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With the post-Sept. 11 travel downturn just a memory, good times are back for the hotel industry. Today's quarterly earnings report suggests they may be staying at Starwood Hotels & Resorts Worldwide (HOT, news, msgs).
The company's earnings per share rose 17%, or 48 cents, from last year, beating Wall Street projections by 23%. The stock quickly tacked on an additional 1.4% and was within striking distance of its all-time high.
But before you book yourself some shares, pull back the sheets on the company's report.
First, the positive surprises: In addition to its earnings, Starwood enjoyed stronger-than-expected growth in worldwide revenue per available room, or revpar, a closely watched barometer in the industry. For its hotels open at least a year, revpar grew by 10.2%, roughly 1 percentage point above the consensus analyst estimate. Even in the competitive North American market, revpar grew 6.1%, again slightly above most projections.
Operationally, the company continues to benefit from strong demand and limited new supply, a combination that has freed hotels to steadily raise rates. It helps that 44% of Starwood's rooms are abroad, a growing market. Margins rose 1.03% in North America and 1.3% worldwide.
Starwood also saw considerable growth in its business managing properties. Following Marriott International's (MAR, news, msgs) lead, Starwood signed 65 new management and franchise contracts during the quarter. Fees from this business jumped 45.5% to $192 million.
Meanwhile, the company has been selling some properties to boost cash on hand and reduce leverage. The change is a key reason the company now sees earnings of $2.57 per share for all of fiscal 2007, according to management. Just a couple months ago the forecast was $2.50.
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But that's where the good news ends. The first sign of trouble comes from the top-line numbers. Sales fell by 0.7% in the latest quarter to $1.43 billion, an early-warning signal of either a slowing economy or added supply, or a combination of the two. None of it spells good news for an industry that has been on a roll for years.
Another worry is Starwood's recent management change. Earlier this month, CEO Steven Heyer was booted due to concerns over his "management style." Chairman Bruce Duncan has assumed the role of on an interim basis. Heyer was largely responsible for Starwood's impressive run in recent years, and replacing him creates a major uncertainty, especially if industry conditions are about to turn.
Valuations are another concern. Starwood trades around 27 times current-year estimated earnings, or more than 1.8 times the company's long-term-growth rate of 15%. Such a valuation might be understandable if investors could be sure that the good times would continue. But with top-line growth slowing throughout the industry (Marriott's growth reported earlier was also slower than the industry average), and with management in flux, such premiums aren't warranted.
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Some people on Wall Street see the current management situation at Starwood as leaving the company open to takeover. At the moment, that seems remote, so such speculation provides only artificial support the stock over the short term.
Assuming a more common premium of 1.4 times growth, Starwood has downside risk to the $54 area, or nearly 23% below current levels. I'm not suggesting that such a decline will occur immediately, but the risk-reward ratio argues against loading up on the stock. Shareholders should use any earnings-related gains to reduce exposure.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this article.
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