Over the past six months, Choice Hotels has been a great trade, beating the S&P 500 by 7.4%. Its stock price has climbed to $146.35, representing a healthy 20% increase. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Choice Hotels, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
We’re happy investors have made money, but we're swiping left on Choice Hotels for now. Here are three reasons why you should be careful with CHH and a stock we'd rather own.
Why Is Choice Hotels Not Exciting?
With almost 100% of its properties under franchise agreements, Choice Hotels (NYSE:CHH) is a hotel franchisor known for its diverse brand portfolio including Comfort Inn, Quality Inn, and Clarion.
1. Weak RevPAR Growth Points to Soft Demand
Investors interested in Travel and Vacation Providers companies should track RevPAR (revenue per available room) in addition to reported revenue. This metric accounts for daily rates and occupancy levels, painting a holistic picture of Choice Hotels’s demand characteristics.
Choice Hotels’s RevPAR came in at $55.16 in the latest quarter, and over the last two years, its year-on-year growth averaged 3.7%. This performance was underwhelming and suggests it might have to invest in new amenities such as restaurants and bars to attract customers - this isn’t ideal because expansions can complicate operations and be quite expensive (i.e., renovations and increased overhead). 
2. Projected Revenue Growth Is Slim
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Choice Hotels’s revenue to rise by 2.1%, a deceleration versus its 8.3% annualized growth for the past two years. This projection doesn't excite us and implies its products and services will face some demand challenges.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We typically prefer to invest in companies with high returns because it means they have viable business models, but the trend in a company’s ROIC is often what surprises the market and moves the stock price. Unfortunately, Choice Hotels’s ROIC has decreased over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Choice Hotels isn’t a terrible business, but it doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 21.6× forward price-to-earnings (or $146.35 per share). At this valuation, there’s a lot of good news priced in - we think there are better investment opportunities out there. We’d recommend looking at a dominant Aerospace business that has perfected its M&A strategy.
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