Description

Playa Hotels and Resorts is a small cap hotel company operating in the upper upscale part of the all-inclusive hotel segment. It operates in the Caribbean and has presence in Mexico (Yucatan and West Coast), Dominican Republic, and Jamaica. It was written up once before on VIC here, and the author (wisely) closed out the position as the COVID-19 crisis was taking hold and the stock was about to fall another 70%.

Background

Playa rooms by region break down as follows: Mexico Yucatan (Cancun and other) at 30%, Pacific Mexico (Puerto Vallarta) at 13%, Dominican Republic at 37%, and Jamaica at 20%.

Traveling to Mexico from the U.S. is easy now and has been for a while despite the pandemic. The Dominican Republic is rapidly opening as well and dropped its testing requirement for vaccinated inbound travelers in April.  Jamaica has the most stringent entry requirements still, but you can get there with a negative test.

The Playa resorts typically get about 70% of their business from Americans. The rest comes primarily from Canadians, who are still very restricted from traveling, and Europeans, especially Brits. The ability of Europeans to travel to the Caribbean during COVID varies but has been limited so far, but is rising quickly with vaccination rates, which are most advanced in the U.K. (similar to the U.S.). I would expect that by the next high season (beginning in December), things should be close to 100% normal for these destinations for the majority of their visitors.

Nearly 70% of the company’s rooms are branded as Hilton or Hyatt, which is an advantage over competitors operating with local brands. These brand names convey a level of standards and quality which helps sell rooms, as does their inclusion in loyalty programs operated by these global brands…. People can use their travel points accumulated via business travel to visit Playa resorts branded Hilton or Hyatt with their families. These brands also aid in securing direct bookings, which are higher margin than those made through travel agents, tour operators, or OTAs.

85% of Playa’s revenue comes from the base food and lodging packages. The rest comes from upsells – spa services, premium rooms (suites and views), premium alcohol and dining, and activities. Playa earns high incremental margins on these upcharges, which are likely to do well as people take their first vacations in over a year.

Investment Thesis

The thesis behind this idea is pretty easy and high level. The stock is trading around the same price as in January 2020, before COVID-19 hit outside China… and now that people are vaccinated, leisure travel is going nuts because of pent-up demand from over a year at home.

Consumers saved a lot of money last year not going on vacation, not going out to dinner, not sending kids to camp, etc. And now they are vaccinated (if they want to be), restrictions are lifted, and wanderlust is back in a huge way. We saw this beginning in the spring, where hotel prices surged in warm weather, fully opened locations… aka Florida.

I could link to a million articles… but leisure travel demand is off the charts. Jet Blue is ordering planes. United is about to be ordering planes. Disney World is selling out and can’t get enough employees. Hotel chains are all complaining they can’t hire enough housekeepers. The evidence is everywhere… I don’t need to catalog it for you.

The problem is everyone knows this. The recovery trade is largely over. Marriott and Hyatt are trading at their pre-COVID levels and near all-time highs, despite having large exposure to all the things that aren’t recovering (or at least haven’t yet)… upper upscale center city hotels, business travel, international travel, etc. Hilton is even trading at an all-time high, despite the delayed recovery in business travel.

These stocks feel more than full to me… but Playa does not. It may be trading at its pre-COVID level, but that wasn’t the right price before COVID, and it certainly is not now. Playa is significantly down from its pre-COVID high of $12 set in 2017. The company was already cheap going into COVID for a number of reasons.

First, the company was in the middle of renovations and had a bunch of rooms offline, temporarily depressing results. It did not communicate the impact of the renovations well ahead of time and confused investors and analysts. Second, it had run into a string of bad luck. Weather is always a risk in the Caribbean, where hurricanes can derail any given geography in July through October. Playa also was having problems in the Dominican Republic in 2019, due to bad press around deaths that derived from tourists drinking tainted alcohol. There have intermittently been bad PR episodes impacting travel to Mexico as well.

So the company was underearning and the stock was depressed going into COVID. And I would argue its prospects are way better now than they were before the crisis. The renovations are done, the portfolio has been optimized a bit… and it is a flat-out leisure boom, which is likely to continue for a couple of quarters, if not a couple of years.

And for the short-term, the grounding of cruise lines and the difficulty of getting them back running at full capacity given COVID protocols and requirements could provide a short-term lift, as all-inclusive resorts provide a good alternative to cruising for travelers who want visibility on total holiday expenses, and a one stop solution that eliminates the need to plan and reserve dining and activities.

The surge in remote and hybrid work could provide a longer-term tailwind to all-inclusives, as less time in the office may create more demand for off-sites, retreats, and other events that bring far flung colleagues together.

Given the boom in everything leisure, it’s odd that PLYA shares haven’t reacted more to the strong demand environment, which should translate into better RevPAR and margins at its resorts. When the company reported second quarter results in May, it already displayed improving trends and gave very strong forward commentary for future bookings.

