A financial analysis on NH-hotels
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The years 2001 and 2002 were very difficult for both travel industry and global equity markets. In light of these developments, we believe a hotel business with a strong capital structure and cash flow would be in an excellent position to wait out the economic downturn and be in a position to take advantage of weaker rivals and any economic recovery. In terms of fundamental analysis we are looking for a moderate gearing ratio, sustainable liquidity ratio, and moderate to good ROCE and asset utilization ratios.
Our analysis of NH Hoteles share price started with the articulation of a desired set of fundamental financial ratios using macro level information about the hotel and the leisure industry and the global equity markets. We then compared NH Hoteles and competitors with these targets to estimate future performance and to identify strong performers within the sector. We used the annual reports of all companies analyzed for 2002 and 2001 as well as more recent information mainly from the Internet and equity markets for 2003 data.
Europe has long been a popular place for tourists which has helped the hotel industry flourish. However, when the first war on Iraq broke out the vulnerability of this industry to the world economy was starkly illustrated. However in the second half of the 1990’s the world economy had recovered, the hotel business picked up again and sales in the late 1990’s broke all previous records.
To accommodate these tourists European hotel chains have been and still are building more hotels. The chains do this to gain market share and to secure European wide coverage. Due to the clear advantages of scale, a few dominant companies control the European market as smaller players merge with the bigger ones or are pushed out the market completely. (Lye, 2003)
However big the companies have become, they all felt the economic bubble bursting. The economic implosion and September 11th put tourism in the doldrums, and the industry was dealt further blows by the second war on Iraq, the Severe Acute respiratory Syndrome (SARS) and the terror attacks in Bali. The Economy started to improve in mid 2003 after the war in Iraq ended quickly without major international terrorist incidents. However according to Klancnik (2003) the number of visitors to Europe is still down 15%, because of the fear of terror attacks and the strong position of the Euro.
III.OVERVIEW OF NH HOTELES
NH Hoteles is a Spanish hotel chain based in Madrid and is become the fastest growing chain of Europe and became third largest business hotel group in Europe 2002. Following the acquisition of the Dutch Krasnapolsky chain in 2000, the Mexican Kristal chain in 2001 and the German Astron chain in 2002 it has currently 242 hotels in operation, with 34,876 rooms in 16 countries, in Europe, Latin America and Africa. NH Hoteles employs more than 12000 employees with 78 different nationalities. (NH Hoteles 2003)
The European Business market is the major market NH Hoteles is operating in. It is targeting this market with 4 and 5 star hotels in the major cities of Europe. It distinguishes from other hotels by its service, interior decoration, good food and technology.
IV.PRESENTATION OF FINANCIAL REPORTS
We used the NH Hoteles Annual Report of 2002 as the main source of financial information about the company. The report was composed of two reports, a glossy main section with many pictures of the various (and glamorous) properties owned by the company and a few consolidated financial statements, and a second report with the full financials tucked in a folder in the back of the first!
We found the full financial document to be difficult to read, requiring frequent referral the notes. Key ratios were not provided, forcing us to do numerous calculations ourselves. This is not in theory a bad thing; but in comparison with metric heavy reports from the UK and America simply getting a quick picture of the state of the company takes some time. Also challenging was the complicated structure of consolidated and partially consolidated companies, which is an unfortunate side effect of the rapid expansion of NH Hoteles.
This report had the following interesting characteristics:
·No cash flow statement–not required under Spanish reporting requirements.
·One-time transactions contributed in a material fashion (> 10%) to the bottom line.
·Property valuation techniques used in Mexico and Latin America reduced the value of Fixed Assets by about 20%.
We found the lack of cash flow statement most disconcerting. Many companies and analysts would like to use EBITDA (Earnings before interest, tax, depreciation and amortization) as a cutout for cash flow, but this violates the principle that profit is not cash. The hotel business is often a heavily geared (mainly to finance fixed asset purchases) business and cash flow problems could create inabilities to make debt payments.
After reading the notes to the financial statements we were less concerned about the other highlighted characteristics. One-time transactions are very common in the hotel industry–most companies buy and sell properties each year to attain their preferred market position. Mexico and Latin America have had occasional bouts of serious inflation in the last 20 years; it is not unreasonable to try to account for this as explained by the notes.
We were however quite pleased with the Fixed Assets valuations and management. Since hotels are asset heavy entities we were pleased with the practice of valuing assets at historical cost. The depreciation method used for property is straight-line, which we felt was prudent.
NH Hoteles expenses maintenance and repairs in the year they were incurred, a straightforward example of the matching principle.
Although we were initially confused by the format of the report, after some in-depth analysis we were quite pleased with its depth. We found it interesting how significant the presentation of the report was in our initial view of the company. This illustrates the differences that still exist between accounting standards and requirements in the European Community.
Table 1: Financial Ratios
Though the general trends of the past two years of NH Hoteles are not particularly distinguished, they are mitigated by the state of the leisure industry during that period. Turnover grew by almost 20% year over year, although most financial ratios are down from 2001 to 2002. ROCE is down by almost 10% despite the execution of several sell and lease back deals in Spain. Net Profit dropped 10% from 10% to 9%. Liquidity ratios are also a bit troubling–both current and quick ratios show a fairly severe decline over the last 2 years, which is a problem in a heavily geared business. The company has made steps to reduce its debt with the gearing ratio holding steady, and the asset utilization ratio has increased in line with the selling of assets.
