Choice Hotels is eager to expand its portfolio more broadly. But a move upmarket is not without risk.
“Currently, every new unit entering our portfolio has continued to generate, on average, twice the revenue as a unit leaving it,” said Dominic Dragisich, chief financial officer, in a Monday earnings call. “The addition of approximately 60,000 Radisson America’s domestic rooms open or in the development pipeline as of the end of the third quarter marks the next chapter in Choice’s higher revenue per room growth trajectory.”
Adding hotels that generate more revenue has already bolstered the Rockville, Maryland-based company. Choice Hotels forecasted that its full-year 2022 adjusted earnings before interest, taxes, depreciation, and amortization — a measure of profit — would rise by more than 25 percent versus its full year 2019, which had been its pre-pandemic peak.
In the third quarter, Choice generated a net income of $103.1 million on $414.3 million in revenue. Net income was down 12 percent year-over-year as higher costs mainly related to the merger weighed on profit. Revenue was up 28 percent year-over-year.
The Shrinking Economy Segment
A strategic move upmarket underscores the comparatively sluggish long-term growth of the U.S. economy segment.
Choice Hotels’ brands — from its flagship Comfort to roadside stables like Rodeway Inn — have been like fast-casual restaurants. Its brands are, for the most part, tolerable, well-priced, and, most crucially, consistent. This formula has enabled Choice to grab a significant chunk of business from inconsistent independent roadside hotels in the U.S., a fragmented sector.
Yet the economy segment for overnight travelers has been shrinking, executives said. In the U.S., the only high-growth brands in the economy segment are extended-stay properties. This dynamic is true even as rates have firmed up as many owners exit the hotel business, reducing supply.
The company’s budget brands Rodeway Inn and Econo Lodge together saw about 5 percent of hotels exit the network this year. Executives said they’re “continuing to strategically evaluate” certain brands, which analysts may interpret as a sign the company may want to sell them.
The company isn’t abandoning its value-based brands. It has a prototype for a new design for its flagship Comfort, under development in several locations.
“Our overall strategy is to be growing in segments that are growing, and the two highest growth segments today are up … upscale select service and upper mid-scale,” Pacious said. “We’ve got great brands positioned and are taking advantage of those trends. And then extended stay, which is just a segment that is undergoing significant growth, and we’ve got four great brands that are positioned for that trend as well.”
The company, which had 969 hotels as of September 30, has a pipeline of about 470 extended stays and about 500 other hotels, mostly midscale and upscale.
Choice Hotels has been investing for a few years in its more upscale brand Cambria, which this year has enjoyed perhaps its best year yet. The brand grew by more than 5 percent year-over-year, reaching more than 60 units with another 69 U.S. properties in the pipeline — about a third of which are under active construction.
Choice’s acquisition of Radisson’s Americas properties — which closed on August 12 — will add 68,000 rooms. Nearly half of those are in upscale segments, while the rest are mostly in upper-midscale segments.
“It’s reflective of our long-term strategy to reposition the company,” said Patrick Pacious, president and CEO.
David Katz and other analysts at Jefferies said they “consider the transaction to be a strategic positive.” Adding upscale properties could “serve as a tailwind for both operating performance and new signings over the longer term,” they wrote. The acquisition will also bring about 10 million new members to Choice’s loyalty program.
Choice’s shift upscale isn’t without risk, however. Travel is bouncing back, but prospects are constrained by economic upheaval. Upscale properties may be more affected if inflation and subpar economic growth linger for years.
“We contemplate the decision to move upmarket where Choice’s value proposition and customer base is comparatively less clear versus its peers, especially given the consistent high-quality cash flows that come from the stability of Choice’s pre-existing business model, the balance sheet requirements needed to incentivize new signings and a possible recession which could weaken higher-end segments,” said the Jefferies analysts in a report two weeks ago.
Choice Hotels saw that growth in its U.S. revenue per available room — a key industry metric — sped up quarter-over-quarter, increasing by 15.2 percent for the quarter, compared to the same period in 2019.
“We are capitalizing on long-term fundamentals that we call the “Five R’s”: remote work, retirements, road trips, rising wages, and the re-shoring of American manufacturing,” Pacious said.
The company has one of the lowest levels of debt relative to its income when compared to its peer companies. That may give Choice the flexibility to pursue acquisitions of hotel portfolios.
The company also noted on Monday that Forbes had named it one of the world’s top female-friendly companies. Meanwhile, Entrepreneur Magazine picked it for being among the top franchise companies for its commitment to diversity, equity, and inclusion. Many hotel companies have aimed to do better on questions of diversity.
Photo credit: Lobby of a Cambria brand hotel in Houston. Source: Choice Hotels.