Key Takeaways
- Hilton World Wide Holdings has been a widely recognized Wall Street favorite because of its asset-light model, network effects/loyalty program, strong brand and geographic revenue mix. We think Wall Street is right in this case.
- The company does indeed trade at a premium compared to some peers, but we think the track record of a capable management, the return of pent-up demand to travel, and the return to 2019 levels (and probably beyond) for key metrics like RevPAR suggest this stock can still run.
- The postponing of travel because of a persistently adverse health situation around the Delta variant suggest a return to pre-crisis growth rates or beyond in EPS when demand booms. Hilton’s franchise fee structure is also more appealing than peers more dependent on management fees.
- Sometimes the market puts a valuation premium on companies with better prospects than its peers and we think that is the case here. Hilton’s fee based model mixed with a premier global brand, huge rewards program (125 million), and pent up demand should be quite lucrative.
- The article is titled based on a quote from company founder and namesake, Conrad Hilton. The survivability despite nearly zero revenue and ability to cut costs and continue growing available rooms faster than peers shows the second part of this quote was prescient.
Many people remain wary and afraid of COVID-19. We certainly understand this. Despite the disinformation around and minimization of COVID-19 by beleaguered and misinformed folks, there has not been a mass-casualty event in US history that exceeds the death-toll from this pandemic. It now outpaces the official death toll of the American Civil War and has killed about 1 in every 500 Americans. Weeks ago it also surpassed the ghastly toll from the Spanish Flu in our country.
Of course, the American Civil War was proportionally worse and killed about 1 in every 50 Americans, or a staggering 2% of the population. Two-thirds of these casualties occurred from disease. The 1860s was a particularly bad and unpleasant time to go camping with tens of thousands of other men. The lesson from this discrepancy? Be kind to your neighbor even if they disagree with you on matters of politics. The consequences of discord and domestic strife can be even worse than those of disease.
Many lives have been affected and many loved ones lost. So, we think it improper to minimize the effect COVID has had on people emotionally and mentally since nothing has ever killed more Americans in such a short time. Not our Civil War. Not even the thankfully defunct Third Reich and Empire of Japan.
We also understand that there have been government failures that lead people to be upset and skeptical. This doesn’t erase the massive tragedy we’ve all faced together or the continued seriousness of the disease and good-faith efforts by many heroes and thought leaders to put it in the rearview mirror.
Taken in this context and throwing in the particularly toxic mix of rightfully scared folks and a media culture with rapidly devolving journalistic integrity and you get a situation where fear is in ample supply. It is hard to even remember the optimistic frame of mind that followed the miraculous breakthroughs in mRNA technology that allowed vaccines which have significantly mitigated the rate of death and hospitalization amongst those who took it. The ample supply of fear is your friend if you’re trying to make money though.
A Room For Every Customer And Room Rates Are Rising With A Bullet
There are a lot of headline risks and reason to be apprehensive in markets. However, what you see with your own eyes can sometimes contradict the narratives of reality that we convince ourselves of. Fundstrat/FSInsight staff were in Las Vegas for a conference and the pent-up demand and activity was really something to see.
A hotel staff told us the Wynn and Encore that they were at 97% capacity and had been around there for weeks. Conference season started here and is building. Intuitively, it sort of makes sense that a destination like Vegas would lead a wider rise in occupancy as the more willing precede the more afraid. Coincidentally, we also had the opportunity to look at Hilton’s new Vegas resort. It is definitely up to snuff and is the first bottom-up addition to the strip in 10 years.
The return of Vegas was really something to see, and reports of its death seem greatly exaggerated. Hilton management confirms that they saw a very noticeable uptick in business travel (measured by midweek occupancy) after Labor Day. Yes folks, business travel is returning and we can personally attest to this. Hilton is also well positioned to meet new trends in the hospitality industry like the rise of mid/upper scale brands that cut costs using technology for cost-conscious millennials. It had the brand value and financial flexibility to pivot based on events. Hyatt is trying to copy Hilton’s model. Luxury RevPAR dropped nearly twice as much as lower echelons favoring Hilton’s room mix as well.
Hilton’s global presence is a major asset. So is the fact that nearly ¾ of revenue is in America which enjoys much higher levels of vaccination than much of the world. The company’s asset-light model coupled with global reach and the network effects from a loyalty program with about the same amount of people in all of Japan or Mexico means this company is better equipped than peers to respond flexibly to the post-COVID-19 environment, whatever that entails. It has the flexibility to cheaply expand into thriving travel markets, like Mexico.
It is so large and global it has network effects as well and also effectively partners with leading network effect beneficiaries like Amazon and Lyft. We believe high levels of fear are sticking around longer than the Delta Variant will and this presents opportunity. One of the core insights behind our bullish call on Hilton is that while currently, much of the discourse around hospitality centers around when RevPAR and room rates will return to pre-COVID levels, not what the future will look like.