A similar fall in industry specific ratios was also inevitable considering the economic situation. A specific hotel industry performance metric is the RevPAR that stands for revenue per available room. It is calculated by multiplying a hotel’s average daily room rate by its occupancy rate. It may also be calculated by dividing a hotel’s total guestroom revenue by the room count and the number of days in the period being measured. Note that RevPAR does not take into account revenue from other services as restaurants, spas, and golf courses. Another important ratio is the occupancy rate of a hotel, calculated by dividing the number of rooms sold by the total of rooms available over a certain period. For NH Hoteles, The occupancy rate fell by several percentage points from 69% to 66%, a 5% drop and RevPAR dropped by about 10% from EUR 81 to EUR 74 from 2002 to 2001.
The financial ratios were in even worse shape over the last two years. Despite a rise in EPS, the P/E ratio is down about 33% over the 2001 figure. This precipitous drop on top of increased earnings illustrates investor’s lack of enthusiasm for the company and the sector.
As mentioned above, we selected three companies to compare with NH Hoteles, two American chains Marriott and Hilton, and a European chain Accor. We found that although companies were in the same general business, it was often difficult to do apples to apples comparisons–Hilton for example has a large gambling subsidiary that contributes materially to their bottom line.
We found that NH Hoteles had the least clear financial reports. Marriott in particular put a lot more emphasis on metrics–lots of rankings both for company and its hotels. Their report was much more of a financial report–much clearer and to the point and focused more on financial results than image. Hilton’s financials were on par with Marriott’s, although Hilton’s lack of strategic information made it harder to understand where that company was going. Accor, NH Hoteles, and Marriott all provided clear short and long-term strategic direction. Accor’s annual report was easy to read with a lot of graphs to explain the figures, as well as 5 years of historical data. We would have preferred that Accor use actual figures rather than the percentage change for RevPAR and the occupancy rate.
All three of our competitors showed similar mixed financial results over the last 2 years, and all three experienced a sharp drop in fundamental stock analysis during the period. NH Hoteles is by far the smallest of the 4 chains we analyzed, which is perhaps a flaw in our methods. All of the chains had similar ROCE b/t 8.5 and 11% over the past two years; Hilton showing a 20% increase in 2002 over 2001. All of the hotel chains have quick ratios under 1, which is typical in a quick turnover business such as hotel management.
The general hotel industry performance indicators are also similar–all of the chains experienced static or a dropping occupancy rates over 2001-2002, and all experienced a sharp drop in RevPar over the period.
The ratios that are markedly different between the competitors are usually more interesting, and these differences are quite favorable for NH Hoteles. NH Hoteles is far more profitable than any of the other chains, despite the 10% drop from 2001 to 2002. Only Hilton has an asset utilization ratio in the same range as NH, but Hilton’s gearing ratio is much higher. Only Hilton has experienced a rise in gearing during the period–a 10% percent rise–from 65 to 73%. Hilton’s precarious liquidity position with interest cover less than 2 illustrates the relative financial strength of NH–only Marriott has a lower gearing ratio, and only after spending a lot of cash to pay down debt in 2002.
The equity performance of the companies is also marked by many similarities and a few interesting differences. The three least geared companies have a dividend cover of between 3 and 6, except for Hilton, which pays an extremely low dividend. Hilton, in line with a company with a lot of debt pays a dividend of EUR .08 a share, while NH and Marriott pay between EUR 22 and 26 cents. Accor is opposite of Hilton here–a company with a good interest cover ratio can pay a generous dividend of EUR 1.05 per share. Investors have more faith in future performance for the two American chains; while their P/E ratios have dropped over the period, they are still more than twice the P/E ratio of NH Hoteles. Taken together, these equity ratios show that NH is not valued as highly as similar American company, a fact that may be explained by their dissimilar sizes and geographic focuses. It also may be an opportunity for equity appreciation if all four companies have similar prospects for the future
Due to spatial constraints we have elected to use share price as a proxy for 2003 quarterly and bi-yearly reports. Since our ultimate goal is compare NH Hoteles within its industry and the general market this approach is valid for the short term.
Our premise that hotel equities would rise in price in the next few years has come true, albeit faster than we anticipated. Buoyed by the general 20% rise in global equity markets, Credit-Suisse First Boston’s lodging sector has risen 34% YTD. The stock prices of our four selected companies have risen on the average of 14% YTD, with NH Hoteles the laggard of four with a 10% rise in stock price.
Our analysis shows that NH Hoteles is in a good financial position. It has made commitments to cut costs and reduce debt both by using the increased cash flow from operations as well as ceasing new acquisitions. This makes an already healthy balance sheet even stronger, a good hedge in an uncertain market.
The Hotel industry specific ratios, Occupancy rate and RevPAR are also in line with other industry players. While a higher rate would be preferable, these ratios show operational competency if not brilliance, and will certainly improve if the company’s strategic cost cutting goals are realized.
The performance of the share price and related ratios do not reflect the strength of the financials. While NH is performing at about the same levels as the other chains, it’s P/E ratio is about 50% that of Accor, the next lowest rate. We believe that this is due to the relatively small size of NH Hoteles and it’s focus on Europe as its core market. We also believe that these are important factors considering recent economic and industry trends, and will continue to hold down the NH share price compared to its larger and better-diversified competitors.
However, the combination of financial solidity and stock price underperformance makes NH Hoteles an excellent acquisition target. We would consider purchasing the stock on this basis alone; however additional analysis would be necessary to ascertain what premium, if any, would be paid for control of NH Hoteles.