THE PENT UP DEMAND THEORY

We think current RevPAR dollar levels are unsustainable. While YoY growth rates may stay strong that won’t tell the whole story.

RevPAR is at an unsustainable dollar level, in our opinion.  Lodging should be in recovery mode given the depth of the recession last year.  However, the macro variables do not support a continuation of these current high levels.  So why is RevPAR so strong? 

We believe in the pent up theory of recent lodging demand, for lack of a better phrase.  Essentially, business transient travel was restricted for a long enough period that business suffered and people had to play catch up.  Pent up demand was apparent in April through July.  August will look stronger but in absolute dollar terms, seasonally adjusted, will mark a slowdown unless growth exceeds 13%.  See our 08/10/10 post, “DOLLAR REVPAR MORE RELEVANT THAN %” to see why.

The recovery bulls are quick to point out the strong and lasting RevPAR growth during the last recovery.  Indeed, from Q1 2004 to Q4 2007, quarterly RevPAR ranged from 5-11% and an average of 8%.  Good stuff.  Even the current high valuations would grow into those numbers.  The problem is that the macro environment isn’t supportive this time.  During that nearly 4 year mega recovery, quarterly nominal GDP growth YoY was 5-7% and averaged 6%.  Q2 2010 YoY nominal GDP growth was only 4.0%.  Looking ahead, 2H consensus expectations is for 3.3% GDP growth and only 2.8% for 2011.  Hedgeye is projecting even less, 1.7% next year and our Macro team has been much better than consensus.

What else is missing this time versus last time?  Housing for one.  The peak of the housing bubble helped propel GDP and lodging demand.  Unemployment – which we’ve proved was a more important driver of lodging demand over the last few years – does not look like it is coming down anytime soon, certainly not to the 5% average from 2004-2007.

Evidence of Pent Up Demand

  • Q1/04 to Q4/07 RevPAR range was 5-11% (ave 8%), GDP range was 5-7% (ave 6%) – current recovery GDP growth is significantly lower yet Q2 RevPAR growth was 8.3%. 
  • The spread between occupied rooms and employment has never been higher
  • Occupied room nights are only 7.5% below the prior peak
  • August RevPAR is up 9%YoY through the first two weeks – a sequential increase in growth but an actual deceleration of seasonally adjusted dollar RevPAR
  • Conversations with private owners

Here are some charts to back up those assertions:

THE PENT UP DEMAND THEORY - LODGING1

THE PENT UP DEMAND THEORY - LODGING2

THE PENT UP DEMAND THEORY - LODGING3

So if we are right about pent up demand when will it show up in the numbers?  Certainly not August.  The sell side cheerleaders will no doubt roll out the pompoms and dance moves to celebrate “accelerating growth”.  In terms of estimates, 2H guidance and consensus look reasonable.  However, whisper expectations are significantly higher.  Moreover, 2011 RevPAR estimates actually look aggressive.  Street consensus is 6.0-6.5%.  Assuming April-July represented a period of pent up demand and the inevitable RevPAR correlation to the typical macro drivers returns, 2.5-4.0% might be the better range.  Given the valuations, we don’t want to be around when numbers start coming down.