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InterContinental Hotels Group IHG
December 30, 2008 - 7:18pm EST by
wan161
2008 2009
Price: 8.20 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 2,340 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Description

          Overview

This investment idea is InterContinental Hotels Group Plc, a UK-based hospitality leader. The shares trade in London under the Bloomberg ticker IHG LN (at around 5 ½ pounds) and ADRs trade in the USA under the Bloomberg ticker IHG US (around $8).   Unlike most hotel companies, IHG does not own much real estate. It has been shedding real estate the past few years and usually obtains a management contract on the sold property. It also operates as a franchisor of the many high-quality brands it owns. As a result of this strategy, owned and leased rooms account for only 1% of total IHG rooms. This means it is really more of a brand marketing and services organization to hotel owners than a traditional hotel company. The result is smoother revenue and earnings than its bricks-and-mortar counterparts. 

Like many equities, the shares of IHG have been overly pummelled by an indiscriminate market. On a relative basis, its valuation is now lower than many hotel companies with a less favourable portfolio mix and it trades at nearly half the multiples of its closest comp, Choice Hotels (CHH US). IHG looks cheap on both a relative and absolute basis, as I will explain later.
 
Business Details
InterContinental is the largest hotel group in the world by number of rooms with 608,285 rooms in 4108 hotels (about 3% of total worldwide; 8% of the branded market) systemwide.  The company operates in 100 countries around the world utilizing seven brands.  IHG is in the top 3 in 6 of the world’s 12 largest markets.  IHG LN operates in the upper upscale segment with the InterContinental brand, the upscale segment with the CrownPlaza, Staybridge Suites, and the Hotel Indigo brands, and the mid-scale segment with the Holiday Inn, Holiday Inn Express and Candlewood Suites brands. 
 
IHG business model utilizes all three typical hotel company approaches: franchising, managing, and owning/leasing hotels which account for 7%, 24%, and 1% of rooms, respectively and 84.5%, 8.5% and 7% of continuing operating profit (before overheads) in YTD2008, respectively.  They are more heavily weighted towards franchising than any other hotel company I’m aware of except for Choice Hotels (CHH US) and Marriott Int’l (MAR US).  Marriott’s business includes a fair amount of timeshares, so it is not as good a comp as CHH.
 
IHG has been selling most of its properties over the past few years as part of its “asset light” strategy, and has returned the cash received to shareholders.  Most recently, in June 2007, it returned £700mm to shareholders in the form of a special dividend combined with a reverse stock split.  The cash returned equates to 238p per post-reverse split share. 
 
IHG still owns 18 hotels.  According to CEO Andrew Cosslett, IHG is primarily a “brand” company now, and the intention is not to hold assets.   [Interestingly, Cosslett, who was appointed chief in December 2004, comes from outside the hotel industry. He formerly was president of Cadbury Schweppes Middle East and Africa division, and prior to that was an executive a Unilever, so he brings a wealth of consumer and brand management skills to the company.] Of the 18 hotels owned (which have a book value of ~£900mm; JP Morgan Cazenove estimated their value at £1.5bn three months ago), four, in Hong Kong, London, Paris and NY, account for the lion’s share of the value of the remaining owned hotels.  In the past IHG has said these four are core and wouldn’t be sold, but more recently changed the tune a bit and said they would not sell without retaining as management contract on them and wouldn’t sell before they have a 2nd Intercontinental in those cities.   If they did sell them, Cosslett indicated rather than return additional capital to shareholders, the company would re-invest the proceeds back into the company.  An unlocking of the value of the remaining owned hotels would be significant relative to the company’s $2.3bn market cap, though it’s unrealistic to expect anything would happen on this front in the current dismal market environment. 
 
