10’000 Hours
Elevator Pitch
I continue to rate Choice Hotels International, Inc.’s (NYSE:CHH) shares as a Buy.
I discussed about CHH’s “recently proposed acquisition and the company’s updated guidance” with my earlier write-up for the stock published on August 30, 2022. In my latest article, I explain why investors should look past Choice Hotels’ third quarter bottom line miss and focus on positives like the growth potential of CHH’s upscale and extended stay segments. My analysis brings me to the conclusion that the recent pullback in Choice Hotels’ share price provides a decent entry opportunity for CHH’s stock. As such, I keep my Buy rating for Choice Hotels.
CHH’s Shares Reacted Negatively To EPS Miss
Choice Hotels’ stock price fell by -9% from $128.37 as of November 4, 2022 (Friday) to close at $116.66 at the end of the November 7, 2022 (Monday) trading day. The substantial share price drop for CHH came after the company announced its Q3 2022 financial results on November 7 before the market opened.
CHH’s last done share price was slightly lower at $114.92 as of November 9, 2022. In aggregate, Choice Hotels’ shares have fallen by as much as -10% since the company disclosed its third quarter financial performance at the start of this week.
CHH’s actual Q3 2022 non-GAAP adjusted earnings per share or EPS of $1.56 fell short of the sell-side analysts’ consensus bottom line forecast of $1.69 per share by a significant -8%.
In contrast, Choice Hotels’ revenue increased by +28% YoY and +13% QoQ to $414 million for the third quarter of 2022. In fact, CHH’s third quarter top line exceeded the Wall Street’s estimated revenue of $375 million by +11%. In other words, Choice Hotels had missed the market’s expectations on costs, rather than revenue.
Choice Hotels’ Operating Profitability Was Weak Due To One-Offs
The company’s non-GAAP adjusted EBITDA margin contracted by a substantial -10.7 percentage points YoY from 80.0% in Q3 2021 to 69.3% for Q3 2022.
A large part of the increase in costs on a YoY basis for Choice Hotels was attributable to the Radisson Hotel Group Americas acquisition which I touched in my August 30, 2022 write-up. CHH highlighted at the company’s third quarter results briefing that approximately 3 percentage points of “the margin” differential “is a result of the core business.”
Separately, there were also other one-offs which hurt CHH’s operating profit margin and bottom line. These included a $1-2 million increase in travel & entertainment costs (the return of the company’s yearly convention which didn’t happen last year due to COVID-19) and a $3 million reversal of prior bad debt provisions (recognized as losses on the income statement as per accounting rules).
Choice Hotels’ guidance for full-year fiscal 2022 normalized EBITDA margin to be higher than for FY 2019 provides further support for the thesis that the spike in expenses for CHH in Q3 2022 should be transitory in nature.
Multiple Bright Spots
Looking beyond CHH’s negative earnings surprise, there were actually a number of bright spots for Choice Hotels in the recent quarter.
Firstly, Choice Hotels’ RevPAR (Revenue Per Available Room) improvement was excellent, as indicated in the company’s Q3 2022 earnings presentation slides.
September 2022 marks the 16th month running that CHH’s RevPAR has surpassed pre-COVID levels for 2019. Also, CHH has delivered quarterly RevPAR superior to that of the industry average for every quarter between the first quarter of 2020 and the third quarter of 2022.
Secondly, the upscale segment was the star performer for Choice Hotels in the most recent quarter, which validates CHH’s earlier decision to acquire Radisson Hotel Group Americas.
RevPAR for CHH’s upscale segment increased by a strong +18.3% for Q3 2022, and this was more than +1,300 basis points better than the industry RevPAR average for the upscale hotel segment in the same quarter.
In my August 30, 2022 write-up for Choice Hotels, I had emphasized that “the acquisition (of Radisson Hotel Group Americas) will allow CHH to increase its presence in the upscale and upper-midscale segments.” Notably, Choice Hotels also stressed at its Q3 2022 earnings briefing that “the Radisson acquisition really cements our position in that Upscale segment” with this recent deal “adding another significant amount of upscale rooms” to its portfolio.
Thirdly, CHH’s pipeline for the company’s extended stay segment grew by a robust +45% YoY to roughly 470 units in the third quarter of the current year.
I have a positive view of the significant expansion in Choice Hotels’ extended stay hotel pipeline. This is because I believe that extended stay hotels are leveraged to multiple positive trends.
One key trend is the rise of flexible work arrangements which encourage more people to consider extended stay hotels as one of the potential work locations. Another key trend is that there is an increasing number of travelers opting for longer road trips, and this is driven by both international travel restrictions and flexible work arrangements as well. This in turn pushes up demand for extended stay hotels.
As such, it is encouraging that CHH has guided for a five-year CAGR in excess of +10% for its extended stay units at its most recent quarterly investor briefing.
Concluding Thoughts
I remain bullish on Choice Hotels and I continue to view CHH’s shares as a Buy. The Q3 earnings miss has led to a meaningful share price correction for Choice Hotels, and I think this offers a good buying opportunity.
