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Morningstar | Brand Advantage Intact as Choice Hotels Works Through Near-Term Headwinds

We don't expect to materially change our $84 fair value estimate for narrow-moat Choice Hotels, after the company's 2018 sales and EBITDA of $1.04 billion and $341 million, respectively, fell near our modeled estimates of $1.1 billion and $339 million. Choice's 2019 outlook for $354 million-$363 million in EBITDA and 0.5%-2% domestic growth in revenue per available room harmonizes with our respective forecast for $362 million and 1.5%. We see Choice shares, trading around 13.5 times 2019 enterprise value/EBITDA, as fairly valued. We find narrow-moat Wyndham shares as more attractive, trading at just 11 times this year's EV/EBITDA while offering similar high-single-digit annual organic EBITDA growth over the next five years.

Choice's U.S. fourth-quarter revPAR was a bit weaker, rising 0.7% versus the 2% increase reported by Wyndham's U.S. hotels. Results were held back by tougher weather comparisons, the government shutdown, and disruption from the Comfort brand transformation (28% of total U.S. rooms), leading to 2018 U.S. revPAR growth of 1.2% versus our 2% estimate. But headwinds from Comfort renovations should subside and reverse later this year as half of the brand's hotels complete the modernization by mid-2019. We find it encouraging that those Comfort hotels that have already transitioned are seeing around a 50-basis-point lift in revPAR a few quarters after completing renovations. It is also reassuring that Choice's revPAR grew 3% excluding Comfort brands in 2018, supporting the company's brand advantage.

We see Choice's brand advantage as intact, as its loyalty program grew by 5 million members to 40 million (versus Wyndham's roughly 70 million) and royalty rates rose 14 basis points to 4.75% in 2018. Also, brands Cambria and Ascend (5% of total rooms) saw solid 14% unit growth in 2018, while the Clarion Pointe concept has around 100 units in the pipeline after its launch in September.

Although we calculate total organic unit growth at 2.6% in 2018, below our 3.2% estimate, we highlight that Comfort brand transformations are weighing on near-term growth, as room growth was up 3.6% excluding Comfort in 2018, according to Choice. We believe this supports our view that the company holds a brand advantage. We may slightly reduce our 2019 global unit growth forecast of 4% as Choice looks to take its termination rate toward 4.5% of its total portfolio in 2019 versus the 4% level experienced during the past few years. We don't think this signals a weakening in its brand advantage but rather a one-time step-up to improve the quality of the overall portfolio, a view we believe is supported by Choice's guidance of the royalty rate improving 8-12 basis points this year.