EUR 850.00 For Business Accounts Only

Morningstar | Choice Hotels' Competitive Advantage Intact, Aided by Brands, Loyalty, Technology, Direct Booking

We continue to see Choice Hotels' brand advantage--the source of its narrow moat--as intact after the company reported a solid second quarter that tracked toward our forecast. We don't expect a material change to our $84 fair value estimate, which incorporates sales growth averaging 7.5% over the next five years with operating margins of 29.9% in 2022 versus 26.3% in 2017. We see the shares as slightly undervalued.

Choice's brand advantage was evidenced by a 15-basis-point lift in franchisee royalty rates as the company sees improved contract terms and only a 1% voluntary termination rate of its hotel partners. As a result, the company now sees 2018 royalty rates lifting 11-14 basis points, up 1-2 basis points from prior guidance excluding the WoodSpring acquisition, which closed in February. Franchisees are finding value in Choice's loyalty program (which grew around 8% to above 37 million members), direct booking capabilities (which represented 62% of transactions, up 100 basis points), and improved reservation tools and modern hotel updates, leading to 18% organic domestic hotel pipeline growth in the quarter. We don't expect a material change to our 2018 organic unit growth estimate of 3.2% versus Choice's maintained 2.5%-3.5% guidance, or to our expectation for an acceleration to above 4% growth on average the next few years as the company nears completion of its Comfort (30% of total domestic rooms) renovations, leading to a slowdown in forced terminations, and leverages its development growth.

Choice's second-quarter revenue per available room grew 2.6% excluding WoodSpring, below the 4% organic increase seen by narrow-moat Wyndham Hotels, as Choice's Comfort brand renovation initiative drove a 70-basis-point near-term headwind that should be alleviated in 2019. Choice guided 2018 revPAR growth to 1.5%-3%, near Wyndham's 2%-3% guidance and our 3% forecast, which we plan to lower to the midpoint of guidance.

Choice has several brands gaining industry revPAR share. Its recently acquired WoodSpring brand (6.6% of total domestic rooms) increased revPAR 9.4%, while its other extended-stay concept, MainStay (1%), saw a 14% lift in revPAR, both ahead of industry levels according to Smith Travel data. In the upper-scale segment, Choice's Ascend and Cambria brands (4.2% of total domestic rooms combined) increased revPAR 8.3% and 5.7%, above industry rates according to Smith Travel data. Ascend's and Cambria's lifestyle concept is resonating with not only travelers but also franchisees, evidenced by the respective 22% and 27% room growth reported by these brands during the quarter, supporting the company's brand advantage.