CHH - Choice Hotels: 2024 EBITDA Growth Could Exceed Expectations

2023-10-17 12:34:13 ET

Summary

• CHH sees its EBITDA expanding by +10% in fiscal 2024 as per the company's most recent financial guidance.
• In contrast, the consensus FY 2024 EBITDA growth forecast for Choice Hotels is +7.5%, and this leaves room for potential positive surprises.
• I maintain my Buy rating for CHH, as I have identified the above-expectations 2024 EBITDA growth as the key re-rating catalyst for the stock.

Elevator Pitch

I still have a Buy rating awarded to Choice Hotels International, Inc. (CHH) stock. My prior August 9, 2023 write-up drew attention to Choice Hotels' above-expectations financial performance for the second quarter of this year.

Choice Hotels' shares continue to be rated as a Buy. I think that the company's actual EBITDA expansion for FY 2024 might beat the market's expectations, which could act as a positive catalyst for the stock. Higher royalty rates, expansion in the higher revenue per room market segments, and contributions from past, and future acquisitions are the key growth drivers for CHH.

Fiscal 2024 EBITDA Growth Guidance

CHH has guided for a +10% increase in the company's normalized EBITDA for the next fiscal year or FY 2024, as highlighted in its Q2 2023 results presentation slides . As a comparison, Choice Hotels' historical FY 2007-2022 EBITDA CAGR was much lower at +6.1% according to financial data taken from S&P Capital IQ . It is also worth noting that the current consensus FY 2024 EBITDA growth forecast for CHH is +7.5% (source: S&P Capital IQ ), which is below the company's guidance.

In a nutshell, Choice Hotels' shares are very likely to perform well, assuming that the company meets its FY 2024 EBITDA growth guidance. This is because the market doesn't have high expectations of CHH's operating earnings performance (+7.5% EBITDA growth estimate) next year, and a +10% EBITDA growth rate is way better than Choice Hotels' EBITDA CAGR (+6.1%) for the past 15 years.

I am of the opinion that CHH can expand its EBITDA by +10% or more in FY 2024, taking into account the multiple growth drivers.

Firstly, CHH has the potential to increase its royalty rate in the future. As an example, the royalty rate for Choice Hotels' "economy transient franchise business" increased by +7 basis points YoY for Q2 2023 as a result of "strengthening the value proposition we deliver to our franchise owners" as per CHH's second-quarter earnings call commentary . This was better than Choice Hotels' overall YoY royalty rate growth of +6 basis points in Q2. As such, I think that there is room for CHH to raise the company's overall royalty rate going forward by optimizing the other business segments' offerings for franchisees.

Secondly, the company has placed a strong emphasis on expanding its portfolio in specific segments that boast higher revenue or royalty rates on a per-room basis. Choice Hotels revealed at the company's second-quarter results briefing that the "domestic system size of the more revenue intense upscale, extended stay and mid-scale segments (for CHH) grew by 10%" YoY in the most recent quarter.

CHH's Efforts To Expand Its Presence In The Higher Revenue Per Room Market Segments

Thirdly, Choice Hotels' 2024 EBITDA will be boosted by operating income contribution from a recent acquisition done this year. The M&A deal involving the purchase of Radisson Hotels Americas was concluded in late July this year. At the Q2 earnings call, CHH guided that Radisson Hotels Americas' EBITDA is projected to increase from roughly $60 million for FY 2023 to around $80 million in FY 2024, and this alone translates into a +4% growth (versus overall +10% EBITDA expansion goal) in the company's EBITDA next year all else equal.

Based on the key growth drivers I have outlined above, I am confident that CHH can achieve its +10% EBITDA growth target for the following year, which should be a re-rating catalyst for the stock.

Further Upside From Potential Mergers & Acquisitions

Choice Hotels' actual fiscal 2024 EBITDA growth might be even better than the current +10% guidance, as this doesn't include any potential operating profit contributions from new M&A deals (excluding Radisson Hotels Americas).

CHH stressed at the Q2 2023 earnings briefing that it is "always looking for M&A" with an aim of "improving the ROI for the owners and growing the brands for the shareholders." Choice Hotels also highlighted at the most recent quarterly results call that "there's still some white space in our portfolio", such as inorganic growth and "opportunities on the international front."

Notably, there are signs which could indicate that CHH is gearing up for future acquisitions.

One key indicator is that Choice Hotels has pulled back on share buybacks in the most recent quarter.

In Q1 2023, CHH spent $173 million on share repurchases. Between January and July this year, Choice Hotels allocated $262 million to buybacks. This means that the company only executed $89 million worth of share repurchases between April 2023 and July 2023, which is much lower than the amount of share buybacks CHH did in the first quarter. It will be reasonable to assume that Choice Hotels is conserving capital for future acquisitions.

Another key indicator is that CHH hasn't been very aggressive when it comes to deleveraging.

Choice Hotels' gross debt-to-EBITDA ratio only declined slightly from 2.9 times as of end-Q1 2023 to 2.7 times at the end of June this year. CHH is willing to have its gross debt-to-EBITDA metric increase to as much as four times based on its targets, which indicates that the company has sufficient debt headroom to finance M&A transactions.

Seeking Alpha News reported today on October 17 that CHH disclosed "a new takeover offer for Wyndham Hotels & Resorts (WH) at an equivalent price of $90.00 per share." As per S&P Capital IQ data, the trailing twelve months EBITDA for Choice Hotels and Wyndham Hotels were $519 million and $569 million, respectively. In other words, Choice Hotels could potentially double its EBITDA with a major M&A deal like this one. It is too early to judge whether this acquisition offer will be accepted by WH, but CHH can still pursue other acquisitions even if this isn't successful.

Closing Thoughts

CHH expects the company's EBITDA to increase by +10% next year. However, the analysts are predicting that Choice Hotels' actual FY 2024 EBITDA growth will be a weaker +7.5%. My view is that Choice Hotels will surprise the market in a positive manner by meeting the company's EBITDA expansion goal for the next fiscal year.

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