I always like reviewing those companies whose market price has dropped considerably and check their financial statements looking for investment opportunities. Among those stocks, I found the hotel chain Meliá Hotels International and decided to analyze its business model along with NH hotels, another publicly traded lodging business.
To begin with, I have conducted an analysis based on Porter’s 5-forces:
- Buyer power: customers do have strong power when negotiating prices. Nowadays, it is very common to check several price comparators in order to get the best rate available given a date, location and hotel number of stars. This is very common for hotels located in cities and main holidays destinations.
- Suppliers power: in general, suppliers do not have power to rise their price products. The reason is that most of them are local, and quantities ordered by hotels are very large. For this reason, hotels will always have the advantage here. However, companies like Booking.com are different since they concentrate a vast number of potential customers and can rise the commissions charged to hotels (the higher fee, the higher the position in the search engine).
- Substitutive products: here, we need to mention the case of Airbnb. This company application has allowed many owners to offer their houses to people that would have chosen a hotel in the past. So here, we need to take into account the Airbnb phenomenon.
- Barriers to entry: there is no barrier to entry except for very special locations (small islands, protected areas, small attractive cities, etc).
- Rivalry among existing firms: generally speaking, the lodging industry suffer from a mild rivalry among existing firms. However, this fact does not affect every hotel chain in the same way. Premium hotels, captive locations and value-added experiences suffer less since they position themselves far from Airbnb-like experiences.
In order to better understand NH or Meliá strategies, I firstly wanted to know how many Spanish hotel chains are competing and the market share they are defending. In the following graph, we can see each market participant with its number of rooms.
As we can see in the graph, the biggest competitors are Meliá, NH Hotel Group and Barceló Hotel Group, but after knowing their size in terms of number of rooms a second question arises: Who has the largest market share?
One thing is having the largest hotel chain and a very different thing is maximizing profitability. In order to know if the size is helping to defend a market share, I have also calculated the market portion of each hotel chain between 2007 and 2017:
As we can see in above chart that Meliá market share has grown and is the first one while NH has lose a 4% market share each period over the past 11 years. Another example is Iberostar, who started in the last position and is just behind Meliá International. Since Iberostar is not a publicly traded company I will compare Meliá and NH hotels.
According to Pat Dorsey, there are several sources of competitive advantages. However, for hotel chains I only find two strong factors that can affect the competitive landscape:
- Economies of scale
- Customer captivity
Regarding the first one, we must understand that hotel business has a high proportion of fixed costs compared to variable ones. For that reason, besides calculating RevPar we also should check who is benefiting from lower costs. In the following table, we can see these metrics:
Both operating costs and salaries have deducted from room revenue to reach total margin. After dividing it by available room we can see how Meliá is benefiting from a higher margin, even with more available rooms. I personally think that such advantage is paramount since it allows the company to reduce prices in case of economic recession, lower demand, market saturation or any other type of unfavorable situation that could produce a price war.
Regarding customer captivity, we need to state that it is a true competitive advantage only if it allows the company to charge a higher price. For that reason, I have compared the Average Daily Rate in the three main markets both chains are competing.
As we can see in the graph, Meliá charges a higher price and makes more revenue in the three main markets they have in common. Thus, we can say that Meliá benefits from lower costs and higher prices than NH.
After looking over the strategies of both companies I have to say that they both have several points in common. They both focus on:
- Revpar increase, to maximize profitability.
- Asset-lite structure, to reduce investment needs and risks associated to real state business and focus only on its core business: hotel management.
- Reinforcement of propietary sales channels, to depend less on suppliers like booking.com or any other comparator.
- Focus on upper scale hotels, to differentiate from lower scale ones and Airbnb-like experiences.
- Reduce of operating costs (only NH), to increase margins.
- Reinforcement of emblematic locations (only Meliá), to increase customer captivity.
In the following table, I provide a side by side comparison of main parts of both Meliá and NH strategies, from 2014 to 2017:
I have measured the Asset-lite factor as the percentage of rooms that are not under rental or management agreement. By the contrary they are owned by the company.
Regarding average daily rates and RevPar, have been retrieved from financial statements and averaged in case a general metrics have not been explicitly stated.
Upper-scale rooms have been calculated as the number of rooms that belongs to upper-scale and premium hotels divided by total room number.
Direct sales channel has been also retrieved from financial statements.
As we can see in the previous table, in each item Meliá International has a superior performance over NH Hotels.
As value investors, an adequate entry price is as important as the quality of the business we are analyzing or investing in. For that reason, I have calculated an intrinsic value that takes into account both the quality of balance sheet as well as cash flow statement. In the following table I show the valuation for both companies as well as the stock price:
As we can see in the previous table, Meliá is trading at a 24% discount whereas NH is trading 2% above its valuation. Regarding Meliá, it is important to state that its assets have been revalued upwards by an external specialized company. Such revaluation has taken into account future cash flow streams and discount rates that range between 7 and 10%, approximately. In order not to rely 100% on the external valuation, a correction factor has been applied, giving a worst case of 10,30 €.
As we have seen in the different sections of this article, Meliá Internationals is the biggest Spanish hotel chain while NH is holds the fourth position. Beyond market share and size, we have also checked that Meliá retains a higher proportion of income due to a higher margin per available room. This is a clear advantage over its competitors.
Related to strategy, they both focus on value and I really like the effort they both put on growing their own sale channels as well as the change towards premium and upper-scale hotels that clearly defend themselves against low cost and Airbnb lodging solutions. I particularly find very interesting (and profitable) how Meliá is choosing captive places to develop its business.
Regarding valuation, Meliá is trading at a 25-30% discount while NH is not. In order to make an investment decision, we also should take into account that lodging industry is a clear cyclical business and that we are closer to the peak of the economic cycle. So this is probably not the best time to invest in such companies. Nevertheless, a potential downside should not affect both companies in the same way since one of them, Meliá, is trading at a larger discount and closer to its NAV per share.