Travel stocks are usually among the first casualties of geopolitical tensions. But investors holding stock in Intercontinental Hotels Group looked past activity on the Ukrainian border and fixed their sights upon a sharper-than-expected recovery in occupancy levels.
Unveiling operating profits for last year that were ahead of consensus and reinstating the dividend earlier than expected, at 85.9 cents a share, fuelled a further bounce in the hotel operator’s shares. A recovery in occupancy and rates led by the Americas and the UK boosted revenue per available room last year to 70 per cent of the pre-pandemic level, up from 47.5 per cent in 2020.
The shares have regained almost all of their losses over the past two years and at just over 19 times forecast earnings for 2023, when revenue per available room is set to be fully recovered, trade at a multiple broadly in line with the 2019 range.
IHG shares rarely come cheap for good reason. Operating its brands, which include Holiday Inn and Crowne Plaza, under a franchised model keeps the business capital light, a saving grace in market downturns. It earns between 5 and 6 per cent of revenue generated by the hotel, in exchange for the use of its brand, technology and marketing services. Owning and leasing a few properties means the benefits of increasing scale are amplified, too. Fee margins expanded by over a 100 basis points a year over the decade until the pandemic, to reach 54.1 per cent in 2019.
But taking full advantage of the benefits of operational gearing will require the hotel group to improve the rate of new openings. But the removal of poorer quality hotels from the estate, predominantly under the Holiday Inn and Crowne Plaza brands, outpaced openings, meaning the number of hotels in operation declined by 0.6 per cent on a net basis last year and only 0.3 per cent in 2020. Chief executive Keith Barr is hoping to improve that rate to roughly 4 per cent this year and 5 per cent during the next.
Slower underlying growth in the size of its hotel estate is reflected in the discount attached to IHG versus US rivals Marriott International and Hilton Worldwide, whose shares trade at forward earnings multiples in the mid-20s. The premium attached to US companies versus their UK counterparts might have played a part. But bringing the net growth rate of its hotel footprint back in line with pre-pandemic levels should address that valuation gap.
What are IHG’s chances of achieving that? Tougher conditions can spur a flight of smaller independents towards the security of larger chains. Conversions of existing hotels to IHG brands represented 25 per cent of openings last year, up from 20 per cent in 2020.
Analysts forecast operating profit of $756 million this year, against $865 million in 2019. Differing speeds at which countries have reopened mean that Europe, the Middle East and Africa division has further to go in terms of recouping revenue. But the extent that business travel will revive remains uncertain.
The balance sheet looks sturdy enough. A relaxation in banking covenants was secured for this year but the leverage interest cover ratios are back within the original limits, while cash and undrawn debt stands at $2.6 billion, against a $400 million minimum liquidity requirement remains in place. Adjusted free cashflow came in at $571 million last year. Improved traveller numbers should lead to a reduction in the leverage ratio.
IHG has weathered the pandemic well, but that’s already fully reflected in the share price.
Advice Hold
Why The group’s recovery potential is already accounted for in the shares’ valuation, which doesn’t represent an attractive entry point for new investors
Benchmark Holdings
It’s no surprise that investors are reluctant to get behind animal health specialist Benchmark Holdings, since it has failed to show a pre-tax profit since it was admitted to London’s junior market in 2013.
Shares in the Aim-traded group, which specialises in nutrition and genetics and develops products for food producers to improve animal health, yield and quality, are still priced below the 2013 initial listing price. Admittedly, naming Neil Woodford, who sold down his 12.5 per cent stake in 2019, among its major shareholders didn’t help.
Underinvestment in research and development has left it playing catch-up. That, together with cash spent on expanding production capacity and the associated cost of servicing a higher debt bill, contributed towards a pre-tax loss of £9.2 million last year.
That was slimmer than the year before and management has pegged last year as the peak in spending on R&D. It is reaching for a target of being solidly cash generative and profitable next year, at which point analysts have forecast a pre-tax profit of £4.5 million, against a loss of a similar magnitude this year.
How does management think it will reach that target?
One, by paying down debt, which stood at £64.2 million at the end of December, or roughly 3.3 times adjusted earnings before interest, taxes, depreciation and amortisation for the 12 months to the end of September last year.
Two, by bringing down the level of capital expenditure from the heightened level to which it has climbed in recent years.
There were hints of the potential from new products reaching commercialisation stage in the first quarter. Revenue for the three months to the end of December was up by more than a third against the same time in the prior year, helped by sales of its recently launched sea lice veterinary medicinal treatment Ectosan Vet and water purification system CleanTreat.
Benchmark is making progress, albeit slowly, but a forward earnings multiple of 42 against 2023 earnings forecasts doesn’t look particularly appealing.
Advice Avoid
Why Slow progress on earnings and a high forward earnings multiple puts shares at risk of treading water
