Why I’d avoid Intercontinental Hotels Group plc today

Full-year results from Intercontinental Hotels Group (LSE: IHG) have sent the shares down around 4% as I write. However, those who invested in the firm at the end of 2008 and held until today are sitting on a capital gain of more than 800%, which is a great run up on a cyclical stock.

Cyclical but expanding

As well as operating in a cyclical sector, the firm is also expanding, and the sheer size of the operation makes it worthy of consideration if you are looking for an investment in the hotel business. Brands include InterContinental, Crown Plaza, Holiday Inn and Staybridge Suites and in 2017 the firm earned around 74% of its operating profit from the Americas, 10% from Europe, 10% from Asia, the Middle East and Africa, and 6% from Greater China. There’s a strong core market across the pond and decent exposure to potentially fast-growing markets around the world. The overall size of the operation stands at around 798,000 rooms, up 4% during the year, which the firm tells us is the highest rate of organic growth since 2009.

Today’s results are good, with underlying revenue 5% higher than a year ago, and adjusted earnings per share up 22%. The directors passed their judgement on the firm’s performance and its outlook by raising the total dividend for the year by 11%. The company’s asset-light operating model seems to be working out well. Around 69% of the rooms are run in franchised hotels, 30% in managed hotels with the rest owned and leased. Chief executive Keith Barr said in the report that he is positive with regard to the outlook for the year ahead and “confident that our ambitious plans will deliver a meaningful change in IHG’s growth and drive industry-leading net rooms growth over the medium term.”

Is the growth here overvalued?

There will be no additional capital return paid to investors during 2018 because the company plans to invest more to stimulate growth. Historically, chunky special dividends have featured in the total-return outcome for shareholders every other year or so, making this move by the directors normal, but it could be another reason for today’s share-price weakness. The directors assure us that “IHG’s commitment to return surplus funds to shareholders remains unchanged.

The firm seems to be firing on all four cylinders, but I’d be banking my returns and thinking very hard about getting involved in the shares now if I didn’t already hold. The enterprise, although growing, is cyclical and the shares have been tearing upwards. But I see the valuation as being too high and believe the market ‘should’ reduce it to slow the stock’s progress during these economic good times. At today’s share price close to 4,498p, the forward price-to-earnings rating stands at 20 or so for 2019 and the forward dividend yield at 2.2%. City analysts, meanwhile, expect earnings to grow 9% that year. I think the market has assigned a growth rating to the firm without taking account of its cyclical vulnerability, so I’m cautious on the stock and will avoid it for the time being.

Compelling value developing

If the shares continue to fall and the valuation becomes compelling, I’ll revisit the success story that is Intercontinental Hotels Group. But for my long-term retirement portfolio, I’m looking at the value that is developing with five superstocks that the Motley Fool’s outperforming stock analysts have focused on.

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Kevin Godbold has no position in any of the 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.