Description

Overview

As a byproduct of covering larger hospitality companies, we found this small cap gem that we think is the best remaning reopening play around - Concentradora Fibra Hotelera (FIHO12). FIHO12 is the largest hotel REIT in Mexico which boasts a portfolio of high-quality hotel assets with meaningful exposure to reopening with a valuation so depressed, offering a dramatically more asymmetric return profile than any other company we came across.

Fibra Hotel’s business is fairly straightforward – the company owns a portfolio of high-quality hotels set to benefit from reopening and the resumption of the types of day-to-day economic activity that characterizes a normal business environment. The company is not only hedged against inflationary pressures, but they actually stand to benefit as elevated construction material costs crimp new supply and increases the replacement value of existing supply (and unlike at developed market hotel operators, labor inflation is not a material concern). On top of this, the company maintains a balance sheet with enough flexibility to capitalize on M&A opportunities in an environment where valuations are still depressed. While the above was readily apparent upon our initial glance, it wasn’t until we saw the company’s CEO and patriarch of the founding family use the COVID-induced dislocation to increase his ownership to 30% from 12% that we knew we were really onto something special and began to peel back the layers.

The takeaway of our research is as follows: at its current valuation, FIHO trades for <7.5x normalized FFO (essentially, distributable free cash flow), which we expect the company to reach in 2023. Using normalized earnings power, we see an easy path to 60%+ upside, merely assuming that economic activity in their markets return to baseline. While the company has a number of attractive potential uses for capital, we see reasonable odds that management decides to reinstate a dividend in the second half of this year. Given that the company is underfollowed, this would almost certainly attract attention from a new shareholder base and catalyze a closing of the gap to fair value.

Building and maintaining confidence in the direction of fundamentals for a company that does business in a number of Mexican markets can be intimidating. In this regard, we have found that a number of freely available data sources correlate closely to FIHO’s reported results, allowing us to track economic activity, mobility and related business trends at a granular (often daily) level. Data from Smith Travel Research, Google Mobility, OpenTable and local airport arrivals tell a compelling story: all have shown consistent sequential improvement from the depths of COVID lockdowns, notwithstanding short-lived setbacks from the delta & omicron variants. In 2022 to date, the data are unanimous in showing an acceleration of the recovery, with several measures of activity surpassing 2019 levels in recent weeks as the country has loosened pandemic restrictions. While not in our base case, we see the potential for pent-up demand to drive FIHO12’s 2022 results meaningfully above 2019 levels given the trends we are observing in the data, notably the STR data indicating Caribbean/Mexico ADR tracking +20% vs. 2019.

While not part of our base case, our research suggests a reasonable probability of a recovery to above-trend growth in Mexico, aided by tighter supply/demand dynamics, potential higher foreign direct investment (ie “nearshoring”) and a resumption of leisure travel akin to what we’ve observed in developed markets. In such a scenario, back of the envelope math supports closer to Ps$1.50/sh, suggesting that shares could more than double from current levels.

As an aside, we have looked closely at Playa Hotels & Resorts, another hotel operator levered to Mexican & Caribbean travel – while we also that asset offers an attractive return profile, the asymmetry of FIHO is hard to match. Interestingly, our conversations with PLYA and other local operators, yielded favorable assessments of FIHO management’s ability as operators.

Underfollowed company with a portfolio of high-quality hotels

-          FIHO12’s portfolio includes 86 hotels (12,588 rooms) located across Mexico

-          Portfolio is reasonably diversified (geographically & across hotel segments)

Expect operating trends (already improving post Omicron) to continue to improve as COVID restrictions are removed

Despite facing continued headwinds from COVID, FIHO12’s operating trends have showed consistent sequential improvement – company ended the year with 4Q RevPAR down 13% vs. 2019 levels (included slowdown from Omicron in December which continued into January)

FIHO12 operating metrics have trended closely with both STR (93% r^2) & Google Mobility data for Mexico (94% r^2) (see below)

Both data sources support a continued recovery in FIHO12 operating trends following a brief disruption from Omicron

-          FIHO12 operating trends

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-          STR – Caribbean / Mexico RevPAR (% vs. 2019)

-          OpenTable (% Diners vs. 2019)

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          Mexico Google Mobility Data

-          As you can see, Mexico City has and continues to lag broader Mexico (consistent with FIHO12 operating metrics with Mexico City RevPAR down 25% below 2019 levels compared to FIHO12 portfolio excl. CDMX down 7.5% – we expect the recovery the recovery of Mexico City (20% of FIHO12 rooms), driven by a combination of return-to-office and tourism, throughout 2022 to provide meaningful uplift for FIHO12

-          It is also important to note how FIHO12’s portfolio today compares vs. 2019

o   In 2019, FIHO12’s portfolio consisted of 86 hotels (84 stabilized), which resulted in a drag on overall operating metrics

§  Without all properties stabilized, the company generated P4.37bn of revenue and P1.16bn of EBITDA

-          Going forward, we expect the now fully stabilized portfolio to exceed 2019 operating levels driven by 1) higher ADR and 2) cost structure changes implemented during COVID

o   Raising ADR – FIHO12 has been successfully (& plans to continue) in raising ADRs across its portfolio (4Q ADR 2% below 2019 levels)

o   Cost structure optimization to drive an additional 200-300bps uplift to profitability vs. 2019 levels

Recovery to normalized earnings implies +70% upside

-          The company generated just over P3bn of revenue & P637mm of EBITDA (28% & 45% below 2019 levels) in a challenging 2021 operating environment

-          2022

o   Given the trajectory of trends and COVID restrictions seemingly on the way out the door, we see a reasonable path to FIHO12 exceeding 2019 levels in 2022 – we expect revenue of P4.7bn and EBITDA close to P1.2bn (+7.5% & 6.5% above 2019 levels)

-          2023/normalized

o   Although the exact cadence of FIHO12’s recovery remains unclear, we see the current portfolio’s normalized earnings power as approx. $5bn revenue & $1.5bn of EBITDA ($750-$850mm FCF), assuming 65% occupancy (62.8% in 2019, 64.8% in 2018) & P1,320 ADR

o   At 9.5x EBITDA, this equates to Ps$13.50/sh (60%+ upside). On a FFO basis, this implies 11.8x.

§  Additionally, we expect the company to reinstate its dividend in 2H22 which we estimate will likely fall in the range of P0.60-P0.80/sh (annually) initially

§  Prior to COVID, shares typically traded for ~10x EBITDA

o   In an upside scenario, FIHO’s normalized FFO could be closer to Ps$1.50/sh. Applying 12x FFO, this supports Ps$17/sh, or 100%+ from current prices.

Catalyst

Reopening and potential dividend reinstatement