Dream scenario for hotel sector

The Investment Column
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Kleinwort Benson's annual review of the quoted hotel sector is eagerly awaited by investors and this year, with signs that the market is starting to reverse its substantial underperformance of the past five years, was no exception.

Analysts at KB confirmed the recent statistical evidence from industry forecasters Pannell Kerr Foster and the anecdotal straws in the wind from firms that this year and next should be bumper periods for UK hotel groups. With GDP growing at 2.2 per cent, the savings rate falling slightly and inflation in retreat, the elements are in place for good domestic demand for hotels.

London is enjoying the dream scenario of limited supply combined with record levels of occupancy. In those circumstances the only pressure valve is room pricing, which can rise quite sharply, allowing hotel owners to reduce the level of room nights contracted to low-margin, high-volume overseas group tours.

That is good news for earnings, because higher room rates fall straight through to profits, unlike higher volumes, which necessarily bring with them incremental costs as well as higher revenue. During its failed bid defence Forte recently said that in 1995 61 per cent of its sales growth was falling through to profits; Brierley has made similar remarks about its Thistle chain. The problem with hotels for investors has always been spotting which companies are best placed to benefit from such a benign trading environment. The combination of a portfolio's location, size, market level of hotel, market share and facilities is such a complex matrix that it can be difficult drawing sensible conclusions.

Faced with those problems Kleinwort Benson has created a hotel index which it hopes will create a more systematic way of analysing the sector. In simple terms it creates a composite score with all the above variables and some others included with an appropriate weighting. That score acts as a measure of how well a company should perform given its asset base and can act as a good first step in deciding whether a share rating is reasonable.

The results make interesting reading. They show, for example that in the top division of UK hotels, the Savoy has the makings of a fine hotel group but is woefully underperforming. Brierley's Thistle chain on the other hand makes a cracking return out of a less than exciting portfolio.

Stakis emerges as a company that makes full use of its available resources, while Queens Moat is not using its portfolio to anything like its full potential. Vaux is another group that KB says could do better. So selecting the right groups remains the challenge. But against such a good trading backdrop, and having underperformed the market by almost 40 per cent since the beginning of 1990, the sector as a whole should have a good run this year.

Hewden Stuart reaches flat spot

Hewden Stuart, the Glasgow-based plant hire group, has long been one of the darlings of the construction sector. Innate Scottish caution, an obsession with cash flow and high levels of investment have served it well through the recession of the early 1990s and the subsequent painfully slow recovery. The result has been a tripling of profits from the recessionary low hit in 1992-93, after last year's 4 per cent rise just nudged Hewden past the previous peak in 1990.

But the record of pounds 36.3m, struck in the 12 months to January, may prove to be, at best, a plateau for the time being. The new executive chairman, Sandy Findlay, despite a plea that he was not being downbeat, was yesterday pouring buckets of cold water on the incipient recovery in the housing market and reiterating that construction remains as weak as ever. Indeed, although he held out the hope that a "very difficult" start to the year might be reversed in the second half, there was a chilling warning that the current state of the industry meant profits from Hewden could be flat for three years.

Mr Findlay has the reputation of being something of a Jeremiah, but his realism has often proved a necessary corrective to the false optimism of the building societies and house-builders. As the largest in the plant hire business, Hewden is something of a bellwether for the construction and building industry.

It is not all gloom and doom. In specialist hire areas like tower cranes, Mobilair compressors and powered access, Hewden's strong market shares and well maintained plant means that premium prices are holding up. Commodity areas like dumper trucks, road rollers and mobile cranes are proving more difficult, while margins in new equipment merchandising have been hit by a stock overhang and profits there slipped 8.5 per cent to pounds 2.7m

The main plant hire division, which contributes a third of profits, is the more worrying area. Some areas of the market have seen prices slip by up to 10 per cent and utilisation rates around the 65 per cent mark are a good 5 points below Hewden's comfort threshold.

Plans to slash capital expenditure from pounds 61m to around the expected depreciation level of pounds 36m this year says as much as anything about Hewden's view of the outlook. Same-again profits of pounds 36m would put the shares, down 9p at 148p, on a forward p/e of 16. High enough for now.

City Centre dishes up profits

We now spend more than pounds 40bn a year eating out, with 30p that every Briton spends on food going to restaurants. The total market is growing at about 7 per cent year, analysts believe.

That ought to be a pretty attractive backdrop for the 10 specialist restaurant stocks on the market, but as the burgeoning of that mini-sector suggests demand has been more than met by supply. It is a competitive market out there.

In that context, City Centre Restaurants' 10 per cent rise in pre-tax profits to pounds 15.5m was a pretty impressive return from its chain of 205 Deep Pan, Garfunkels, Caffe Uno, and a string of other, restaurants. The jump in profits for the year to December was struck from an 8 per cent rise in sales to pounds 111m. After a 12 per cent increase in earnings per share, the dividend rose by a similar margin to 2.24p and the shares nudged up 1p to 94p.

City Centre's performance is better than it might appear, because, unlike many of its peers, it operates a pretty prudent policy of writing off up to pounds 20,000 every time it opens a restaurant. Others in the sector capitalise pre-opening costs - perfectly acceptable from an accounting point of view, but not necessarily the safest approach from a shareholder's perspective.

With the group planning 50 openings this year, that policy is likely to knock up to pounds 1m off underlying profits. During 1995, the 28 openings completed cost pounds 423,000.

James Naylor, chief executive, freely admits that he is really in the fashion business - at his end of the restaurant market each site is really just a shell into which the latest ethnic food fad can be poured at relatively low cost. The trick is reading trends and keeping costs low.

On the basis of forecast profits of pounds 16.3m this year and pounds 19m next, the company seems to be getting both of those about right. A forecast p/e ratio of 16 falling to 14 incorporates most of the good news, however. High enough.

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