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Why I’d avoid this ‘hot’ stock despite today’s 20% rally

Millennium & Copthorne Hotels (LSE: MLC) announced today that it is going private after receiving a 552.5p per share cash offer for the group from its Singaporean owner City Development. The proposal is a premium of 21% to the closing price on Friday. 

City Development is owned by Hong Leong Group, which is itself part of Singapore billionaire Kwek Leng Beng’s business empire. It already owns 65.2% of Millennium. 

The 552.5p offer includes a 7.5p special dividend and values the hotel business at just under £1.8bn.

Performance leaves much to be desired

Now that this deal has been announced, I would avoid Millennium in favour of buying its larger peer InterContinental Hotels (LSE: IHG). 

These two companies operate in the same industry but have both achieved very different results for investors over the past five years. For example, even including the rally inspired by today’s bid, shares in Millennium have underperformed those of InterContinental by around 50% excluding dividends over the past five years. 

Including dividends, InterContinental has blown its smaller peer out of the water. Indeed, since 2003 the company has returned $12.8bn or £9.8bn to investors via special dividends, 125% of its market value today. For comparison, Millennium’s shares only yield 1.9% today. 

The better buy 

The owner of the Intercontinental brand is a model hotel operator and outperforms most of its peers on many metrics. Last year the company reported an operating margin of 40%, compared to Millennium’s 11% and return on capital employed was 38%, compared to just 2.4%. These figures are slightly misleading because the smaller company owns the majority of its hotels, so has a higher asset base, but InterContinental’s asset-light strategy has paid off for investors. 

For the year ending 31 December, the company reported a 9.5% increase in underlying profit as global revenue per available room – a key industry metric known as RevPAR – grew 1.8% in 2016. On an underlying basis, stripping out asset sales, managed leases and other items, revenues rose 4.6% to $1.6bn, while operating profit rose 9.5% to $702m. 

Off the back of these figures, the company announced a $400m special dividend as well as an 11% hike in its regular dividend to $0.94 per share. The regular payout is equivalent to a yield of around 2.1% at current prices. However, including special payouts, the firm returned 510p to investors last year giving a total yield of 12.4% and this year shareholders are in line for an overall yield of 5.6%. 

Expensive shares 

The one drawback to InterContinential’s success is that it’s put the company on the radar of income-seeking investors, which means the shares now trade at a premium valuation. Specifically, shares in the group trade at a forward P/E of 21.1. 

Still, while this valuation might seem dear, it’s not all that demanding considering the group’s cash generation, steady growth, brand reputation and dividend history. 

As long as the company can continue on its current trajectory, I believe that a multiple of 21.1 times forward earnings is a premium worth paying for this world-class business. 

You can't live without dividends

You can't live without dividends, that's why I believe InterContinental is a great addition to any portfolio. The steady income from this company will improve your returns and substantially increase the chances of you being able to achieve financial independence. 

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Rupert Hargreaves owns no share 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.