of the Toronto-based luxury chain Four Seasons Hotels & Resorts, received approval—along with investors such as Microsoft's (MSFT) Bill Gates and Saudi Prince Alwaleed Bin Talal Bin Abdulaziz Alsaud and his family—to take the company private.
Four Seasons agreed in February to a $3.37 billion offer, for which shareholders will receive $82 a share. (The stock had been trading in the low 60s before the offer was announced.) There's speculation that other hotel groups, such as Orient-Express (OEH), could also be targets.
Goldman's Kent questions the wisdom of such an attempt, though. "Why would a private equity shop look at the hotel right now? They're seeing the same trends of decelerating RevPAR and supply acceleration that we're seeing."
Unlike Four Seasons and Orient-Express, most publicly traded hotel companies aren't pure-play luxury businesses. Marriott owns Ritz-Carlton but also has a portfolio that includes more moderately priced chains such as Renaissance and its flagship Marriott Hotels & Resorts. Starwood owns St. Regis as well as Sheraton, Westin, and Four Points.
While the North American and European luxury markets are being saturated, there are still opportunities in Asia and India. The drawback for investors is that many of those regions' dominant luxury hotel chains, such as Peninsula, Shangri-La (SHGM), Mandarin Oriental (MNOIY), and Taj Hotels, aren't widely traded in the U.S. Mandarin, for example, is traded on the London and Singapore exchanges as well as Over-the-Counter in the U.S. Mumbai-based Taj and Hong Kong-based Peninsula are both private.
So what hotel stocks are attractive? Goldman's Kent likes Wyndham (WYN), which he believes is still in the middle of a turnaround and has an inexpensive valuation and earnings before interest, taxes, depreciation, and amortization (EBITDA) of 9.2 times 2007 estimates. He gives the stock a 12-month $40 price target; it was trading at $36.40 at press time. (Goldman maintains a position in Wyndham.)
The consensus is that hotel stocks are unlikely to make a dramatic downward movement in the near future but that share prices are trading at or near the top of the cycle. If investors hadn't bought before, they may want to hold off and wait for the next dip.
For travelers, on the other hand, that may translate into more aggressive pricing, as luxury hotels look to fill rooms. So where might they want to stay? For that, you'll have to see our slide show of the 50 Most Decadent Hotels in the world.