Choice Hotels: Significant Growth Potential, But Overvalued (NYSE:CHH)

Over the past two years, Choice Hotels International, Inc. (NYSE:CHH) has experienced an upward trend. The company has demonstrated significant growth in its net income, and un-levered cash flows to the firm (UFCF) are also on the rise. CHH acquired Radisson Americas, launched a new brand (Everhome Suites), and had a 5% increase in its royalty rate. However, it’s important to note that the current P/E ratio is higher than that of its peers, and the current market price is trading above its intrinsic value. So, while there are some positive trends at CHH, I’m limiting my current enthusiasm for the stock to a Hold.

About the company

Choice Hotels International, Inc. is a franchisor in the hospitality industry that was established in 1939 and has grown to become one of the largest franchisors of hotels worldwide. The company is divided into two main segments, which are Hotel Franchising and Corporate & Other. Choice Hotels offers a range of hotel brands, such as Comfort Inn, Comfort Suites, Quality Inn, Sleep Inn, Clarion, Cambria Hotels, MainStay Suites, Suburban Extended Stay, Econo Lodge, and Rodeway Inn. Each of these brands is tailored to meet the needs of different segments of the market, ranging from budget-conscious travelers to those seeking luxury accommodations. Apart from franchising hotels, Choice Hotels also manages its own loyalty program, known as Choice Privileges.

Recent performance

Over the past two years, CHH has exhibited remarkable performance, achieving a substantial surge in revenue of about 37% in 2021 and 29% in the prior year. The company also successfully acquired Radisson Americas, which generated an additional adjusted EBITDA of $18 million. Moreover, CHH observed a growth of nearly 30% year-over-year in its domestic upscale units, and its franchise agreements increased by 11% in the past year. CHH also outperformed the industry in (RevPAR) growth for the third straight year.

Strengths

The company’s extensive global reach is one of its most notable advantages. Its presence in 47 countries worldwide reduces reliance on the performance of a specific economy. With a significant number of approximately 7,500 hotels operating across five distinct segments and under 22 different brands, CHH has a highly diversified portfolio.

The recent acquisition of Radisson Americas is another factor that contributes to the company’s strength. Radisson America is a prominent hotel chain in the upscale segment of the industry. Following the acquisition, CHH was able to realize an additional adjusted EBITDA of $18 million in under six months. This suggests the growth potential that Radisson Americas has brought to CHH, which may result in increased income for investors in the future.

CHH is not solely expanding through the acquisition of established hotel chains, but also through internal growth. As of the end of 2022, the company had more than 1,000 hotels in the pipeline globally. The completion of these projects could result in significant revenue for the company and enhance its performance in the years to come.

A closer examination of CHH’s income statement to gauge the company’s financial strength reveals its robust performance after the pandemic. The company’s bottom line increased by 283% following the lifting of COVID restrictions in 2021, and by 15% as things began to return to normal in 2022. Furthermore, the company’s operating expenses grew at a slower pace relative to the revenue, resulting in increased income available for debt repayment and equity holders.

Weaknesses

One of the biggest weaknesses of the company is its high debt. The current debt to equity (D/E) is 8.24x which means that for every $1 of the company owned by shareholders, the business owes $8.2 to creditors. This indicates that the company is relying more heavily on borrowing than its own equity. A high debt-to-equity ratio for CHH may indicate a significant amount of financial risk as the company would first need to pay high-interest payments which can affect the profitability of the investors.

Another weakness indicated by CHH’s balance sheet is its short-term liquidity risk. The company’s current ratio is 0.8, which poses a threat to its day-to-day operations and may suggest a situation where the company could face difficulty in meeting its short-term obligations.

Looking forward

The analysis of CHH’s intrinsic valuation, utilizing both EV/EBITDA and P/E multiples, yielded an average value of $110.30. As a result, the current stock price of $122.85 appears to be 11% above the estimated intrinsic value, indicating that the stock is slightly overvalued at this time. These valuations were based on the following assumptions:

Peers – For comparison and valuation techniques, CHH’s peers were selected based on the similarity of their business and market capitalization. The five companies considered for this purpose are Wyndham Hotel & Resorts, Inc. (WH), Marriott Vacations Worldwide Corp. (VAC), Hilton Grand Vacations Inc. (HGV), Travel + Leisure Co. (TNL), and InterContinental Hotels Group PLC (IHG).

In terms of EV/EBITDA, a peer average multiple of 12.81x was utilized to compare with CHH’s 14.61x.

As for the P/E multiple, a peer average multiple of 19.02x was employed to compare with CHH’s 20.63x.

Conclusion

Based on recent developments such as CHH’s acquisition of Radisson Americas and over 1,000 new hotels in the pipeline, it appears that the company has a significant potential for added revenue and net income growth, indicating a bright future. This is why I would like to keep CHH in my watchlist.

However, it’s important to note that the company is highly leveraged, and its short-term liquidity could pose a risk to its day-to-day operations. Additionally, the assessment of intrinsic value calculation suggests that the company is slightly overvalued at present. All things considered; I would rate CHH as Hold.