V for victory or going to L

The hotel industry is divided on the type of recovery it is set to enjoy: a sharp V-shape or a struggling L-shape. 

The split was encapsulated at the International Hospitality Investment Forum in Berlin last week by two CEOs. Hilton’s Chris Nassetta believes we are heading for a golden age of travel while Accor’s Sebastien Bazin fears that international business travel may be permanently impaired. 

Nassetta said on stage that the pandemic and associated restrictions had impacted not just business life but personal life. “This has been a unique experience for all of us”.  

He added: “My reflection on the last year and a half is one of pride and optimism. Pride in the sense that we have 450,000 team members in 120 countries who had to go through the industry shut down, the world was shut down.  

“And they did everything they could to support our customers, to support our owners, to continue to do great works to support our communities and most importantly to support one another. 

“Optimism: on this very stage in 2019 I talked about the golden age of travel. I believe in it more now. I don’t think what we’ve experienced is going to create a scenario where people travel less, I think it created a scenario where people are going to travel more.” 

Nassetta caveated in that it would take time to get back but “when you wake you wake up three, four or five years from now, our demand levels will be greater than they are now.” 

Pieter Elbers, CEO of KLM, said that his airline was now flying to 95% of the destinations it was flying to pre-Covid. The number of flights is close to 75% of previous levels and customer volumes at half. 

“We see an enormous enthusiasm among people to get travelling again. If we look at this summer in Europe, people were willing to travel despite all the mess such as do we have a Covid pass or not,” said Elbers. 

Sebastien Bazin was similarly enthusiastic about the return of leisure travel. He said it was “even better than we expected”. He added that there has never been such demand: “It is incredibly strong”. 

Domestic leisure travel accounts for about 40% of Accor’s business. Another 40% is domestic / regional business travel and Bazin was less bullish here, believing that up to 5% of this 40% may be permanently lost. 

The hardest hit, however, is international travel. This 20% of Accor’s total business will see 20% to 25% lost, said Bazin. The efficiency of Webex / Teams / Zoom etc damages the prospects of any recovery. 

Where Bazin was more optimistic was with the opportunity to harness the work from anywhere crowd. He described these “hundreds of millions” of people as “an audience we have never catered for, stupidly enough”. 

Bazin said the opportunity here was bigger than the lost business from international business travel. “Here we have a billion plus, give or take, people,” he said. “We can cater to them, reconfigure the hotel lobby, make it for them, get the f&b, get the interaction between the traveller and the local community.” 

There was an echo of Bazin’s short to medium term caution from private equity investor Starwood Capital. Cody Bradshaw said, in a separate panel, that “now is not the time to play hero”. He added: “We still have a lot of uncertainty ahead in terms of the shape of the recovery; in terms of the future of vaccines and the virus; and in terms of global events, major corrections in the markets and any overheating of markets that could occur as a result of record low interest rates. 

“A year or two from now we could not just be talking about Covid as it relates to generating distress or opportunities.” 

Bradshaw said Starwood had exited USD8bn of hotels in the three to four years before Covid. “The demand-supply situation was deteriorating. There was 105 straight months of revpar growth in the US. It was an opportune time to exit even before Covid hit.” 

And for Starwood it was possible to be active without buying real estate. Earlier this year “we spent a lot of time in the public markets in the US and Europe”. Starwood has been most busy on the credit side. “If it’s overheated on the equity side then there’s usually an opportunity on the lending side. Traditional lenders have yet to get comfortable with the recovery and are taking more of a wait and see mode.” 

Bradshaw also explained how private equity has diversified its sources of capital in recent years. As well as traditional value-add funds there are now more core-plus vehicles that have a longer hold period and can accept lower returns. “These can even buy leased hotels. It used to be the German funds buying all the leased hotels but we’re going to be buying several leased hotels this year.” 

The different buckets of capital available to PE means that its historic “high octane” approach has changed. Even for value add Bradshaw stressed there would be “no over stretching” but rather finding the different angles. 

Benjamin Habbel from Limestone Capital, speaking on the same panel, said that his firm had seen discounts but that it played in a different area, being focused on small, boutique and usually family-owned hotels. 

For some family-owned hotels “there are problems and distress that go beyond traditional hotel operations”. Such issues might be inheritance with next generations wanting an exit. “A lot of these issues were magnified during Covid”. 

