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Starwood (HOT): Why Is This Stock So HOT?

Added on by Gordon Gekko .

Be sure to check out our detailed stock analysis (click here). The hotel industry could be a big benefactor from the rebounding economy and increased consumer spending. It appears one of the big winners in the sector so far has been Starwood Hotels & Resorts Worldwide (NYSE: HOT). Starwood posted 1Q 2013 EPS of $0.76, compared to $0.63 for the same period last year, blowing past $0.53 consensus estimates. The question is, does this mean there are more good things to come for Starwood investors? Or is there another hotel stock that could be a better investment?

Starwood's better than expected results were on the back of higher vacation ownership and residential operating income. Its European segment remained stable, China improved and North America did better than the company expected.

Some keys for Starwood include its opportunities for emerging market growth, namely Latin America, and Brazil and Mexico are two relatively untapped markets. Meanwhile in Africa, Starwood intends to have 48 properties by 2015. Also, Starwood opened 23 hotels in North America in 2012, but the company expects 2013 to be its strongest year in terms of hotel openings in North America since the recession, with 28 scheduled hotel openings. 

One of Starwood's biggest initiatives is its plan to up its fee-based business. This includes increasing revenues from managed, unconsolidated joint venture hotels and franchised hotels. Currently, these hotels represent around 90% of the company's total portfolio, compared with 21% in 2004. Making this structure attractive is its capital efficiency, where owner/developer partners provide the capital and the company then earns a fee for managing and franchising the hotel. Starwood's long-term goal is to generate some 80% of revenues from this fee-based business.

Starwood is also committed to returning capital to shareholders. Since 2003 through the end of 2012, Starwood bought back 82 million shares for $4.5 billion. Meanwhile, the company has a dividend policy for paying out 25% to 40% of earnings per share every year. During 4Q 2012, Starwood raised its annual cash dividend by 150% year over year to $1.25 per share, offering investors one of the highest yields in the sector at 1.8%. 

A better way to play the hotel industry?

Although Starwood is executing well, there could be a couple of other stocks that could be better investments. These include Choice Hotels (NYSE: CHH) and InterContinental Hotels (NYSE: IHG). While Starwood trades at 22 times forward earnings, Choice and InterContinental are at only 18 times earnings. What's more is that both of the companies offer investors better returns, with Choice having an 19.4% return on assets and InterContinental at 17.3%, while Starwood's at 5.4%. 

Choice Hotels is one of the largest hotel franchise companies in the world with hotels, inns, all-suite hotels and resorts open and under development in countries across the globe under the brand names Comfort, Quality, Sleep Inn, Econo Lodge and MainStay Suites. The one downside for Choice is that the company is a pure franchisor of hotels. 

InterContinental Hotels   operates various hotel brands that include InterContinental, Crowne Plaza Hotels & Resorts, Holiday Inn, Holiday Inn Express and Staybridge Suite. InterContinental also happens to be a hotel manager and franchisor. 

The hotels that manage and franchise hotels have greater exposure to emerging markets and stronger unit growth prospects than pure franchisors. Worth noting is that pure franchisors do generate higher margins and returns on invested capital. However, their inability to manage hotels limits their growth prospects internationally. For example, most developing international markets, such as China and India, do not provide a favorable legal environment for hotel franchising. 

For operators that both manage and franchise hotels, new-room pipelines as a percentage of total existing rooms average 24%, compared with an average of 12.4% for pure franchisors. Starwood and InterContinental in particular are strong in China, which represents approximately 30% of their pipelines.

Morningstar notes that it projects system size (as measured by total rooms) to increase 18.2% on averageover the next five years for operators that combine hotel managing and franchising, significantly higher than the outlook for five-year system growth for pure franchisors Choice Hotels' 11.6% and Wyndham Worldwide at 9.2%. It also expects EBITDA to increase at a five-year compound annual growth rate of 9.5% for operators that manage and franchise, compared with an average of 7.3% for pure franchisors.

Hedge fund trade 

Going into 2013, there was a total of 31 hedge funds long Starwood, an 11% decrease from one quarter earlier. The top hedge fund owner was Tiger Consumer Management, with an $89 million position in the stock, which makes up 4.2% of its 13F portfolio (see Tiger Consumer's best picks).

Meanwhile, InterContinental had 13 hedge funds long the stock, an 8% increase from the previous quarter. Billionaire Jim Simons' Renaissance Technologies holds the biggest position in the stock, worth $16 million (check out Simons' tech picks).

Choice Hotels has the lowest hedge fund interest of the three, with only four hedge funds long the stock, which was a 43% decrease from the third quarter. Billionaire Israel Englander's Millennium Management dumped the biggest stake of all the hedgies, with Paul Tudor Jones's Tudor Investment Corp selling off the second largest position (see Tudor's top five picks).

Don't be fooled

2012 was a positive year for the hotel and lodging industry, which should continue through the interim due to a better economic operating environment and stronger travel and tourism. PWC forecasts 0.8% supply growth and around 1.8% demand growth in 2013, which will come on the back of a rise in occupancy levels. 

Although Starwood appears to be in full favor, blowing past earnings expectations, it appears investors might also be able to uncover some value from investing in InterContinental. InterContinental pays a 2.2% dividend yield, while it is also the top growth and best-value play among the three listed.