Marriott International – Buying A Piece of the World’s Largest Hotel Chain

SUMMARY

  1. After its merger with Starwood Hotels, Marriott International has increased tremendously in scale which will give it a huge advantage in the industry it operates in
  2. Marriott’s competitive advantage includes not only scale but superior branding, pricing power and a crown-jewel leadership team.
  3. The company has proven to be financially robust as it generates a high return on capital and steady free cash flows.
  4. Patient investors will be handsomely rewarded in years to come.

 

  1. Introduction

I have a special fondness for family businesses and even more so when they are dedicated to brands and cultures built for the long haul. I’m recommending a sterling example and I doubt you’ll need an introduction.

Marriott International (NASDAQ: MAR), with more than 6,000 properties amounting to 1.2 million rooms across 120 countries, is a brand the travellers among you may know well.  For almost a century, this classic American company has been in a state of constant evolution, searching for new ways to delight its customers and keep pace with ever-changing times. Over the years, it morphed from a Depression-era root-beer stand to a worldwide hospitality conglomerate, refocusing again in the early ’90s as it split its core hotel business from its real estate management operations.

Today, Marriott features great management, solid financials, and fast-paced growth after its merger with Starwood Hotels.

  1. Business Model and Competitive Advantages

Marriott mostly manages or franchises hotels or leases them rather than owning them out right. This means that the business is extremely asset-light as the company earns the majority of its revenue from service and management fees (usually calculated as a percentage of the revenue collected from the properties that it manages). On top of that, the company is incentivised to deliver outstanding results as additional fees are tied to its performance. Thus, exceeding contractual performance yields a higher management fee. This ultimately translates to a very stable revenue base and cash flow for the business over the long haul as the tenure of contracts stretches over decades at a time.

Whilst an owner-operated hotel enables the owner to have full control over hotel operations, it has a high barrier to entry as it requires a hefty amount of capital investment which also means that the financial risks and burdens are heavier to bear. On the flip side, for hotel-brand owners, franchised or managed model enables quicker rooms growth due to lower capital investment. The downside to this business models, however, is that it requires strong relationships with the third-party hotel owners.

The competitive advantages of Marriott are based largely a few factors. Firstly, it has a brand name that is extremely popular amongst travelers. This also results in pricing power (the ability to raise prices on its rooms without losing a huge chunk of its customer base). From the third-party hotel owners’ point of view, switching costs is high as contracts are long-dated and scale is a huge advantage in a fragmented industry like the one Marriott operates in.

To sum it up, Marriott’s business model not only enables it to produce a steady amount of cash flow but is also sufficiently nimble in an industry that can be affected by the economic outlook and other unforeseen circumstances.

  1. Financials and Management

For the investors who see buying stocks as owning a part of a business, the financial health of a company is one factor that requires consideration before deciding that it is worth investing in. Here are the numbers for Marriott:

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The 3 metrics to focus on here is the company’s revenue, operating income and net income. Over the last 5 years, the company has been able to grow its revenue base and bottom line without much hiccups. With its acquisition of Starwood Hotels, investors should expect to see that revenue and profits pick up steam over time as synergies from the merger play out.

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Cash flow from operations and free cash flow has also been on the rise over the last 5 years. While past performance is not indicative of future performance, Marriott is positioned well in its industry to continue to dominate over the next decade as it continues to expand under a competent management team.

In 2012, Arne Sorenson became the company’s first CEO from outside the Marriott family, but he hasn’t missed a beat and boasts an impressive 89% approval rating on Glassdoor. Since joining the company in 1996, Sorenson has held a variety of positions, including Chief Operating Officer and President of European Lodging, and by all indications he embraces Marriott’s culture. As a long-term investor, I’m delighted with the management team as a whole and love Marriott’s promote-from-within strategy. A strong, supportive culture should help to delight both its customers which includes a total of 100 million members, employees and ultimately, shareholders.

 

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  1. Potential Risks

As prudent investors, we ought to always consider both the good and bad before we invest in a business.

In the case of Marriott, while having the title as the largest hotel chain under its belt may seem like a huge advantage, it does not disinfect it from being impaired.

After merging with Starwood Hotels late last year, investors and analysts are still cautious about whether or not the merger will bring about synergy between both brands. The combined entity’s portfolio will house one of the most recognized brands within the industry. This includes Marriott, Courtyard by Marriott, J.W. Marriott and Ritz Carlton – and not to mention brands from Starwood which includes W Hotels, Westin, Sheraton and St. Regis. While having a huge number of well-known brands may serve the business well, it will take time for the effects of the merger to play out. If Marriott is unable to integrate Starwood into the way it operates to achieve scale and cost efficiency, revenues and profits may not pick up at the rate that management estimates. Investors also need to remember that a successful merger is extremely difficult to achieve and are not common in reality.

In the hotel industry, room supply and the general economy drive daily rates and occupancy, which in turn are key determinants of profitability. And, unfortunately, management has little ability to control these factors. It takes years to develop new hotel properties, and the economy can turn very quickly. This can cause large and sudden fluctuations in hotel profits and stock prices.

Lastly, while some may consider Airbnb, the room sharing service juggernaut, to be a disruption to Marriott, the business model and target markets of both companies are largely different. Furthermore, with more rooms and brands under its umbrella, Marriott would be able to cater to an even larger base of travelers.

  1. Conclusion

In the hotel game, size means better negotiating power, more money to invest in technology and development, and more choices for loyalty program members. The downside here is that it is largely cyclical and unpredictable.

The company has a market capitalization of almost $40 billion and it is trading less than 40 times earnings. While that PE ratio is above the average market, it has not accounted for the forward-looking element of the business which is its future growth. Over the next 3 years, the company plans to add roughly 250,000 new rooms to its ever growing portfolio and drive its Revenue per Available Room (RevPAR) growth by approximately 1% to 3%. Overall, I think that the upside far outweighs the challenges and investors would be taking a calculated risk by booking their stay with this investment for the long haul.

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Marcus Ho
Research Analyst, Mind Kinesis Value Investing Academy

Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.

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