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MAR’s quarter and guidance shows why we are more cautious on hotels over the near-term but also why we like MAR’s business model.

THESIS

MAR’s quarter was in-line but low quality in our opinion.  Guidance on recurring EPS was weaker than expected.  While management may or may not be a little conservative, there are real issues with the world economy and this is an economically sensitive business.  Moreover, our math suggests a sequential slowdown in YoY RevPAR growth in July without even considering a Macro slowdown.  These factors could weigh on the sector over the near-term and MAR which have both otherwise performed relatively well. 

The relative strength of MAR’s business model was and will be evident particularly if the economy worsens.  MAR bought back an astounding $400 million worth of stock in the quarter.  The company is a cash generating machine, especially since the spin of the capital intensive timeshare business.  The company’s cash flow is more insulated from softening demand trends due to the almost exclusive fee-based model.  While we are not recommending purchase of any lodging stocks right now, if you have to own one, MAR would be it.  Longer term, this is a great business with favorable supply/demand trends. 

We’re hoping for a significantly better entry point.

 

Q1 ANALYSIS

Marriott reported an in-line quarter that was low quality.  The $400MM buyback in the quarter was impressive though and exceeded our estimate.

Q2 would’ve been a miss if not for:

  • Higher termination fees and unusually high increases in branding and credit card fees
  • A $2MM receipt of business interruption insurance related to the Japanese Tsunami.    
  • The $400MM buyback in the quarter was impressive though and exceeded our estimate.

Somewhat offsetting the non-recurring positives above was higher SG&A that had $7MM of “one time charges” and $5MM of higher reserves. 

On the surface, it looks like MAR raised EPS guidance, but when you exclude the $40MM gain on the sale of the Courtyard JV guidance for 3Q12, EPS would have been about 8 cents lower and below consensus. Offsetting the gain on the Courtyard JV sale could be the loss of income from the sale of the corporate housing business which MAR has yet to quantify.

Some takeaways:

  • Room growth was disappointing in the quarter.  Excluding the sale of the Courtyard JV, rooms at the end of 2Q were still 5k lower than we estimated.  System-wide room growth was only 1.7%.  Gross room additions for the year were reduced by 5,000 at the midpoint due to opening delays.
  • On the positive side, absolute dollar ADRs were higher than we modeled
  • Fee income of $342MM came in $8MM below the midpoint of MAR’s guidance
    • Base fees only grew 4.4%.  Base fees as a % of estimated managed room revenues decreased to 4.7%, down 20bps YoY.  2Q was the 3rd consecutive quarter of declines.
    • Incentive fees increased 12%, below the 20% growth annual rate given on the last call.  NA fees grew 15% and International fees increased 10.4% - both slowed sequentially.  The % of hotels paying incentive fees increased by 1% QoQ.
    • Excluding fees on timeshare, which we estimate at $15MM in 2Q, franchisee fees grew 8.4% YoY.
  • For owned, leased, corporate housing and other gross margin came in $23MM above the midpoint of MAR’s guidance
    • Termination fees were up $12MM YoY
    • We believe that the $9MM jump in branding and credit card fees include some one-time items and do not expect to see this type of growth for 2H12
    • Benefit of $2MM of business interruption related to the Tsunami in Japan
    • Excluding branding and termination fees, we believe that gross margin would have been $22MM, which still represents a nice 5% increase in margin to 10% YoY.
    • Marriott mentioned that it sold its corporate housing business as one of the reasons for lowering guidance but made no further mention of the transaction in the release
  • SG&A would have increased 6% if not for some one-time charges and higher reserves for guarantees in the quarter.  MAR’s full year guidance for a 3.4% increase SG&A implies a YoY decrease in SG&A for the 2H12.