Why we use EV-to-EBITDA instead of PE ratio for the hotel industry
Investors often use value multiples to compare companies in a given sector. They can 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. But capital-intensive sectors like the hotel industry have companies operating with varying debt levels, so a different approach is required.
EV (enterprise value) is the sum of market capitalization and net debt, and it amounts to the cost of acquiring a business. Companies with varying levels of debt can thus 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 Marriott International (MAR) with its peers.
Marriott versus peers
For the fiscal year ending 2014, Marriott had forward EV-to-EBITDA multiple of 15.3. The company traded at a premium over the median valuation multiple of peers. Marriott was trading at 11.2 as of January 1, 2016, which was the highest among peers. Starwood Hotels & Resorts Worldwide (HOT) was trading at 10.3, Hilton Worldwide Holdings (HLT) at 9.8, Hyatt Hotels Corporation (H) at 9.1, and Wyndham Worldwide Corporation (WYN) at 8.1.
Investors can gain exposure to the hotel sector by investing in the First Trust US IPO Index Fund (FPX), which has approximately 6% of its total portfolio holdings in the hotel sector.
Historical valuation multiple
The chart above shows that Marriott’s EV-to-EBITDA has moved in line with the median valuation multiple of its peers. But Marriott has mostly traded at a premium to the median valuation multiple of its peers. On January 1, 2016, the company’s stock traded at a premium of 16%.
The valuation multiples of hotel companies depend on the performance of general economic indicators. For example, in late 2011, hotel valuation multiples—including Marriott’s—saw steep declines. This was due to the fear of Euro crisis spreading to other regions and resulting in a global economic crisis. The valuation multiples of Marriott and its peers decreased by more than 20% in 2015, largely driven by global economic concerns driven by the slowdown in China.
Why is Marriott trading at such a premium?
Marriott trades at a premium over its peers due to its successful adaptation to an asset-light model. In an asset-light model, a hospitality company splits real estate ownership and hotel management in order to remain competitive. With a lighter balance sheet, these companies can utilize its capital with more flexibility and focus on growing their presence in different regions and segments.
The asset-light model provides more stability than the asset-heavy company, wherein capital is tied down to real estate. Marriott has come to focus only on its hotel management franchise business and has low investments in real estate ownership. Moreover, having an asset-light model is less risky due to the cyclical nature of the hospitality segment and the high fixed-cost structure of the hotel industry.
For more analysis, check out Market Realist’s Hotel and Lodging page.