Like most hotel companies, IHG is expanding through room additions.  The growth has been strong, despite market conditions. A few years ago IHG targeted 50K to 60K net organic room adds by the end of 2008 from the June 30, 2005 starting point, and it has already surpassed this by June 30, 2008 with 60,490 rooms added.  13,071 net rooms were added in H1 08.  48,282 rooms (356 hotels) were signed in H1 08.  242,349 rooms (1,788 hotels) are in the development pipeline at the end of H1 08.  This pipeline is 41% of current rooms in operation and represents over £6bn of investment in hotels (by franchisees and others, not by IHG). 
 
Geographically, the Americas account for 69.5% of rooms, EMEA accounts for 18.9%, and Asia-Pacific accounts for 11.6%.  IHG has a strong presence in emerging markets, especially China.  IHG has been operating in China for 22 years, and has 87 hotels currently with 38 more in development (the target to open 125 by the end of 2008 will be achieved a little late – in early 2009). 
 
The billionaire Barclays Brothers (David and Frederick, who own the Ritz Hotel in London and the Daily Telegraph newspaper) are the largest shareholders of IHG LN through a 10.48% stake held by their holding company, Ellerman Corp.  Their stake-building in the company led to speculation earlier in 2007 that they were possibly preparing a bid, but in fact they rarely make public bids, preferring to buy divisions of public or private companies. 
 
IHG LN had been the subject of persistent takeover rumors for the past few years.  Before the credit market debacle, it was thought the company was the target of a possible private equity bid.  As one of the most crowded UK pre-event names, the shares were hit hard by the credit market problems in 2007. Since then it has significantly outperformed peers, no doubt thanks to its asset light business model and focus on franchise fees.  It’s had the smallest decline from its 52 week high of the comps (9% drop compared to 55% drop of the comps, on average).  I think its business model is best poised to weather the remainder of the recession and emerge with a strong pipeline of new hotels/rooms to propel future growth.
 
Valuation (see attached valuation chart below, which will hopefully format correctly, fingers crossed)
 
For valuation purposes, I looked at comps including Accor, Rezidor, NH Hoteles, Sol Melia, Millennium & Copthorne, Mariott International and Choice Hotels.  On EV/EBITDA, EV/EBIT and P/E  bases, IHG trades at lower multiples than the average of the comps for trailing, 2008E, 2009E and 2010E data (projected data taken from Bloomberg EEO function; latest 28 day analyst estimates).  The best comp is Choice Hotels since it operates a similar business model with mostly franchised rooms, though IHG has much better brands (InterContinental, Crowne Plaza, Holiday Inn, Staybridge Suites, Candelwood and Hotel Indigo) compared to Choice’s brands (Comfort Inn, Quality Inn, Clarion, EconoLodge, Rodeway, Mainstay). IHG LN trades at EV/EBITDA, EV/EBIT, and P/E multiples that are nearly half of those of CHH. IHG has EBITDA, EBIT and net income margins that are a bit higher than those of CHH. In 2007 IHG had average RevPAR in the Americas of $66 while CHH had average RevPAR of $41, thanks to IHG’s greater mix of mid-scale properties. 
 
On an absolute valuation basis, using the MagicFormulaInvesting.com criteria and definitions, IHG ticks all the boxes. Return on Capital, defined as EBIT / (net working capital + net fixed assets) works out to 35%, 34%, 28% and 30% for the LTM30Sep08, 2008E, 2009E and 2010E, respectively. 2009 is a trough year where EBIT dips to $437mm from $556.5 in the LTM9/08 period, but the return on capital is still a very respectable 28%.
 
Earnings Yield in MagicFormulaInvesting.com is defined as EBIT / Enterprise Value. I focus on the inverse of this, or EV / EBIT, though the two are directly comparable. On this basis IHG has an EV / EBIT of 6.6x, 7.4x, 8.6x, and 7.7x for LTM30Sep08, 2008E, 2009E and 2010E, respectively. Over the same four time periods, the mean comps/CHH are: 9/8x/10.6x, 8.9x/11.0x, 11.9x/11.9x, and 10.1x/10.4x, respectively. 
 
