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Why fat dividends from InterContinental Hotels leave me cold

Over the past five years, InterContinental Hotels (LSE: IHG) has dished out more than 1,100p per share to investors in dividends. If you’d bought the shares at the beginning of 2013, this cash return is equivalent to a dividend yield of 59%. 

Including capital growth, over the past decade the shares have produced a total return for investors of 18.2%, which means InterContinental has doubled investors’ cash once every four years.

And City analysts are expecting the company to increase its cash payouts further over the next two years. Dividend growth of 21% is projected for 2018 and growth of 10% is pencilled in for 2019 — that’s excluding any special distributions.

Today’s first quarter trading update indicates to me that these City targets could be conservative. 

Revenue per available room — a key industry measure — rose 3.5% in the three months to March 31, above City estimates and last year’s benchmark of 2.7%. Analysts had been expecting earnings per share to fall by 5.7% for the full-year, but these figures seem to suggest that the company will now outperform expectations. This could mean increased cash returns to investors. 

Trouble ahead? 

However, while I do believe InterContinental could make an excellent income pick for your portfolio, I’m worried about the state of the group’s balance sheet. 

Over the past few years, the hotel group’s cash returns have been funded by assets sales and borrowing. The result is that since 2012, assets such as owned property have fallen from $2.2bn to under $900m, while net debt has jumped from $1bn to $1.8bn. Shareholder equity has fallen from $300m to under -$900m. 

There’s no reason why the company cannot continue on its current trajectory in my view when times are good, but there may be hard times ahead for the enterprise if another economic crisis rolls around. 

A better buy? 

Considering the above, a better dividend buy for your portfolio might be InterContinental’s competitor easyHotel (LSE: EZH). Like its larger peer, it is returning plenty of cash to investors. City analysts expect the firm’s dividend payout to jump 100% over the next two years to 70p, giving a dividend yield at the time of writing of 3.4%.

The company is also expanding rapidly. Its latest trading update shows that the group achieved a 33.6% increase in sales during the first half of 2018, with revenue per available room leaping 11.2%. 

What’s more, the firm has a stronger balance sheet than InterContinental. Rather than borrowing money, the company is asking shareholders for extra cash and reinvesting cash from operations to expand its portfolio of owned properties and franchisees. 

According to the company’s latest set of results, the group has a positive net cash balance and a shareholder equity value of £70m. In my opinion, these strong financial metrics put the business in a strong position to be able to continue its expansion and weather any downturn in the hotel market.

Put simply, if you are looking for a long-term buy and forget income investment, easyHotel might be the better buy.

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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.