GROWING OPTIMISM ABOUT A REVIVAL OF business and leisure travel has made Wall Street crazy for hotel stocks that investors abandoned in late 2008 and early 2009. Really crazy, based on the shares’ valuation.

Hotel profits are highly sensitive to modest changes in occupancy levels and room rates. As they say in the industry, room rates change overnight, allowing hotel operators to benefit quickly from an economic upturn, like the one that’s apparently under way in the U.S.

Hotel stocks, however, look overpriced because the industry is only starting to come out of one of its deepest slumps in decades. That slump choked cash flow at major operators, such as Starwood Hotels and Resorts (HOT) and Host Hotels and Resorts (HST), by 35% to 45%. Investors are banking on a multiyear recovery that could return profits to peak 2007 levels by 2012 or 2013.

But based on projected 2010 and 2011 earnings and cash flow, the shares look expensive, and they even appear rich on estimated 2012 profits, which are very hard to predict. This makes them vulnerable to any faltering of the economy. And, like airlines, hotels are a favorite of the hot-money crowd, and that money can exit just as quickly as it poured in.

SHARES OF INDUSTRY LEADERS are up an average 30% this year, despite last week’s broad market pullback. And they’ve doubled, tripled or quadrupled from early 2009 lows. Hyatt Hotels (H) went public in November at 25; it’s now around 40, even though the company probably will be in the red this year. Starwood, at a recent 47, was fetching a stiff 52 times projected 2010 profit of 90 cents a share and 35 times estimated 2011 earnings of $1.33. Marriott International (MAR), at a recent 34, was changing hands at 33 times estimated 2010 profits of $1.03 a share. Host Hotels, around 15, trades for 23 times projected 2010 funds from operations (FFO) of 66 cents a share.

Host Hotels, a real-estate investment trust, is valued on FFO, a cash-flow measure that adds back depreciation and other noncash expenses. The problem with using this to gauge a hotel REIT’s operations is that these trusts usually have significant capital expenditures. It’s expensive to maintain and upgrade rooms, restaurants and meeting facilities. Host, which owns 110 hotels — mostly Marriotts — with 61,000 rooms, is expected to produce little or no free cash flow this year. In fact, the entire industry is unlikely to generate much free cash flow in 2010.

Investors often value hotel companies on Ebitda, or earnings before interest, taxes, depreciation and amortization, even though this tends to significantly overstate free cash flow. The major stocks trade for 15 to 18 times projected 2010 Ebitda and 13 to 16 times estimated 2011 Ebitda, against an average of 11 over the past decade.

More From Barron’s

  • Visa: Stifel Downgrades, S&P Defends
  • Regional Banks May See Deposit Growth Slow
  • Google Shutting Nexus One Web Store; Shifts Focus To Retail

Similar Posts:

Share