The downturn is underway. Recession? Not so much
 
The downturn is underway. Recession? Not so much
14 JANUARY 2020 8:22 AM

There seems to be agreement that the U.S. hotel industry is in a downturn, but the economy continues to chug along, for now. A shallow downturn that lasts a year or two seems likely, but risks remain.

Looking back on my last two columns, it looks like I nailed it in early July when I stated that an industry downturn had begun. In October, I predicted that a recession appeared imminent or might already have begun. I was wrong about that one.

As I have previously written, I believe hotel industry downturns can be marked by a long-term decline in occupancy, one best quantified by looking at the U.S. 12-month moving average change in occupancy. There are a lot of reasons why this works for me, including that once occupancy falls broadly, it becomes increasingly difficult to maintain rate growth, even when absolute occupancy is high. In addition, the timing of that smoothed occupancy turning point tends to correspond pretty closely to a peak in hotel stock prices.

Jan Freitag, SVP of lodging insights at STR, was kind enough to furnish the actual STR data for 12-month moving average occupancy change for 2019 through November, the latest data available. As the table below shows, it has been a bumpy ride, with occupancy change fluctuating around 0% since June of last year. (STR is the parent company of HNN.)

There is always volatility in monthly numbers, and with supply and demand so closely in balance, this signal is hardly unambiguous. But I suspect that demand growth will continue to lag supply growth in 2020 and likely in 2021 as well. That expectation is in line with STR’s and other forecasters’ predictions.

The June data point came out in mid-July, shortly after my column was published. Let me interrupt this victory lap with an analysis of my incorrect prediction about the economy. I have to hand it to the Federal Reserve—its recent round of rate cuts did seem to boost the economy and put off a recession, at least for now.

I still see substantial risks to the economy, including overextended consumers, a lack of availability of labor nationally, trade upheaval and deep political uncertainty. Perhaps the best evidence of this risk is in the continued behavior of corporate leaders. Part of the justification for the tax cuts that went into effect in 2018 was that the cuts would get corporate cash off the sidelines as companies would be incented to invest more capital into their businesses. This didn’t happen. Frankly, I viewed that argument more as a rationalization than as a justification.

What has happened instead is that companies have returned capital to investors, helping to fuel a record bull market. Cash deployment has been focused on share buybacks and dividends, but not on capital investment. This seems to reflect continued uncertainty around trade policy, as global companies deal with disruptions in their supply chains. But it also reflects uncertainty about the economic outlook and doubt about whether there are workers available to staff positions created by potential investment-fueled business expansions.

And it is business-fixed investment that most closely correlates to hotel demand, particularly demand for business travel, both group and transient. Business travel has been a weak spot in hotel demand. A risk for the next two years is that consumers begin to feel pinched by high debt levels, leading to a slowing of leisure demand. And the construction pipeline tells us that supply is going to continue to grow at or above the long-term average rate of about 2%.

So did hotel stocks peak around the time that smoothed occupancy turned negative? Yes, for a short while. My past research found a less precise indicator of when stocks trough, but it generally correlated to the time that occupancy trends stopped getting worse. With smoothed occupancy bouncing between 0.1% decline and 0.1% growth, and with the economy showing strength, investors had mixed signals.

Does this mean that hotel stocks will decline over the next year? A closer look at the nature of the Baird/STR Hotel Stock Index is required to understand this measure. The index is heavily weighted toward the global brand companies which have the largest market capitalization. Marriott and Hilton have an outsized impact, and these companies’ fortunes are much more tied to their ability to grow their brand networks. They have fertile territory for growth outside the U.S., where brand penetration is much less than it is in the U.S.

The hotel real estate investment trusts, as measured by the REIT sub-index of the stock index, could have a bumpier ride. But if investors have confidence that fundamentals will trough over the next year, give or take, they may bet that growth in 2021 and beyond will be enough to buoy stocks.

Of course, individual hotel and portfolio performance will vary broadly, given different market dynamics and property-specific factors. Supply growth is highest in the top 25 markets, so a lot of smaller markets could see occupancy and RevPAR growth in the year ahead.

And let’s keep in mind that occupancy, margins and profits are high now, so a small decline is not the end of the world. And soon enough we will all be talking about the next growth cycle.

After a 30-year career as a stock research analyst, David Loeb created Dirigo Consulting LLC, which advises on capital markets, strategy and communications issues. Clients have included REITs, brands and private equity investors. He a member of the board of directors of CorePoint Lodging Inc., a publicly traded hotel REIT. He can be reached at davidloeb@earthlink.net.

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