Lodging: Flow-Driven or Forward-Looking?

CLEVELAND—Second quarter was more of the same on the operating front. That was according to a recent lodging REIT report from RBC Capital Markets . According to the firm, the lodging REITs / C-corps produced another quarter of soft RevPAR growth and RevPAR growth expectations were cut across the board, but the stocks took the news in stride. Similar to last quarter, the firm says that visibility remains low for the business transient and international demand segments; domestic leisure and group appear healthy. “The only major difference between quarters was that the second quarter benefited from the Easter holiday shift, which was a negative for the industry in the first quarter. The small incremental operational negative that emerged in the quarter was that short-term group softened a bit. The outlook for large group remains solid.” As for what to look for in the second half? The firm says that the third quarter is expected to be stronger than the fourth quarter due to better group bookings and holiday shifts benefiting the quarter at the expense of the fourth quarter results. For the third quarter, September is expected to be the strongest month and August is projected to be better than July. “Of note, July started slow, as the timing of the July 4th holiday likely pulled demand into 2Q. We believe the soft start to 3Q and limited visibility into September led some companies to take a more conservative approach to second-half guidance. We believe many of the transient-focused companies have only 1–2 months of visibility.” But the firm says that REITs/C-corps absorbed the bad news. “The lodging companies have absorbed a lot of negative news flow of late including lower than expected RevPAR growth, earnings guidance reductions, Zika, BREXIT, terrorism, and a stronger USD. We note that some companies sharply reduced guidance, with the new high end of RevPAR guidance below the previous low end of guidance, only to see shares trade higher. In total, the SNL Hotel REIT index increased +3.9% vs. the SNL REIT index return of -0.5% since the start of earnings. We heard nothing on the conference calls that would make us more bullish; however, the S&P 500 is near an all-time high, which suggests that corporate profits could be on the rise and the market is forward looking, thus justifying the rally in lodging stocks.” However, the firm adds that central bank policies have likely aided the markets to some degree (flow-driven). So where do we go from here? RBC Capital Markets says that the hotels stocks are no longer cheap and fairly valued in a base case of a very low growth environment with declining fundamentals. “We believe a return of corporate profit growth is needed to spur incremental corporate travel and drive upside in shares from current levels. Should corporate profit remain soft and corporate travel decelerate, RevPAR growth could go negative for the industry in the fourth quarter. We recommend exposure to the group with the idea of adding should economic data improve. PEB is our favorite idea for an expansion. We like INN as a core holding and view RLJ as the best value in the space. For the C-corps, we continue to like HLT and MAR and believe both companies will continue to take share.” The company adds that M&A could be the next catalyst should growth remain low. “Faced with a potentially low/negative growth environment, management teams might be more willing to entertain M&A. We believe that M&A is needed in the space and that the potential spin-off of HLT’s REIT could spur some consolidation in 2017.”