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Why Choice Hotels Is a Buy

Lodging franchisor Choice Hotels' (NYSE:CHH) growth strategy could boost its financial performance. The company is investing in renovation, construction and improving its customer offerings in order to capitalize on the growing business traveller category.

Although it faces an uncertain economic outlook, the stock could continue to beat the S&P 500 after its 14% outperformance in the last year.

Construction and renovation

The company is undertaking a major renovation program across its Comfort Inn estate. So far, it has completed the renovation of two-thirds of hotels in its renovation pipeline. The company has recorded improved financial performance following changes such as adding new exterior signage and interior improvements.

For example, the company's revenue per available room (RevPAR) at its hotels that have been renovated increased 60 basis points versus its non-renovated hotels in the most recent quarter. In addition, the business reported that its renovated hotels increased their business travel revenue five times faster than their non-renovated peers.

Alongside a focus on renovation, Choice Hotels expects to open over three mid-scale hotels per week in 2019. This follows its increase in new construction hotel openings of 22% in the most recent quarter, which is its strongest period for new construction openings since 2010. They are expected to improve its long-term RevPAR through strengthening the company's competitive advantage.

Business travel potential

Choice Hotels is seeking to increase its exposure to the corporate travel market. According to the Global Business Travel Association, the corporate travel market is expected to reach $1.7 trillion within the next three years.

Choice Hotels is investing in the customer offerings provided by its Cambria hotels, which are focused on business travelers. For example, it is aiming to tailor its offerings to business travelers through greater differentiation and an increasingly indulgent experience. As a result of its investment, Cambria was only one of two brands that earned the highest rating tier for customer satisfaction among upscale brands in the J.D. Power Hotel Guest Satisfaction Index in 2019.

The company is also ramping up its investment in marketing activities in order to communicate its enhanced business offering. It launched a nationwide multimedia advertising campaign in June 2019 that leverages consumer insights and seeks to broaden its appeal to a wider range of customers.

Potential threats

The company's recent financial performance has been disappointing. For example, it reported a decline in domestic RevPAR of 0.1% in the most quarter, as well as a 6.8% fall in net income. Its fall in profitability was largely due to higher costs, with its marketing and reservation system fees increasing 17% compared to the same quarter of the previous year. With U.S. consumer sentiment falling to a seven-month low in August, the company may face challenging operating conditions that act as a drag on its near-term revenue and profitability.

In response, the company is seeking to widen its economic moat through investment in its loyalty program. In the first half of fiscal 2019, it added over 2 million loyalty program members to take the total number to 42 million. Since 40% of the business delivered to its franchisees is from its loyalty program, Choice Hotels may have a more resilient financial outlook than the wider travel and leisure industry during an uncertain period for the segment.

The business is also investing in its international operations. For example, it added 49 hotels to its international pipeline in the most recent quarter. It now has a pipeline of 123 hotels in international markets that are expected to further diversify the business and reduce its reliance on the domestic market.

Outlook

Choice Hotels is forecast to deliver a rise in earnings per share of 10% in its current fiscal year. Since it trades on a price-earnings ratio of 23, it seems to offer fair value for money given its long-term growth strategy.

The stock could therefore continue to outperform the S&P 500 following its 14% rise over the last year.

Disclosure: the author has no position in any stocks mentioned.

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This article first appeared on GuruFocus.