This interview excerpt is part of an interview from our 50-page Online Travel issue featuring in-depth interviews from two analysts and top management from ten sector firms discussing consumer behavior, growth prospects, industry consolidation, earnings visibility, corporate volumes, recovery in pricing, brand strength, emerging luxury brands, stocks to avoid, stock recommendations and more. This issue is available to subscribers by telephoning 212-952-7400 x1799 or through The Wall Street Transcript
TWST: You cover both online travel and hotels. Shall we first cover the online travel and then move on to hotels?
Mr. Fuller: We have spent a lot of time working to understand the correlation between the online travel and lodging sectors and would argue that each is being impacted differently by the same underlying trends. In other words, what happens to one group should directly impact the other.
TWST: Why don't we start with that? Tell us about your coverage and how you have combined the two sectors.
Mr. Fuller: First, I cover the online travel retailers
TWST: And how do you account for this growth online as opposed to the more traditional channels? What are the advantages of online? And what is the outlook going forward?
Mr. Fuller: The Internet is simply a better way for the consumer to buy travel, that is why that channel continues to outpace more traditional channels. Internet hotel room volume increased 50% in 2002 versus an increase in total industry volume of less than 1%. Why? The answer is convenience. The customer now has a means to quickly and efficiently comparison shop, pricing one hotel against another. Sounds simple, but that was a time consuming process before the Internet. Moreover, the Internet has led to the broad availability of wholesale room rates and airline ticket deals. Such deals used to be buried and extremely hard for the ordinary traveler to find.
The convenience factor, easy access to pricing information and the availability of bargains should yield sustained growth over a several year period. I would point out that less than 8% of hotel rooms and 15% of airline tickets are currently sold over the Internet. I would expect penetration in each category to top 20% within a few years, which would imply compounded sales growth for the online travel retailers of 15%-20% over the next five years.
TWST: Who uses online travel services? Is it the leisure traveler for the most part or are businesses starting to use it more?
Mr. Fuller: For the most part, the travel sites cater to the leisure traveler, but there is a surprisingly large business travel component and several new online efforts are being targeted at the corporate travel market. Of the $30 billion or so of travel sold online in 2002, about $5-$6 billion was managed corporate travel. Another $5 billion was unmanaged business travel. In fact, Expedia or Hotels.com have indicated that as much as 30% of their volume is unmanaged business.
Several companies, including Expedia and Sabre, are also specifically targeting the managed corporate travel space. Sabre owns GetThere.com, the leading online travel tool, and Expedia is launching a product that combines a traditional corporate travel agency with its own online tool. Business travel should prove to be a major source of growth for the online travel companies over the next several years
From another angle, online distribution into the corporate travel market will be a negative for the travel suppliers, including the large hotel chains. The corporate traveler is the highest paying hotel guest, but Expedia aims to bring that guest access to its discounts. In other words, the hotel chains will face pricing pressure on a second front. Not only will the leisure traveler see discounted room rates on hotels.com, Expedia and priceline.com, the business traveler will soon gain access to the same deals.
TWST: What are your recommendations of these online travel companies at this time?
Mr. Fuller: Among the online travel companies, I have a buy rating on Hotels.com, an attractive rating on Expedia and a market performance rating on priceline. What it really comes down to is valuation and growth. Hotels.com trades at the lowest multiple and has among the best growth prospects in the travel industry. Expedia has very, very attractive growth prospects as well, but trades at a higher multiple. Although priceline.com trades at a sharp multiple discount, its growth has stalled out and it is no longer profitable. At the same time, I have market performance ratings on all of the hotel companies. In the case of Cendant and Sabre, you have a very different dynamic playing out. I have a buy rating on Cendant, which is based on our view that the market has underestimated its ability to generate free cash flow. Sabre, meanwhile, is in a difficult spot, given the potential for long-term erosion in its pricing power as a travel middleman. We might be cautious on the stock here in the short term.
TWST: If we can we move onto the lodging sector in your coverage, can you tell us how the stocks in this group have performed over the last year and whether RevPAR is improving?
Mr. Fuller: The recovery has very clearly decelerated so far in 2003. Whether with airlines, casinos, cruise lines or hotel chains, the message has been the same - the threat of war and terrorism have chilled travel demand. We recently cut our 1Q03 RevPAR estimates from flat to down 1%. RevPAR appears to have stalled out at less than 90% of the pre-September 11th peak, even as operating expenses have hit greater than 100%. So the top line has softened, even as expenses trend higher.
Against that backdrop, stock performance has been weak. The group is off 35% over the last 12 months versus a decline for the S&P 500 of 31%. The group is down 6% over the last month (market down 2%) with the obvious erosion in demand.
TWST: Are there signs of business travel picking up perhaps after the war with Iraq?
Mr. Fuller: Although military conflict is likely to lead to further erosion in travel demand, it may prove to be a catalyst to buy lodging stocks. We estimate that war could shave 5% off room demand, with a recovery period of nine to 12 months (similar to the Gulf War experience). However, a look back at historical conflicts (Gulf War, Panama, Somalia or Libya) reveals that lodging stocks outperform the broader market significantly from the point of initial engagement. Although demand is depressed by war or conflict, investors shift their horizon out to a recovery.
TWST: Can you just give us a brief reason for those four companies in your coverage?
Mr. Fuller: Extended Stay, Hilton and Starwood are all asset owners, so have significant operating leverage. That leverage is negative in an environment of deteriorating RevPAR. Marriott is a manager/franchisor, so has less operating leverage. The issue is more complex for Marriott. The company has faced a range of questions regarding its accounting and pressure from its largest hotel owners to reduce fees. In a time of uncertainty, investors tend to avoid those types of issues, as do we.
This interview excerpt is part of an interview from our 50-page Online Travel issue featuring in-depth interviews from two analysts and top management from ten sector firms discussing consumer behavior, growth prospects, industry consolidation, earnings visibility, corporate volumes, recovery in pricing, brand strength, emerging luxury brands, stocks to avoid, stock recommendations and more. This issue is available to subscribers by telephoning 212-952-7400 x1799 or through The Wall Street Transcript.
The Wall Street Transcript does not endorse the views of any interviewees nor does it make stock recommendations.
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