The pessimism pervades the response in many cases. As one conference presenter said, you always sound smarter being bearish than telling people to ‘buy-the-dip,’ but despite this perception, the folks saying the latter have been largely proven correct since the pandemic. The situation is changing quick. We think Bearishness will lose its fashionable nature pretty soon as greater earnings power and lower costs converge with burgeoning demand. Merck has announced a therapeutic and approval of vaccines for younger ages is happening. We are all tired, but a bright future is ahead if history is any indicator. We are a resilient and adaptive species.
We would suggest that while now the concern is about low occupancy, in the very near future the concern will be the opposite. We believe very soon there won’t be enough hotel rooms for the people who want them. Hilton is a beast of a company with a great management team. Add pricing power into the mix and you could see fireworks. Hilton’s CEO commented that in his 40-year career he has never seen room rates rise faster. He believes 2022 volumes will be offset by the higher rates. Eventually, the return of demand will come back to levels exceeding anything seen maybe ever. We suggest buying now, not when nobody can find hotel rooms because of tsunami of demand we anticipate.
Fear Can Be A Friend of The Bold
Hotels were amongst the Epicenter cadre from the very beginning. Many folks remember our Head of Research, Tom Lee, going on TV in the height of the pandemic-induced fear when a bright future was a lot less certain than it is now. Many thought Tom was crazy and some even said so. However, those who listened were glad they did. In the world of investing fear can really be your friend.
On a fundamental level, we just believe fear sometimes has some catching up to do with reality. Take for example, the Soviet Union/Russia who are perpetually afraid of foreign invasion because of several traumatic experiences with it in the past. Does the United States want or need to invade Russia proper and does this necessitate forming a buffer of former Soviet Republics between itself in the West?
Well, the world has changed a lot since then and we would argue probably not, but they still prepare for the worst. Perhaps, it is partially human nature. Our relatives were likely more anxious than those who didn’t make it. Hrmm I’m very nervous we might run out of grain this winter. It’s thoughts like these that majorly contributed to self-preservation over our mostly unpleasant history (relative to modern times) so it is wired in us to be risk averse.
Despite the virtues of risk aversion when dealing with investing, it can make your performance severely average. Thinking ahead and outthinking consensus, as successful military leaders do, is more what you want to do investing. Taking calculated risks is the name of the game. Taking risks ahead of when the crowd wants to take them is where you can often find alpha. You can also find ruin if you do so in a foolhardy fashion.
We’d like to explain why even though Hilton is near its all-time highs and trading beyond its pre-COVID levels that we think it is one of the best in the industry to take advantage of what we see as a multi-year travel recovery. Well, firstly the company has survived the unthinkable, learned to cut costs, has much lower fixed costs than many rivals and is better equipped to weather a storm than others. Similarly, when demand does return we suspect that Hilton’s leverage will come down quickly and lead to a virtuous cycle that reduces its WACC (Weighted Average Cost of Capital). This coming tailwind should help shares be able to soar and should mean upside for earnings.
Experience Is a Good School, But The Fees Are High
Hilton does enjoy a premium compared to peers. However, we think rising tide in travel will be so different from fear-ridden markets expectations that you will be surprised how high Hilton can make it. Particularly if you hold this stock for a while. There are several reasons why we think this stock is almost certain to be one of the major beneficiaries of a globally synchronized travel recovery. The track record of this solid management team and its ability to execute also helps explain the premium. Remember the modern iteration of Hilton was forged in the fires of Blackstone, who spun it off in 2014.
There’s also a very good reason for the premium. Managing hotels is hard work and a lot can go wrong. Hilton has a higher proportion of franchise fees than key competitors like Marriott and this partially explains the higher multiple. Also, when you have competitors trying to copy Hilton’s desirable asset-light model it helps intuitively explain the premium as well. The rest of the industry is trying to become more like Hilton, which should give you an idea of the competitive advantage.
Risks And Where We Could Be Wrong
Hilton has price risk given its premium relative to peers. However, we would urge you to also allow for the fact that sometimes the market rightly assigns premiums to companies who have superior business models and survivability than their peers. We think this is the case with Hilton and we think that it is a favorite of institutional investors (One of Bill Ackman’s flagship picks) also might factor into this a bit.
The company does have a junk credit rating which is understandable given the interruption of revenue and massive losses experienced by the company. We’d prefer to see the company reduce the overall cost of capital rather than rush to returning capital to shareholders too quickly. Getting a bump up in credit would be good for the company in our opinion, so there is some risk here. However, we’re sure a seasoned management team who understands how to deliver to shareholders will carefully consider the matter.
There’s always a risk that the rate of adding new capacity is overly optimistic and that projections are not as positive as initially forecast. Also, one of the primary risks for Hilton is the delayed return of business travel. Earnings have been propped up by excessive demand in leisure but that is probably going to decline because of normal seasonal factors. The longer you hold this stock, the less risk from near-term factors you will have. We believe there will be a renaissance in travel once COVID-19 is in the rearview mirror and we think Hilton is primely positioned to benefit from a multi-year recovery.