Choice Hotels has had an impressive run over the past six months as its shares have beaten the S&P 500 by 13.7%. The stock now trades at $117.03, marking a 18.8% gain. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is now the time to buy Choice Hotels, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Choice Hotels Will Underperform?
We’re happy investors have made money, but we're cautious about Choice Hotels. Here are three reasons we avoid CHH and a stock we'd rather own.
1. RevPAR Hits a Plateau
In addition to reported revenue, RevPAR (revenue per available room) is a useful data point for analyzing Consumer Discretionary - Travel and Vacation Providers companies. This metric accounts for daily rates and occupancy levels, painting a holistic picture of Choice Hotels’s demand characteristics.
Over the last two years, Choice Hotels failed to grow its RevPAR, which came in at $49.82 in the latest quarter. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Choice Hotels 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. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Choice Hotels has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 9.4%, below what we’d expect for a consumer discretionary business.
3. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Choice Hotels’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
We see the value of companies helping consumers, but in the case of Choice Hotels, we’re out. With its shares topping the market in recent months, the stock trades at 16.6× forward P/E (or $117.03 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are more exciting stocks to buy at the moment. We’d suggest looking at our favorite semiconductor picks and shovels play.
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