It’s no surprise that a hotel company is at its 52-week low, but Choice Hotels (CHH) is differentiated enough to merit consideration by longer term investors. The company achieves high ROIC a franchisor of various lower-end/lower-service concepts, notably Econo Lodge and Comfort Inn. While the traditional metrics/drivers hotel investors concern themselves with (namely ADR and RevPAR) may indeed flag over the medium term, CHH’s history has shown that unpleasantness in the hotel space causes independents to seek the safety of a franchise system. Therefore the lagged effect of a downturn may well be significant growth in operating income as independents sign on (straight growth plus operating leverage as incremental royalty fees drop down the income statement without proportionate incremental overhead).

The company is simple and members are likely pressed for time in such a target-rich environment. Mindful of this, I’ll keep things brief and will try to elaborate if a Q&A develops.

 

The company aims to provide franchisees the highest possible return on investment. While independents may focus on increasing ADR to maximize revenue (increasing occupancy carries variable costs), CHH helps its franchisees maximize occupancy via brand awareness, booking systems and loyalty programs. It helps them lower costs through scale buying, provision of yield management systems and consultations with a dedicated team of field services staff. Franchisee retention has averaged ~95%. Meanwhile, the proposition to the end-user, the guest, is “consistency, quality and guest satisfaction.”

 

A helpful presentation gives the business’ key drivers and their recent earnings release has management’s estimates for 2008. Between the two you can build a simple model for the year ahead that will leave you not particularly excited, especially with the Bargain Meter almost pegged and several of Buffett’s stocks on the 52-week low list.

 

More important is the longer term picture, which the below table hopefully illustrates.

 

 

The story is simply that the company can grow at GDP+ rates for a long time with limited investment. Trading at roughly 8.5x EV/EBIT, I would argue that the company is cheap on a no-growth basis. Just getting to a 10x multiple (which comports with Goldman’s recently revised price target) implies a nearly 25% return. In this market and with this company, I will gladly take a 25% return.

 

 

- The economy is less than great, and given the targeted guests/price points, there is very limited visibility. People do not book $35 rooms at a Rodeway Inn alongside an interstate months in advance.

 

- Credit markets are less than great. While conversion of existing hotels can continue, and lessened credit availability keeps a lid on introduction of room supply, development of new hotels is severely crimped.

 

- Tied in with the above, the company is planning to drive growth by allocating $20-40MM in financing, investment and guaranty support to qualified franchisees in 2009. This is a departure of sorts from the company’s usual buyback/dividend-out use of cash.

 

- The above program is in aid of CHH’s new Cambria Suites concept. One could say that CHH may be pricing themselves outside their circle of competence, and that they are striking precisely when the iron is cold.

 

- Turnover in management.