On a forward P/E basis, IHG is at just 9.7x 2009E trough EPS while the mean comps are 14.0x and CHH is at 17.6x.
 
On a relative or an absolute basis, IHG looks appears quite undervalued. There is no good reason for this, especially considering IHG is the largest hotel group in the world with the strategy (asset-light) that deserves the highest valuation considering its portfolio of world class brands and it extremely high-quality remaining 18 owned hotels. 
 
Valuation chart

 

30-Dec-08

NH

Millennium

Marriott

Choice

Inter-

 

 

Accor

Rezidor

Hoteles

Sol Melia

 &Copthorne

Int'l

Hotels

Continental

 

 

AC FP

REZT SS

NHH SM

SOL SM

MLC LN

MAR US

CHH US

IHG LN

 

 

 

 

 

 

 

 

 

 

HQ Location

France

Sweden

Spain

Spain

UK

MD, USA

MD, USA

UK

 

 

 

 

 

 

 

 

 

 

LFYE

Dec-07

Dec-07

Dec-07

Dec-07

Dec-07

Dec-07

Dec-07

Dec-07

LFQ

Jun-08

Sep-08

Sep-08

Sep-08

Jun-08

Sep-08

Sep-08

Sep-08

 

 

 

 

 

 

 

 

Price

€ 35.02

€ 1.72

€ 3.69

€ 4.26

£2.22

$18.40

$29.21

$8.15

 Shares Outstanding

   224.38

  150.00

 147.97

   184.78

       302.25

    349.10

      62.87

     285.55

   Equity Market Cap.

7,858

258

546

787

669

6,423

1,836

2,328.4

Short term Debt

109

8

44

Long term Debt / net debt

2,160

1,255

890

263

3,002

234

1,351.0

Preferred / Minority Int.

58

0

215

48

123

14

6.0

Cash & Equivalents

1,280

30

117

63

Total Enterprise Value

8,905

237

2,016

1,725

1,055

9,366

2,008

3,685.4

LTM 2008 EPS

2.73

0.29

0.32

0.50

0.34

1.61

1.74

1.11

2008 EPS Estimate

2.73

0.24

0.24

0.44

0.28

1.58

1.73

1.06

2009 EPS Estimate

2.45

0.16

0.02

0.29

0.21

1.19

1.66

0.84

2010 EPS Estimate

2.62

0.15

0.26

0.39

0.21

1.29

1.74

0.87

LTM EBITDA

1,431.0

85.7

223.3

295.4

202.0

1,342.0

198.3

690.6

2008 EBITDA Estimate

1,377.5

75.8

241.8

273.5

162.7

1,258.8

197.0

653.3

2009 EBITDA Estimate

1,301.7

57.1

189.8

232.5

150.3

1,008.9

180.4

568.3

2010 EBITDA Estimate

1,345.7

57.2

232.7

256.3

126.5

1,053.4

189.7

585.3

LTM EBIT

979.0

53.7

106.6

194.8

129.7

1,117.0

188.6

556.5

2008 EBIT Estimate

960.3

49.0

135.2

169.0

134.8

988.0

186.5

528.0

2009 EBIT Estimate

861.3

25.8

78.8

128.7

120.3

771.7

169.0

437.0

2010 EBIT Estimate

877.2

30.6

112.0

146.5

123.0

846.5

187.0

474.0

Current Net Debt

1,047.0

(21.2)

1,469.9

937.9

385.8

2,943.0

171.9

1,357.0

2008 Net Debt

827.5

(43.9)

1,103.0

866.7

215.5

2,921.5

219.5

1,553.5

2009 Net Debt

1,074.5

(43.8)

1,095.0

833.0

187.0

3,034.8

180.0

1,447.5

2010 Net Debt

1,012.7

(45.5)

