Shares of the Holiday Inn and Crowne Plaza brand owner InterContinental Hotels Group (LSE: IHG) closed near all-time highs yesterday as the company continues to improve margins and pump out ever higher profits. But despite the firm’s success I believe now represents a good point for investors to reexamine this stock and its outlook in the coming years.
My main concern is the highly cyclical nature of the hotel industry. The sector’s health in recent years has improved alongside the global economic recovery following the financial crisis, but it is unclear how long this growth can continue.
The IMF may have recently upped its global GDP growth estimates for 2017, but it also issued stern warnings on the risk of rising protectionism, a lack of structural reforms in key markets and a dearth of international economic cooperation. This matters hugely for IHG as its ability to fill new hotels and jack up rates is directly tied to global economic health and the spending power of tourists and business travellers alike.
An added wrinkle is one investors in airlines will be all too familiar with: companies’ tendency to add capacity at breakneck speeds that inevitably results in too many empty rooms when demand growth inevitably falls.
Indeed, the speed at which global hotel groups are adding capacity is already negatively impacting IHG’s ability to increase rates. Growth in revenue per available room (revpar), the industry’s key metric, has fallen for two consecutive years at IHG. In FY 2014 year-on-year revpar grew at 6.1%, which fell to 4.4% in 2015 and then 1.8% in 2016.
This hasn’t been a critical problem as the company’s move to a franchisee business model has seen it increase margins and cash flow, which all investors love. But with the company’s shares priced at a relatively expensive 21.8 times forward earnings and an industry fixated on expanding rapidly, IHG is one cyclical stock I’d steer clear of right now.
Flying into turbulence
It’s almost the exact same story for BA, Iberia and Aer Lingus owner International Airlines Group (LSE: IAG). Unlike American carriers, that have kept capacity growth artificially low through what some argue is collusion, European carriers have been adding capacity at a rapid clip in recent years.
In 2016, IAG increased capacity by 3.9% year-on-year excluding its Aer Lingus acquisition. This is even more dramatic for smaller rivals such as easyJet, which upped capacity by 8.6% y/y in the previous quarter, and Ryanair, which is forecasting a 12% increase in passenger numbers for this year.
All of this is driving fares down across the industry. In 2016, IAG’s revenue per available seat kilometre, a key industry metric, fell 4.3% year-on-year and this effect was even more extreme for budget carriers.
With the age old cyclical nature of the airline industry once again returning to full force I’ll be avoiding legacy carriers such as IAG due to high debt, high staffing costs and far less flexibility than nimbler budget rivals. Although the airline’s shares may look cheap at 7.5 times forward earnings I wouldn’t be buying shares of IAG at this point.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.