Why we use EV/EBITDA over the PE ratio
We use valuation multiples such as EV-to-EBITDA (enterprise value-to-earnings before interest, taxes, depreciation, and amortization) ratio or PE (price-to-earnings) ratio to compare companies operating in the same sector and to determine whether a stock is undervalued or overvalued. However, capital-intensive sectors like the hotel industry have companies operating with varying debt levels, so a different approach is required.
Enterprise value (or EV) is the sum of market capitalization and net debt, and it amounts to the cost of acquiring a business. Companies with a varying level of debt can be more accurately compared using the EV-to-EBITDA ratio, just as companies with negative net income can also be compared using EV-to-EBITDA—unlike the PE ratio. So we’ll use the EV-to-EBITDA ratio to compare Hyatt with its peers.
Hyatt versus its peers
For the financial year ended 2014, Hyatt had a forward EV/EBITDA of 11.4. The company traded at a discount over the median valuation multiple of peers. Hyatt was trading at 9.9, which was lower than the median valuation multiple of peers of 10.9 as of November 20, 2015.
Historical valuation multiple
The chart above shows that Hyatt’s EV/EBITDA has moved in line with the median valuation multiple of its peers. Hyatt, with rare exceptions, has always traded at a discount to the median valuation multiple of its peers. On November 20, 2015, it traded at a discount of 10%. The valuation multiple of hotel companies depend on the performance of the general economic indicators.
Including Hyatt, hotel valuation multiples saw a steep decline in late 2011. This was due to the fear of the Eurozone crisis spreading to other regions and resulting in a global economic crisis.
Why Hyatt trades at a discount
The main reason for Hyatt’s lower valuation multiple is due to the company’s inability to move away from an asset-heavy model to an asset-light model, unlike its competitors. In an asset-light model, a hospitality company splits real estate ownership and hotel management to remain competitive. With a lighter balance sheet, these companies can utilize the capital to focus on growing their presence in different regions.
Moreover, hospitality companies that follow the asset-heavy model are riskier due to the cyclical nature and the high fixed cost structure of the hotel industry.
Investors can gain exposure to the lodging sector by investing in the iShares US Consumer Services ETF (IYC). IYC invests 11.5% in the lodging sector.