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Morningstar | Hilton's Brand Advantage Remains Robust, Despite Cyclical Slowdown Fears; Shares Undervalued

Narrow-moat Hilton reported third-quarter results that are tracking toward our 2018 forecasts for 3.5% growth in revenue per available room and 6.4% unit growth, and we don't plan a material change to our $82 fair value estimate despite growing concern that industry fundamentals could be decelerating, supporting our long-held view that we are in the later innings of this hotel cycle. We continue to expect slowing revPAR growth in 2019 followed by negative revPAR growth in 2020. Still, although it might require patience, the 25% correction in Hilton's share price from the start of 2018 (and a forward EBITDA multiple that has dropped from above 15 times in early 2018 to nearly 12 times) presents an opportunity for long-term investors to own a company with brand advantages that continue to strengthen.

Hilton's leading position is evident in its 11% pipeline growth to 371,000 rooms, which represents an industry-leading 42% of its existing room base. Third parties remain interested in the Hilton portfolio due to its revPAR index (metric of share), which grew 100 basis points in the quarter, and a loyalty presence that books 60% of all rooms and measures 82 million (third largest in the industry), up 16%. These dynamics continue to support unit growth well above the long-term U.S. industry average of 2%, shown in the 6.7% lift posted this quarter and guidance for around a 6.5% increase in both 2018 and 2019, near our 6.3% forecast.

That said, there are signs of an industry slowdown, as Hilton's third-quarter revPAR grew 2% versus 2.5%-3% guidance, led by a 1% increase in the United States (harmonizing with the 0.5% drop InterContinental reported). As a result, Hilton lowered its 2018 revPAR growth target to 3%-3.5% from 3%-4% (versus our 3.5% forecast) and initiated a 2019 outlook for 2%-4% growth, which we view as potentially aggressive, despite signs that industry supply growth is now decelerating. Therefore, we see little change to our 1.5% forecast for 2019.

While a deceleration in U.S. industry supply growth can help support revPAR (assuming no change in demand), it also could be a signal that pipeline growth could slow, thereby slowing out-year unit growth. This concern could find support in Hilton's comments that it’s a bit harder to get deals done in the U.S. (higher labor, construction, and financing costs). Still, given our unchanged stance that Hilton's brand advantage is strengthening, we don't expect any material change to our estimate of 4%-5% average annual unit growth over the next decade, as compared with the 6% lift the past four years.

Despite signs of an industry slowdown, Hilton remains constructive on the industry's outlook into 2019, based on its conversations with corporate travelers and their willingness to travel and pay more than this time last year and also supported by third-quarter European and Chinese revPAR growth of 7% and 11%, respectively. Further, Hilton said it is not seeing any signs of slowdown in the Chinese market. Regardless, we maintain our view that we are in the later innings of this hotel cycle and continue to model decelerating revPAR growth in 2019 and 2020.