Starwood (HOT) reported falling revenue and strong earnings in a sign that the company is struggling with and adapting to a cooling global economy. Revenue from hotels grew by 12% while overall revenue remained steady at $1.53 billion and net income fell to $142 million (EPS of 72 cents), down over 17% on a year-over-year basis but above EPS expectations of 65 cents. The steady revenue and above-expectations income is largely due to cost-cutting from expansions and a rise in revenue per available room (REVPAR), which climbed by 4.1%. North America saw the strongest REVPAR of 5.2%, with Asia behind at 3.9% and Europe falling below the rate of global inflation at 1%. The regional breakdown of Starwood’s REVPAR not only indicates where the company’s future growth is likely to come from, but also how each region’s economy is developing . The low growth in Europe is hardly surprising, considering the region’s protracted economic troubles.
The Macro Picture
The growing revenue potential of North America operations over Asia might be a bit more surprising to the casual investor, but should be no surprise to the pros. Asia has a glut of hotel properties and a cooling economy; while GDP growth in China and India are several multiples above the developed world, they have recently fallen from their double-digit heights; in 2012, China’s GDP rose by 7.7% and India rose by 5.5%. These numbers might seem enviable, but they’re a sharp decline, and the trend is more important than the whole numbers to an investor.
Asia’s economic softness is an old story by now. Both China and India are heavily dependent on exports to the European Union (despite popular lore, the EU is China’s biggest export market), and European softness has a direct impact on China. The Market Vectors China ETF (PEK) is down over 17% since the beginning of 2011 and the SPDR S&P China ETF is down over 5% for the same period. India ETFs (INP, EPI) are down even more for the same period. Hope in a strong, resilient China morphed into hope for a soft landing in 2010 and 2011, which is now morphing into hope that job repatriation and political stability will spur growth in the U.S. that will trickle down back to Asia and Europe.
The Micro Implication
So Europe is weak, Asia is struggling, and America is recovering slowly. For a company like Starwood that depends on a strong consumer base to spend on pricey hotel rooms and business travelers with generous company travel budgets, this macroeconomic sluggishness is a challenge.
Starwood has impressively adopted. “While REVPAR came in at the low end of our range, good cost control at owned hotels and our SG&A helped offset the revenue shortfall,” said Vasant M. Prabhu, CFO of the company. By keeping costs down and squeezing as much revenue as possible through more efficient operations, the company outperformed on earnings in a slow growth environment.
Other fundamentals of the firm were impressive. EBITDA rose to a bit over $1 billion thanks to lower selling, general, and administrative expense (SG&A). These necessary costs are difficult to cut without lowering operational quality, but Starwood was able to optimize operations without hurting quality, thus delivering to investors without depending on easy money from a booming economy.
How–and Why–Investors Responded
The after-hours earnings call was met with admiration by investors. They saw in Starwood’s response to a challenging environment a strong fundamental reason to buy. Starwood outperformed earnings amidst slow revenue, demonstrating the company’s ability to make a profit in even the worst environment. Likewise their frank, honest, and professional demeanor in the earnings call showed a mature company that can confidently challenge competition such as Marriott (MAR), Hyatt (H), and Wyndham (WYN). Paradoxically, the bullish case for Starwood for value-oriented investors was strengthened by the company’s tepid growth.
On the other hand, the company’s performance was a sign that the global economy is still weak, and it might be a signal that the tourism industry as a whole is still facing an uphill battle. While recovery is inevitable, it might be further ahead than some macro-oriented investors would like, causing good reason to pull back from Starwood and others in the hospitality industry. Thus the bearish case from a macro perspective is strengthened by the company’s performance.
For now, investors are cautiously optimistic of Starwood’s ability to deliver to investors in this economic environment, which should keep the stock safe from a significant drop. However, the softness of the tourism industry will keep Starwood investors on guard for a while still.
The harder part is figuring out if and where this stock would fit into your portfolio.