These past few years haven’t been easy for Hyatt (H). COVID is for the most part behind it now save for some remaining soft spots, but with an economic downturn a real possibility there is a risk that we could be looking at ‘two steps forward, one step back’ here over the next few quarters. I don’t want to go overboard on the near-term outlook, as there are good reasons not to be too concerned in this cycle, but having waited a few years for the post-pandemic recovery here a setback will be about as welcome as a skunk at a lawn party.

Hyatt’s recent operating environment has muddied what I think is a decent long-term investment case. The company is a bit behind peers in the evolution of its hotel portfolio (i.e. shifting to asset-light managed and franchised rooms), but it is moving in the right direction on that front while also sporting a healthy room pipeline that I think can power above-average medium-term growth.

Whether the above is already in the stock price is a slightly different matter, though, and having gained close to 25% year-to-date I do think Hyatt was much better value just a few weeks ago. “Growth at a reasonable price” is probably a fair reflection of where we are at. These shares can still do okay for long-term investors, albeit with the caveat that the near-term could get a little tricky.

Shifting The Room Mix

Hyatt is at the smaller end of the global lodging firms with a total estate of just under 300,000 rooms. Most of those (~65%) are in the Americas, with Asia Pacific (~18%) and EAMA/SW Asia (~17%) making up the rest.

For the most part, those rooms fall under highly cash generative franchise or management contracts that see Hyatt take a straight ~3-6% cut of room revenue, or a mix of room revenue plus a share of hotel profits. The physical real estate is typically owned by third parties, including listed hotel REITs like Host Hotels and Park Hotels & Resorts.

The above describes around 96% of Hyatt’s estate. The other 4% or so of rooms are in hotels owned/leased by the company itself, and that includes properties like the Park Hyatt New York and the Andaz West Hollywood. It takes on all the revenue of these hotels – the room rate, food & beverage sales and so on – and bears all the operating and capital expenditures.

Hyatt has been working to shift its room mix away from these assets, making good progress in recent years albeit lagging peers. With that, the owned/leased room count has fallen to around 12,000 from over 25,000 ten years ago, with the owned/leased share of the total estate falling from around 20% of rooms to its current level of 4-5%. Just by way of comparison, Marriott, Hilton and Intercontinental Hotels typically sit on estates with a 98-99% share of managed and franchised rooms.

As for the pros of this strategy, managed and franchised rooms are very high margin and capital light. Growth is easy to fund and, in contrast to owned/leased hotels, the fatter margins of the managed and franchised business make it less sensitive to economic conditions. Hyatt inching closer to peers on this is a plus-point in my view.

Shaking Off COVID

It has been a protracted recovery, but 2022 will at least see Hyatt post some positive comps on pre-COVID times. Full-year results aren’t released until mid-February, but comparable revenue per available room (“RevPAR”) is expected to land around 4-7% below 2019, with stronger comps in the back part of the year. With that, Q3’22 comparable system-wide RevPAR of $133 was around 2% higher than equivalent-period 2019 levels, while the month of September saw comparable RevPAR come in 3% higher than 2019 levels.

That global RevPAR figure has lots of moving parts to it. Firstly, room occupancy remains way down on pre-COVID levels – by around 8ppt or so – and that is being offset by double-digit growth in average daily rate. China is responsible for a big chunk of that, with Asia Pacific occupancy down more like 15ppt on Q3’19 and RevPAR also still lagging 2019 levels. The stronger US dollar is also having a negative impact. On the plus side, business in the Americas segment is doing much better, with RevPAR past 2019 levels by high single-digits, again led by price. Europe is also ahead after normalizing for exchange rate changes.

As for earnings, group adjusted EBITDA (~$250m for Q3’22 and $675m for 9M’22) is already way ahead of 2019 levels ($165m for Q3’19 and $565m for 9M’19), with Hyatt increasing its global room count from ~215,000 to ~295,000 in that time, including via acquisitions like Apple Leisure Group.

The Outlook

My main worry in the near-term is an economic downturn halting the ongoing recovery. In a ‘normal’ recession I’d expect RevPAR rates to typically take a low single-digit dip, though I am a bit more optimistic this time around given how much latent travel demand there is due to COVID. China throwing off lockdown restrictions is by itself a fairly big part of the puzzle, so even with an economic downturn I think there’s a decent chance that group-wide RevPAR levels will actually continue to climb higher this year.

In the long run there is good reason to be bullish. Hyatt’s room pipeline ended 2022 at around 117,000 rooms, up around 2.5% sequentially and worth a peer-leading 40% of its current estate. Management guided for 6.5% year-on-year net rooms growth last year, and with its pipeline as strong as it is I think it can keep that rate up for some years to come.

More broadly, I do like the structural advantages that the branded players seem to enjoy. They are grabbing global share because, among other things, they drive higher occupancy levels and have loyalty programs that also drive higher per-stay spending. Hyatt’s loyalty program – World of Hyatt – has around 30 million members, roughly double its pre-pandemic tally.

On the flip side, I can see near-term pricing softening as consumer finances weaken in these economic conditions. On top of that, lower construction activity during COVID has probably artificially helped pricing a little (less competition), and that may cool off as activity normalizes. Hyatt’s higher share of owned/leased assets also makes it more sensitive to the wider economy as its margins are more fragile. On a longer-term basis, I think 3-4% per annum RevPAR growth coupled with 6-7% annualized room count growth can drive double-digit per annum EBITDA growth, with that assuming owned/leased margins hold up at current levels.

What Does The Market Think?

Hyatt stock trades for around $111 at time of writing, putting it on an EV/EBITDA of around 16x my estimated FY’22 EBITDA of ~$900m.

I like to value Hyatt on a simple discounted cash flow basis. With that, the current share price seems to be baking in medium-term growth in the 9-10% per annum area, with that based on my FY’23 free cash flow estimate of ~$560m, a 9% equity hurdle rate and terminal growth in the 3% area. The market’s growth assumptions aren’t very aggressive, but these shares were were much better value around the $90 area at the start of the year.

Summing It Up

I like where Hyatt is moving its hotel portfolio, shifting the room mix more toward franchised and managed rooms over owned and leased. These shares don’t look overvalued on a combination of 6-7% annual room count growth, low single-digit annualized RevPAR growth, and owned/leased hotel EBITDA margins staying stable in the mid-20s area, but having been much better value just a few weeks ago I’m inclined to adopt a wait-and-see approach here.

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