On the call, Playa reported that bookings for the third quarter were up 25% versus 2019 levels. For the fourth quarter, they were up 40% versus 2019 levels. Operations are recovering… and then some. This demand surge is incredible when you consider that the 30% of visitors that typically come from somewhere other than U.S. are still restricted when it comes to travel. When Canadians and Europeans can freely travel again, demand should get even stronger.

Strong demand of course helps pricing as well as occupancy, and pricing gains are very high incremental margin. Playa was adamant on the call that because of the demand outlook, there will be no discounting in 2021 and the early part of 2022. Often tour groups and travel agents can obtain discounts on all-inclusives, but Playa had already pivoted to doing more direct bookings, which are higher margin. With demand so strong, there should be no need to participate in discount plans. And it’s not just the company saying so… I spoke to one group travel booker who greatly lamented the fact that most hotels in the Caribbean and Florida are refusing to book discounted room blocks for conferences in 2022… and even in 2023.

So far, Mexico is leading on the demand front… partially because it has been open the longest, but also because Mexico has been evolving into more of a year-round destination versus the Dominican Republic and Jamaica, which remain more highly seasonal. Rates are of course lower for Mexico in the summer and fall… but the resorts often fill now in Mexico during the summer, which is another long-term positive for Playa.

The company is poorly covered by the sellside, with only four analysts covering the stock – and only one at a firm with substantial reach (analysts are at Deutsche, Macquarie, Janney Montgomery, and Truist). Lack of coverage combined with the company’s small market cap may contribute to the market not reacting to the improved demand environment.

Given the strong demand environment and the prospects for future pricing, the street seems too low on EBITDA estimates. While consensus has climbed from 140 to 163 for 2022, I think the company could do north of 200 mm. The key assumptions here are 85% occupancy (versus 80% in 2019) and an average daily rate (ADR) of $300, versus $257 in 2019 and $285 in 2020. Putting that together, I’m looking for RevPAR of $255 in 2022 versus $204 in 2019. That’s a 25% increase, but since 2019, three newly renovated Hilton resorts have completely come back online, Playa disposed of lower ADR, non-strategic, unbranded rooms representing 10% of the 2019 room count… and leisure demand is soaring.

Valuation

PLYA currently trades at 13.8x the street’s 162 million EBITDA estimate for 2022 (which I think is meaningfully too low). If PLYA puts up 210 in EBITDA in 2022 like I expect it to and holds its multiple of just under 14x, the stock would trade north of $11. Meanwhile, hotel real estate investment trusts – most of which have more exposure to still-depressed center city upscale hotels – trade at 15x to 17x, so further gains through multiple expansion is possible. The Hotel REITs like Playa own their properties but not the flagship brands, making them a better comp than relatively asset-light companies like Marriott and Hyatt, which seek to only own key properties and grow instead through licensing agreements and management contracts.

There are a ton of questions about how things will shake out for business travel… whether the recovery in business travel is just delayed versus leisure, or if the business travel market will be permanently altered by the pandemic experience.

Most people think conventions, conferences, and incentive travel will return – perhaps even bigger than ever. The bigger question mark pertains to one-off transient business travel… will the day trip by a handful or bankers or lawyers or advertisers from New York to California to make a one-hour pitch become more of a rarity in a post-Zoom world? Or will that only last until the first deal is lost to a competitor that decided to fly out instead of doing a Zoom? I tend to lean towards the former… with increasing environmental sensitivity, as well as the continued push to cut costs at corporations, I think some elements of business travel just may never come back entirely. But even if I am wrong about that, a return to 2019 business travel levels is not expected until 2023 or 2024.

For years prior to the pandemic, privately and publicly held hotel groups fought over deals for upper upscale and luxury center city properties in first tier cities. Now, those properties are underperforming as other categories see RevPAR bounce back and then some. As center city upscale remains depressed, extended stay units and anything leisure and beachfront, whether basic or luxury, are seeing RevPARs at 2019 levels and beyond. This outperformance has made its way into the M&A market, as per key prices for Florida waterfront hotel properties are exceeding expectations when they trade.

If the business market takes time as expected to bounce back, and the leisure boom has legs, I think we could see some hotel REITs or privately held hotel groups look to shift their business mix to include more leisure properties. Given its relatively small enterprise value just over $2 billion, Playa could make a bite-sized acquisition for an urban-focused hotel group looking to diversify from business travel to leisure travel.

In a takeout, 16x would be an appropriate multiple, yielding a takeout price of around $14, and nearly 100% upside from here.

Risks

If you think that vaccines will stop working or that some variant is going to break through the vaccine barrier, you probably don’t want to own any hotel or airline stocks.

General economic turndown/recession.

Hurricanes and bad PR around safety in Mexico, the DR, or Jamaica.

Flight availability becomes a constraint to affordable travel.

Catalyst

1. Improving RevPAR at Playa properties

2. EBITDA handily beats 2022 consensus estimates

3. Company gets bought by a hotel group looking to shift some of its room mix from business to leisure