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Morningstar | Marriott's Industry-Leading Brand Advantage Intact Despite Near-Term Sheraton Deletion Headwinds

In our view, there are two takeaways for investors from Marriott's second quarter: The firm's brand advantage, the source of its narrow moat, remains the industry's strongest, and higher deletions are only a near-term headwind that supports its long-term competitive positioning. We don't expect a material change to our $120 fair value estimate, as slightly lower unit growth in 2018 and 2019 is offset by the time value of money, leaving shares fairly valued.

Marriott lowered its 2018 net unit growth to 5% from 5.5%-6% prior, as its deletion rates are near 2% of its total existing base this year, above typical levels of 1%-1.5%, which we believe is being driven by efforts to evaluate the quality of the Sheraton brand. We expect deletion rates to return to 1%-1.5% by 2020, as 75% of the roughly 160,000 Sheraton rooms (the brand is 12% of Marriott's total unit base) are already moving toward meeting the quality standards of Marriott. This leaves 25%, or about 40,000 rooms (around 3% of the total existing base), to negotiate standard terms, which implies the recent elevated deletion levels should subside by 2020. Further, quality efforts have begun to regrow the brand's market share of revenue per available room.

Marriott's brand continues to strengthen, evidenced by its revPAR index that has grown 120 basis points over the last year, implying share gains. Additionally, Marriott's development remains robust, with its room pipeline growing 6% to 466,000 rooms, representing 36% of its existing base and 30% of all midscale to luxury scale industry rooms. Further, Marriott's direct bookings are growing materially faster than online travel agency channel transactions (unquantified), while a unified industry-leading loyalty program of its 100 million members this August will make it easier to accumulate and use points. We may slightly lower our unit growth in 2018 and 2019, but we see little change to the mid-single-digit annual average lift we expect over the next 10 years.

Marriott's revPAR grew 3.8% during the quarter, at the high end of 3%-4% guidance and near the 4% lift reported by narrow-moat peers Hilton and Hyatt. Meanwhile, the company maintained its 3%-4% revPAR growth target for 2018, tracking toward our 3.5% estimate.