U.S. Markets close in 3 hrs 58 mins

Extended Stay Is an Excellent Yield Play Bet After a Tepid 2018 for the Hotel Industry

- By Ishan Majumdar

Yield-hunting investors usually have a limited set of industries to focus on, such as shipping or real estate. This is why they often miss out on hidden gems in other industries that tick all the boxes for providing solid, long-term yield, such as Extended Stay (STAY).

The hotel industry player is a mid-cap stock with a unique value proposition, good stability in revenues and excellent free cash generation, which is transforming into yield through dividends as well as buybacks. The company has an experienced management led by CEO Jonathan Halkyard and is consistently delivering good quarterly results in an otherwise difficult year for the hotel industry.


Extended Stay's value proposition

As the name suggests, Extended Stay focuses primarily on customers having lodging requirements of longer durations. This niche segment essentially includes business travelers working on temporary projects, attending trainings, preparing for relocation, and so on. Per management, this niche accounts for about 22% of total U.S. hotel demand, but only 9% of the hotel rooms in the country belong to the company, implying a massive possibility for expansion. Management has targeted having 700 Extended Stay America properties by the end of 2021, of which 70% would be company-owned and 30% would be franchised.

Good financial performance in a tough year

The year 2018 was tough for the hotel industry and a number of larger players such as Hilton (HLT), InterContinental Hotels Goup (IHG) and Marriott International (MAR) lost more than 15% of their value. Extended Stay also failed to beat the index, but its results were promising. In the third quarter of 2018, management reported revenues of $351.08 million and were able to beat revenue estimates by $6.91 million. Extended Stay's earnings per share of 38 cents were about 1 cent higher than estimates. It is worth highlighting that the team has consistently beaten analyst estimates for three quarters prior to the third quarter of 2018.

The company's management is undertaking some solid strategic initiatives to reduce costs and increase the revenue per available room (RevPAR). This is evident from the RevPAR in the third quarter rising by 1.9% compared to the corresponding quarter of the previous year. There was also a rise in the occupancy rate to about 80.1%. The operating margin of the company has always been exceptionally good at 30.1%, translating into a net margin of 7.91%. The margin expansion is visible in the three-year earnings per share without NRI growth rate of the company, which is as high as 29.20%.

Extended Stay is all about the yield

Extended Stay has a fantastic dividend yield of 5.33% at its current levels, which is backed by a return on equity of 12.66%. The company's free cash flow generation is solid enough for it to maintain its payouts at the rate of 88 cents per share. It is important to highlight that the payouts have never been less than 70 cents per share in the past four years.

The buyback plan was the icing on top of this cake and the yield from buybacks alone was as high as 2.71% in 2018, resulting in an overall yield of 8.46%. Given that Extended Stay's management is consistently able to convert one-fourth of its revenues into free cash implies that this high yield is here to stay. In fact, the management's plans to have more properties under its three main brands, especially through franchising, might result in better cash flows and better yield.

Risks and key takeaways

The risks associated with Extended Stay are two-fold. It has a very limited international presence, and the North American market where it operates is highly competitive. However, despite the geographical concentration, management sees a sufficient chance for expansion in North America itself given the company's focus on a specific niche. The fundamentals of Extended Stay are very solid, especially its conversion of Ebitda to free cash flows, and the management's dividend and buyback policy has also been consistent. The stock is available at reasonable valuations and is a good bet for yield investors from a long term perspective.

Disclosure: No positions.

This article first appeared on GuruFocus.