7/2/2010
By Conley Turner, Research Analyst

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As with everything else, the recent global economic crisis has been particularly challenging for the hotel industry.  Business and leisure customers drastically scaled back travel budgets and in response hotel operators have had to significantly modify their operations to compensate for the unprecedented drop in demand.  Fast forward to present day and the operating environment appears to be emerging from trough levels.  However, it still may be too soon to declare a full blow recovery.

Through the first half of 2010, the domestic hotel industry has experienced steady improvement in demand which paralleled the improvement in consumer sentiment during the period. There is a historically positive correlation between the performance of the industry and consumer sentiment. The Reuters/University of Michigan consumer sentiment index increased to 75.5 in the month of June from 73.6 in May representing the highest level attained since January of 2008.

Business travel is up over prior year levels and driving the improvement particularly in the upper upscale and luxury hotel brands.  This is typical during the lodging cycle where the upscale brands are most affected during downturns but are the first to benefit from a recovery. The leisure segment is also trending well due to an increase in domestic and international travelers.  Hotel operators are also experiencing some level of pricing power which contrasts to the previous year that was punctuated by heavy discounting and promotional activity.

Lodging Metrics

By and large the measures that quantify the performance of hotel companies are registering meaningful improvements.  Revenue per available room or (RevPar) which is a key metric has risen by about 7 percent in the U.S. to date.   This increase in RevPAR can be attributed to an overall increase in hotel occupancy.  Important also is that hotel operators have also been able increase by some degree the Average Daily Rates (ADR) it charges its guests. Higher occupancy translates into an increase in operating expenses but higher rates provide an offset for these additional costs.  One major operator, Marriot International Inc, has recently announced that an increase in the room rates at its North American properties.  This was the first time that this has occurred since 2008. Outside North America, results are also tracking well as International RevPAR among operators improve.  This is occurring as business in the Europe and the U.K. emerge from the global recession.
In statistics drawn from Smith Travel Research, the Asia-Pacific region is also registering solid performance.  During the month of April, RevPAR increased by 26.4% to $84.96.  The region also registered an ADR increase of 13.1% to $130.06 for the month along with an 11.7% increase in occupancy to 65.3%.   Among the key adjustments made by operators due the crisis was in CAPEX which declined by about 40 percent to $3.3 billion versus 2008 level.  During that banner year, the industry allocated around $5.5 billion to property improvements.  That priority quickly shifted at the onset of the recession and at this juncture, appears not likely to be reversed until the market conditions demonstrate sustainable improvement.

International Expansion

All the major hotel brands are well represented in the North American market which means that it is difficult for them to grow organically.  As such, in an effort to achieve this objective, a number of operators are turning to other economies with high GDP growth rates.  More so than not, they are turning to the Asia/Pacific region with a major emphasis on China.  In fact, many operators view China as the country with the biggest potential over the next decade. 

One such operator, Intercontinental Hotel Group (IHG) already has an established presence in China and continues to expand.  In the most recently completed quarter, the Company's Asia/Pacific and Americas divisions delivered results that surpassed expectations.  By contrast, the performance of European, Middle Eastern and African divisions trailed expectations. Star wood Hotels (HOT) similarly recorded a 27% increase in growth of its Chinese operations in the 2010 first quarter. Marriott has announced plans to expand its Chinese portfolio of hotels from 47 at the end of the first quarter to a total of 60 by the close of 2010. India is also providing to be an option for expansion with some in the industry comparing it to how the Chinese market was a decade ago.  The increase in business and economic activity are the driving forces behind the attractiveness of these emerging hotel markets.

Drawbacks

While it is clear that there is improvement taking place in the lodging space, it does not suggest that a robust recovery is in order. Though business travel is up, it is still significantly down from pre recession levels.  While one data point does not a trend make, the latest report on consumer confidence as the Conference Board points to a decline to 52.9 in June from 62.7 in May.  Furthermore, the jobs picture in the US remains a major caveat to a sustained economic recovery as the unemployment rate remains stubbornly high.  Confidence will likely remain tempered unless jobs pick up.

Outlook

There are a number of factors that point to a healthy environment for the lodging space in the long run. There is a dearth of new rooms coming on the market due to the difficult operating environment and the situation is likely to last for some time.  Some estimates point to supply growth in the U.S. falling below the 1.0 percent level in 2011 and remaining that way for as much as three years.  In the final analysis though, while the near term outlook is somewhat nebulous, in the long run the lodging space is well positioned to benefit from ongoing positive developments.

Conley Turner
Wall Street Strategies