• Starwood looks to rates to maintain investor interest

Starwood Hotels's fourth-quarter earnings last week were ahead of expectations, leading the group to raise its 2011 profits forecast. It predicted it could maintain 7% to 9% revpar increases for the full year thanks to the likelihood of rising room rates.

While the company warned that the global economy could be "volatile and unpredictable", the wider investment community continues to renew its interest in the hotel sector and Starwood's earnings upgrade drove further positive sentiment.

Fitch Ratings raised its ratings outlook on Starwood to positive, citing recovery in the lodging sector and Starwood's ongoing efforts to cut debt. Fitch now rates Starwood at BB+, which means the group is just one notch below investment grade.

CEO Frits van Paasschen said that, in 2011, the "real story will be about rising rates". He was bullish about the group's prospects, telling a conference call that the company remained "cautiously confident" about the near-term and even more so in the long term, as revpar increased by 10.1%, despite increasingly-challenging comparables.

Starwood backed this optimism by raising its earnings outlook to a range of $1.55 to $1.65 per share from a prior forecast of $1.44 to $1.55 per share.

In North America, occupancy accounted for almost all the revpar growth last year, with the group forecasting that rate would drive 50% or more of revpar growth in 2011. The Middle East and Africa was the only region that had not yet recovered fully, mostly due to the Gulf where the group has a large presence. However, occupancies were rising into January, although rates have lagged so far.

The CEO added that Starwood was seeing lengthening booking windows, corporate rate negotiations on track to increase in high-single digits and group bookings that were improving "dramatically".

Van Paasschen added "many refer to 2011 as the beginning of the two-speed recovery – according to the line of thinking, the developed world will see moderate economic growth". However, in the hotel sector, he said, North America and Europe "may be on the verge of a multiyear surge on rates", driven by a lack of supply, with "virtually no new hotels being built".

He said that with business travel up and leisure demand rising, revpar had a good chance of rising from well below its historic trend line, with the next three to four years potentially seeing "the strongest real growth in the rates in North America that we've seen in decades".

In the emerging markets, van Paasschen maintained that Starwood had "an extraordinary growth opportunity", adding, "rising wealth and growing demand for infrastructure, travel, and of course, hotels, has a long way to go up".

The group has continued to benefit from its business focus, reporting that Monday to Thursday volumes were driving occupancies in the 90% range "in most major metro markets".

Adding a note of caution for some investors, the group, which owns around 5% of its hotels, said that it was expecting to see an increase in capital expenditure, with several significant renovations to be undertaken in 2011, including the Grand in Florence, which is being converted into a St. Regis, the Alfonso XIII in Seville, the Westin Gaslamp, the Sheraton Kauai and other smaller projects.

Vasant Prabhu, the group's CFO, said: "Over an extended time frame, our maintenance capital spend at owned hotels has averaged 7% to 8% of gross operating revenue, ranging from 5% when the cycle turns down to highs of 10% when the cycle turns up. We expect to be at the high end of the range for the next couple of years."

However, Prabhu added: "Despite the increase in capital spending, we expect to be modestly positive on cash flow before any asset sales. All the time, as we continue to sell hotels, the capital needs of the business will decline."

In the fourth-quarter the group saw cash inflows in the form of $245m from a previously-flagged tax refund, $75m from the legal settlement with Hilton Worldwide and cash from the sale of a joint venture hotel, all of which meant that net debt was down to $2bn. Prabhu said that, with ratios are "well below" covenant levels "we are moving rapidly towards achieving an investment-grade rating, hopefully, before the end of 2011".

Efforts to cut debt through asset sales remained restrained. The group said that it was its practice not to assume any asset sales, but that it had "a few assets on the market", with Prabhu adding, "we will close deals where we get that right price, the right management-to-franchise contract and the right buyer".

Van Paaschen said that the company was "delighted" to see a recovery in a hotel transaction market, but described it as a "partial recovery", meaning that the buyers were from two sources, the first being "well-capitalised Reits looking for operating hotels, mostly in gateway cities that are well-financed and have no complication". The second group were  identified as high-net worth individuals.

He commented: "What you're not yet seeing is depth in terms of the buyer base, meaning private equity funds, other investors and more high net-worth pockets of wealth in different places. And you're also not seeing the depth in terms of the kind of assets that are being traded."

On those grounds, he concluded that Starwood remained "committed to the asset-light strategy, but we think this market is still some time away from being a fully robust buy-and-sell market for hotels".

 

HA Perspective: Starwood seems to be positioning itself for a medium-term hold on its owned portfolio. This makes sense if the priority is to capture the bulk of the recovery in profits in these lumps of real estate.

The risk, however, is that Starwood misses the opportunity to drive its fee business forward as fast it can. If it uses its balance sheet to refurbish its owned hotel portfolio rather than investing in growth opportunities in management and franchising it will leave the field open to more focused rivals.

Van Paasschen speaks convincingly about how great the fee business is. He now needs to back that talk with action rather than taking the cautious route. While Starwood might leave some money on the table by selling assets now, if it redeploys its capital wisely, it should be able to make a greater return.

By not selling, Starwood risks looking like a believer in the hotel industry's reputation as a destroyer of shareholder value.

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