In January, I attended Alpha Summit 2019 by The Fifth Person. During the summit, I was introduced to some ratios and criteria to identify potential multi-baggers. One of them was to have a asset light business model.
This reminded me of my company’s business model, which is touted to be asset light by management.
Inspired by this, I decided to put the largest listed companies in my industry – the hotel management industry – to the test to see how they fare using these ratios.
And maybe identify my next multi-bagger 😛
Traditional Hotel Industry Business Model
The traditional hotel industry generally has 3 business and operating models as follows:
- Owned and Leased
Owned and Leased Hotels
Owned and leased means that the hotel company coughs up the capital to buy / build the hotel before operating the hotel.
The company makes its money predominantly from travelers staying at the hotel, while also potentially selling the property sometime down the line for a profit.
This is the business model that historically all hotel companies went with.
The largest hotel brands in the world have since moved away from this model as it is a highly capital intensive business model.
The main issue is that while you retain 100% control over hotel operations, you take a long time before you break even, let alone generate enough cash to expand and build another hotel.
An example of a hotel brand that still use this model is Shangri-La Hotels.
Managed hotels are hotels managed by a professional hotel management company. The land and lease is owned by a independent owner instead. The hotel management company predominantly receives income in the form of management fees and licensing fees charged to the owner.
Although you lose some control over hotel operations, you can still ensure that hotel operations is largely in line with your standards. This model also allows you to expand more quickly as you rely on independent owners’ capital to build more hotels.
Examples of hotel brands that operate under this model are Marriott, Hilton and InterContinental Hotels Group.
Franchised hotels are essentially Donald Trump’s favourite business model. You slap your brand on the hotel and hand over the operations standards to the owner. You are not involved in daily hotel operations.
The hotel management company receives only licensing fees charged to the owner.
Similarly, Marriott, Hilton and InterContinental Hotels Group also use this model.
In summary here are the differences between the business models:
In light of this comparison, hotel companies utilising the Managed and Franchised models should theoretically be asset light by nature.
The Hotel Companies
The largest hotel companies by system size (industry jargon for number of hotels) are the following:
- Marriott International
- InterContinental Hotels Group (IHG)
- Accor Hotels
As I have no desire in investing in a French company, I will focus my analysis on 3 companies – Marriott, Hilton and IHG.
There were 3 ratios introduced during the Alpha Summit, Free Cash Flow to Equity, Return on Incremental Invested Capital and Gross Profit to Tangible Assets.
The following ratios were calculated using figures lifted straight from the respective companies’ financials. There were no adjustments made to account for differences in accounting between the US and the UK.
Free Cash Flow to Equity
This is a measure to determine whether a business is asset light or not. Formula for this being:
FCF to Equity = FCF / Equity = (Operating CF – Capex) / Equity
As you can see, this ratio turns out to be ridiculous high or negative for most the years, especially for Marriott and IHG. This is due to the share buybacks and dividends paid out over the years that cause equity to become negative.
As such, it is largely true that hotel management companies are asset light in nature.
Return on Incremental Invested Capital (ROIIC)
This is a measure to determine how effective a business is at investing its capital. Formula for this being:
ROIIC = Change in Profit before Tax / Change in Tangible Assets
As you can see, the ratios are all over the place. I think this ratio is not very useful for hotel management companies as there are not much reinvestment needed for the business, other than investing in support systems and intangibles.
As such, I’ll probably disregard this ratio in this analysis.
Gross Profit to Tangible Assets (GPTA)
This is a supposed to be a clean measure of profitability free from manipulation by overheads. Formula for this being:
GPTA = Gross Profit / Tangible Assets
During the summit, Victor mentioned that GPTA for average companies were in the 20% range, with above average companies above 30%. Hilton and IHG ratios were impressive as they were more than 30%, especially after Hilton’s divestiture of Park Hotels in 2016
Marriott’s ratios were rather weird, as they were extraordinarily high, only after the mega acquisition of Starwood Hotels in 2016 did you see some compression in GPTA.
My guess on this is that due to the company’s financials not computing a gross profit, I had to exercise judgment in selecting expenses to include in gross profit computation. I picked expenses that were directly related to revenue to compute the gross profit and maybe the different companies may have different classifications for expenses.
With the fact that most expenses incurred by a hotel management company is in overheads and marketing, maybe Profit before Tax to Total Assets is a more accurate ratio to use.
Looking at these ratios, things seem more normal. IHG comes out first for PBT to TA.
This simple thought exercise taught me that not all ratios are best for all companies. Based on the 2 ratios checked above, it seems like IHG and Marriott is worth doing more work on.
This is article is for general informational purposes only and does not constitute a call to buy or sell shares in the companies covered. Please do your own due diligence to decide if a particular stock is suitable for your portfolio.
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