According to Warren Buffett, the best business to own is one that has low capital requirements. I have a FTSE 100 stock to buy in December that fits the bill perfectly.
The stock is InterContinental Hotels Group (LSE:IHG). The stock is down by around 5.5% since the start of the year and it’s catching my eye at today’s prices.
I think that the falling share price reflects a risk of slowing travel demand in the near future. But the company’s strong business model makes it a great business for me to own.
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InterContinental Hotels Group
Around 99% of the rooms in the Group’s hotels are run either on a franchise basis (71%) or a managed basis (28%). This means that the business itself doesn’t have much in the way of costs.
A franchise arrangement involves the hotel owner running their own operations using InterContinental’s branding and marketing. In return, InterContinental takes 5%-6% of the revenue from the hotel’s rooms.
With a managed setup, InterContinental provides staff to run the hotel in exchange for 1%-3% of the total revenue from the hotel. Again the ownership of the building stays with the operator.
This means that the business has very low operating costs. The costs of running the hotel are taken on by the hotel owner.
It also means that InterContinental doesn’t take much capital to grow. Since the buildings are owned by the individual operators, the company doesn’t need to find the cash to buy them.
Cash generation
This business model means that InterContinental has an impressive ability to generate cash. This is demonstrated in the company’s financial statements.
The fact that InterContinental doesn’t use much capital in its everyday operations means that it can earn a strong return on its fixed assets. The company earns $772m on $411m of fixed assets—a 187% return.
For context, Marriott International—the largest global hotel chain—manages a return of 121%. That’s still pretty good, but InterContinental has a clear advantage here.
In addition, not needing cash to expand its business means that most of the income InterContinental brings in becomes free cash available to distribute to shareholders. The cash conversion ratio is around 74%.
Again, this compares favourably with the market leader. At Marriott, the amount of operating income that becomes free cash is around 67%.
A stock to buy in December
Tighter economic conditions are likely to create a headwind for InterContinental in the near future. But I’m expecting this to provide me with an opportunity to buy the stock at a good price.
The business has the profile that Warren Buffett describes when looking for the ideal company to invest in. Its approach of making money through royalties means it has low capital requirements.
InterContinental’s low costs give it some protection from inflation. As a company that doesn’t have to spend much, the business is largely unaffected by increased costs.
In fact, the company might even be an inflation beneficiary. If operators raise prices, this boosts the amount the company brings in via its franchise model.
That’s why InterContinental Hotels Group is the FTSE 100 stock that I’m looking to add to my portfolio when I have money available to invest in December.
