IHG - InterContinental Hotels: Industry Setup Favorable; Credit Card Strategy Gaining Traction

2023-09-14 09:55:56 ET

Summary

• InterContinental Hotels' 1H23 results show positive growth, with RevPAR increasing by 9.9% and prices rising by 12.2% compared to pre-COVID levels.
• I expect IHG to continue growing at mid-teens in the next few years due to supply shortage and travel recovery.
• The credit card strategy is gaining traction and I see this contributing to a strong flywheel effect.

Summary

Readers may find my previous coverage via this link . My previous rating was a hold as I believed InterContinental Hotels Group ( IHG ) valuation (EV/NTM EBITDA) was hard to justify given no visible strong catalysts that would have driven valuation higher back then. I am revising my rating from hold to buy as I am now more positive about the industry setup for IHG. Furthermore, its credit card strategy seems to be gaining traction, which should continue driving the flywheel effect of the business.

Financials / Valuation

Compared to pre-covid levels (FY19), IHG's 1H23 results were positive, with RevPAR increasing by 9.9%; the rate increased sequentially from 6.8% in 1Q23 to 10.9% as the company exited June. Greater China and EMEAA contributed significantly to the sequential RevPAR growth, and positive sequential trends were also observed in the Americas. IHG was able to raise prices by 12.2% compared to the same period in 2019, which is a marked improvement from the 9.5% increase seen in 1Q23. This was driven by a 16% increase in US leisure rates, a 6% increase in US business rates, and a 7% increase in US group rates. 2Q23 also saw an increase in adjusted net system growth of 4.8%, while gross system growth increased by 6.3%, and 2Q gross openings of 12.6k rooms were higher than the 2Q22 rate of 8.3k.

Based on my view of the business, IHG should be able to continue growing at mid-teens for the next few years as it takes advantage of the supply shortage and recovery in travel (both volume and pricing). As a sense check, I used historical figures to estimate what the normalized revenue figure would be for FY25 if COVID did not happen. Using the revenue figures from FY17 to FY19 as a benchmark, I extrapolated the growth rate from FY19 using 5% growth (which is IHG's historical growth rate, in the mid-single digits), and I got to a "normalized" figure of FY25 revenue of $2.8 billion, which is what I am modeling for IHG in FY25 ($2.82 billion).

As EBITDA is already trading at its historical average of 13x EBITDA, which is in line with peers like Marriott, Hilton, and Accor, I don’t see any reason for it to re-rate any higher or lower. Overall, I have a target price of GBP7,800 (pence), which is a 25% upside.

Comments

Starting from a high level, I believe the industry setup is going to be favorable for IHG in the next couple of years as the US hotel industry has entered a phase of low supply growth. According to CBRE , the low supply of hotels is likely to be driven by the increase in construction costs, the high interest rate, and the availability of financing. This bodes well for IHG because it is a big player in the industry that has a strong balance sheet and brand recognition to capture a larger number of upcoming openings compared to subscale players. Management comments from the 2Q23 earnings call also indicate that they are "expanding" their coverage to enable more share capture of pipelines, in my opinion. For instance, they talked about launching a new best-in-class, midscale conversion brand that has the opportunity to scale much bigger over time. This is significant as it effectively expands IHG's addressable hotels by a ton and further diversifies IHG's revenue exposure. While these are just expressions of interest at this point, I expect the conversion timeline for the hotels to be significantly shorter than that of new builds once deals begin to be approved.

Look, we're very excited about the soon-to-be-announced launch of our new midscale conversion brand. It's a very big market, over 700,000 rooms, over 9,500 hotels and we've just heard from guests that they want a more trusted brand, an IHG brand in the space, and we've heard from owners that they would like to be part of the IHG system, while maintaining a lot of the elements of their current product, which may be in very good condition, very new, but needs to have the trust and strength of an IHG system. Source: 2Q23 earnings

Aside from the hotels part of the business, I thought it was interesting that management pointed out that U.S. cardholders represent an increasing proportion of reward night stays and there is a strong double-digit growth in overall co-brand credit card spend both year-on-year and versus 2019. I believe a flywheel effect is ongoing between the credit card business and hotels, which is going to continuously benefit the business. Recall that in the 1H22 earnings call, management explicitly mentioned that, unlike peers, their focus for the credit card business was to reinvest in the business so that they could offer more compelling offers. This seems to be working out, and I expect it to turn even better. With a better credit card offering, it brings in more cardholders, which should translate to IHG customers (that’s the entire idea of holding an IHG card anyway), which brings in more revenue for the card and hotel business. The more customers the hotel has, the more scale it has to build or convert more hotels, which means IHG will be able to offer even more compelling programs.

Unlike our peers, a significant portion of our income goes into the system fund to support marketing efforts in driving that and some does come to the P&L as well though. Source: 2Q23 earnings

Unlike my previous view that there were no visible catalysts to push the valuation up, I now believe that the outlook (supply situation and credit card flywheel effect) is a lot better than I initially thought. I believe IHG is on the right track to catching up to its historical growth rate and margin expansion.

Risk & conclusion

IHG faces the same risk as all other players in the industry: a steep recession or any COVID-like pandemic that will basically wipe out all the positive sentiment that the stock has been gaining. Especially for the latter risk, it would be another catastrophic moment as we would see a replay of FY20, where the stock dropped by more than 50%.

Concluding my post, I'm upgrading my rating for IHG stock from hold to buy. The industry setup appears favorable, with a low supply of hotels in the US market, benefiting IHG due to its strong position and brand recognition. Management's expansion plans, including the launch of a new midscale conversion brand, indicate a drive for more market share and revenue diversification. The credit card strategy is gaining traction, with increasing co-brand credit card spend and a growing proportion of reward night stays by US cardholders. This synergy between the credit card business and hotels is expected to continue benefiting IHG.

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