July 31, 2006

Slowing economy haunts US hotel stocks

By Paritosh Bansal

NEW YORK - U.S. hotels are busy now, but investors fear that a slowing economy will soon start keeping more Americans at home, hurting the industry's profits.

Interest rates are rising, the housing market is cooling and gasoline prices are around historical highs -- all leaving Americans with less money in their pockets.

And investors are betting that slowing consumer spending will catch up with businesses too, leveling off growth in the sector, despite assurances that the hotel industry's fundamentals still look good.

"We are in a situation now where the sentiment and the fundamentals are at war with each other," Susquehanna Financial Group analyst Robert LaFleur said. "And unfortunately, in the stock market, in the battle between sentiment and fundamentals, sentiment usually wins."

Hotels have enjoyed an upswing over the last few years. Steadily rising room rates have driven up profits as soaring construction costs limited supply and a buoyant economy saw more Americans traveling.

The Dow Jones U.S. hotels index rose some 139 percent between January 2003 and April this year, compared with a 49 percent rise in the S&P 500 Index. Marriott International Inc. and Hilton Hotels Corp. both saw their stock prices more than double over the same period, recovering from a slump in the economy after the September 11, 2001 attacks on the World Trade Center and the Pentagon.

Several big hotel chains served up healthy profits in the second quarter of 2006 and promised more in the coming months. But Wall Street, which rode along until earlier this summer, is losing its appetite for U.S. hotel stocks.

Investors are jittery about demand in a slowing economy. The pace of economic growth slowed abruptly in the second quarter to less than half the pace at the beginning of the year due to softer consumer spending.

As discretionary spending starts to slacken, hotel stock investors generally head for cover.

Starwood Hotels & Resorts Worldwide Inc., set a new 52-week low last week after it reported sharply higher earnings, but forecast profits for next quarter that missed the Street's expectations.

Its stock fell 5.7 percent that day, and dragged down the rest of the sector, with Marriott down 4.6 percent and Hilton off 4.1 percent.

"There are general concerns ... that things are going so well right now -- how much better can it get?" Calyon Securities analyst Smedes Rose said.

The lodging sector has been feeling the heat this summer, with the Dow Jones hotels index down about 8 percent since May through the end of last week, compared with a 2.5 percent fall in the S&P 500 Index.


Hotels, however, insist that they have not seen any signs of a slowdown.

Room rates are up 6.8 percent year to date through June, while occupancy levels are up 2.1 percent to 63.5 percent, according to Smith Travel Research, a widely followed lodging industry research firm.

Starwood raised its forecast for the year and said it now expects revenue per available room -- a key measure of health in the lodging industry -- to increase 11 percent in 2006, at the high end of its previous forecast.

Earlier this month, Marriott's profit also topped the Street's expectations, and the hotel company said the rest of the year looked good.

"Businesses are sitting on a lot of cash," said Peter Dunay, chief investment strategist at the Leeb Index Group. "(But) you have to be concerned that (the economy) would start to affect the travel industry, which has been very strong to everyone's surprise."

Hotel companies such as Marriott and Starwood get most of their revenue from business travelers versus vacationers.

But Choice Hotels International Inc., which gets most of its business from leisure travelers, said revenue per available room would decelerate in the second half of the year and trimmed its earnings forecast for the year.

Choice -- which runs a hotel franchise business with brands that mostly cater to the lower-end of the market -- saw its shares post their biggest one-day drop ever, falling nearly 25 percent on July 26, the day after it reported results.

If the economy keeps slowing and oil prices do not let up, other hotels will start to feel the pinch too, analysts said.

"They have been pretty strong and are pretty full," Dunay said. "But they are not going to be able to do much more if the environment is slowing."