Valuing hotel companies
In the previous part in the series, we saw that Marriott (MAR) provided good returns to shareholders over the years. Apart from having the highest share price growth among its peers in 2014, the growth in its earnings per share (or EPS) allowed it to increase dividends to shareholders over the past few years.
In this part of the series, we’ll discuss if Marriott’s share price is undervalued or overvalued compared to its peers.
Why we use EV to EBITDAR
We’ve considered the enterprise value (or EV) to earnings before interest, taxes, depreciation, amortization, and rent (or EBITDAR) multiple to analyze Marriott’s valuation. This multiple is used in businesses where there’s significant rental and lease expenses—hotels and airlines. Hotel properties can be owned, leased, managed, or franchised. As a result, capital investment differs for each hotel company.
Companies that lease assets tend to have artificially lower debt and operating income compared to companies that own assets. This is because leasing is an off-balance sheet financing. The asset doesn’t appear on the balance sheet of the lessee. It remains on the lessor’s balance sheet. The lessee only shows the lease rental expenses in the income statement.
Companies use off-balance sheet financing to keep their leverage ratios—like debt-to-equity—low. In some cases, they use it to avoid breaking debt covenants.
In order to make the companies with different asset ownership comparable, adjustments have to be made to capitalize the operating lease. Lease obligations are added to debt. Lease rentals are deducted from the operating costs.
Marriott’s EV to EBITDAR multiple is 16.47x. This is higher than all its peers’ multiples—including Hilton (HLT), Hyatt (H), Starwood (or HOT), and Wyndham (WYN). A high multiple can mean that the stock is overvalued or that the stock is demanding a premium for its future growth prospects.
Marriott’s future growth looks promising going by the company’s planned pipeline of rooms, investment, and expansion plans. However, its high leverage low margins is a concern. When adjusted for lease obligations, Marriott’s leverage—measured by dividing adjusted debt by capital—is comparatively very high at 145.3%.
Debt requirements could increase more to finance its future expansion plans. There’s also Marriott’s low operating margin. Its EBITDAR margin is lowest among its peers.
Investors can participate in the hotel industry’s growth without exposure to company-specific risks. They can invest in specific exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY), the PowerShares Dynamic Market Portfolio (or PWC), or the PowerShares Dynamic Leisure & Entertainment Portfolio (or PEJ). These ETFs hold a diversified portfolio of companies—including 20%–80% in hotel and lodging companies.
For a detailed company overview of Marriott’s competitor, Hilton Worldwide Holdings, click here.