1,038.3

788.7

158.5

3,113.0

105.0

1,299.5

Rooms

465,084

52,000

50,961

77,896

28,682

550,453

452,027

608,225

Hotels

3,893

247

345

313

104

3,105

5,570

4,108

Americas as % of all rooms

30%

0%

13%

28%

27%

85%

86%

69%

Rooms Owned/Leased

58%

30%

88%

48%

2%

0.4%

0.5%

1%

Rooms Managed

22%

48%

11%

46%

48%

0%

0%

24%

Rooms Franchised

20%

22%

1%

6%

51%

99.6%

99.5%

75%

 

Mean

TEV/Revenues

1.1x

0.3x

1.4x

1.3x

1.5x

0.7x

3.1x

1.3x

1.9x

TEV/trailing EBITDAR

3.8x

0.8x

4.1x

4.6x

2.7x

8.4x

10.2x

4.9x

5.5x

TEV/trailing EBITDA

6.2x

2.8x

9.0x

5.8x

5.2x

7.0x

10.1x

6.6x

5.3x

TEV/2008 EBITDA

6.3x

2.8x

6.8x

6.0x

5.4x

7.4x

10.4x

6.5x

5.9x

TEV/2009 EBITDA

6.9x

3.8x

8.6x

7.0x

5.7x

9.4x

11.2x

7.5x

6.6x

TEV/2010 EBITDA

6.6x

3.7x

6.8x

6.1x

6.5x

9.1x

10.2x

7.0x

6.2x

TEV/trailing EBIT

9.1x

4.4x

18.9x

8.9x

8.1x

8.4x

10.6x

9.8x

6.6x

TEV/2008 EBIT

9.0x

4.4x

12.2x

9.8x

6.6x

9.5x

11.0x

8.9x

7.4x

TEV/2009 EBIT

10.4x

8.3x

20.8x

12.6x

7.1x

12.3x

11.9x

11.9x

8.6x

TEV/2010 EBIT

10.1x

7.0x

14.1x

10.8x

6.7x

11.3x

10.4x

10.1x

7.7x

Mtk. Cap./Pretax Income

8.7x

4.2x

12.5x

7.1x

4.1x

6.2x

10.6x

7.6x

5.3x

LTM P/E

12.8x

5.9x

11.5x

8.5x

6.5x

11.4x

16.8x

10.5x

7.4x

2008E P/E

12.8x

7.1x

15.7x

9.7x

8.0x

11.4x

16.8x

11.7x

7.7x

2009E P/E

14.3x

11.1x

 nmf

14.9x

10.5x

15.5x

17.6x

14.0x

9.7x

2010E P/E

13.4x

11.5x

14.4x

10.8x

10.4x

14.2x

16.8x

13.1x

9.4x

EBITDAR Margin

29.4%

35.8%

33.0%

28.4%

58.0%

8.5%

30.0%

31.9%

34.6%

EBIT Margin

12.4%

6.7%

7.2%

14.8%

18.9%

8.5%

28.7%

13.9%

29.0%

EBITDA Margin

18.2%

10.6%

15.1%

22.4%

29.5%

10.2%

30.2%

19.4%

36.0%

Net Income Margin

7.6%

5.2%

3.1%

7.9%

20.0%

4.6%

16.7%

9.3%

17.2%

Conclusion
IHG has a very attractive business model and brands.  It’s very well advanced in its move to an asset light model which means it should have less volatile results over the economic cycle compared to its more asset heavy peers.  The assets it does still own are very valuable and can be tapped to unlock further value down the road (for investment or to return to shareholders).  It’s got an ambitious growth plan with rooms in the pipeline equivalent to 41% of its total current rooms, and it has great brands well recognized in emerging markets and elsewhere.  Most of all, it’s clearly very cheap on both a relative and an absolute basis.

Catalyst

While there is no immediate catalyst, IHG is a true deep value equity where one has the chance to purchase a highly profitable, leading business in an attractive industry with a deep bench of growth drivers at a fraction of its intrinsic value. Execution, execution, execution, and an eventual change in market sentiment to lodging stocks will help IHG reach a much higher valuation.
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