Dominic Seyrling of Archer Capital said that where there has been transactions done at 2019 levels he had been unable to compete. He said it was a matter of perspective. He cited Brookfield as an example of a buyer of leisure orientated assets that were at or exceeding 2019 levels. “We have gateway cities with international demand and business demand. We’ve been suffering throughout and just about turned a profit last month”. 

Starwood’s Bradshaw concurred with the challenges of some pricing. “We’re not leaning-in to those levels.” He pointed out: “If we get through a global pandemic – which is still underway by the way, international travel is still stopped – and we get through this as a hotel sector operating on 24-hour leases with our valuations intact at pre-pandemic levels then why would we ever worry about exiting again? We are bullet proof.” 

The only way the maths works if you are trying to hit the same returns as 2019, said Bradshaw, is on the exit of the deal. “It needs a tighter cap rate. You’re not stepping into a cash flowing asset in most instances, so you have several years of cash flow below historic levels. You’re not getting the same level of historic financing – you were getting 65%, you’re now getting 50%.  

“But if you’re paying the 2019 price the only way it pencils out to the original return target is if you make it up on the back end with some hockey stick recovery and a tighter cap rate.” 

Later in the session Bradshaw said that the current crisis was not one of leverage but of liquidity. The challenge facing some businesses was running out of cash. “We will see more distress from this liquidity issue,” he said. 

Bradshaw also had a further explanation on why distress is less apparent. “We don’t talk about IRRs anymore within our existing portfolio. It’s gone. It’s about maximising profit from our investment which generally means a prolonged hold period. 

“When I work on our current portfolio now, it is almost like a new portfolio we’ve just bought without the pressure of a near-term exit [to hit IRRs].” 

HA Perspective [by Andrew Sangster]: It was good to be back. Even if things are still quite a way from being normal. 

At IHIF the surprise was to see so few advisers. In more normal times, it is wall-to-wall lawyers and brokers but not last week. The strongest showing was by the brands and operators, keen to emphasise that business is back. 

The absence of advisers can be explained by a couple of things. Firstly, many are being understandably cautious. They are not paid to take risks, especially when it comes to the health of their employees, clients and future clients, and for the most part, particularly with the big names, caution was the most sensible response. 

The other issue is that many advisers are so busy that taking even a few days out was challenging. Factor in the risk of being forced to isolate, and a no-show is the smart decision. 

But the game is changing. This is not a world that has been changed forever by the response to Covid. Although many changes have been sped up, the essential outlook looks much like it did in 2019. 

For investors, the big calls are around inflation and interest rates. Guess the future for these macro indicators incorrectly, and however good your underlying investment case is, you will have problems. 

Despite a huge amount of fuss around government debt burdens, the picture is far from bleak. In the UK, total government debt has increased roughly 20 percentage points in relation to GDP, going from 80% pre-Covid to 100% now.  

There is more to come, but it still looks a lot better than what happened following the Global Financial Crisis when the debt-to-GDP ratio climbed from 35% to 80%. And the cost of servicing that government debt is at an all time low, accounting for just 3% of government expenditure. 

Optimists believe that this is not a financial crisis but rather a supply shock that does not seem to have created the demand shock that was feared at the outset. Unemployment appears to be heading down and consumer demand is proving robust as things reopen. 

Less clear is inflation and interest rates. If you buy the V-shape recovery, then inflation and higher interest rates look more likely. 

The pessimists’ case was put eloquently by Linda Yueh from Oxford University. She believes we have had both a demand and supply shock. And global recovery is not going to be until 2023. 

But I think Yueh and the other doomsters are failing to take account of just how strong a position both consumers and corporates are in. Average weekly earnings in the UK are up almost 9% (ONS figures three months to end June compared to a year earlier) and surveys of company attitudes, such as the IHS Markit PMI, have hit highs never seen before (it hit 65.6 in May, above the previous high of 61.0 in July 1994). 

Yueh made a smart point when she said that supply shocks – which the Covid lockdowns were – can make monetary policy “tetchy”. And it is monetary policy which, in my view, will be the thing to watch in the years ahead. 

Modest inflation is not going to be a bad thing for the hospitality sector given how it can adjust prices far quicker than many other sectors but interest rate rises might well be the undoing of some investments in the medium term. 

The operating challenge is to balance the price hikes that are going to be needed to compensate for rising costs, particularly labour but also food, energy and construction, and maintain demand. 

For investors, the test is going to be striking deals that are not overleveraged and can survive in a rising interest rate environment while meeting return targets.

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