Value Investing Forum

Follow up.. Fair value reached in short time.. Closing position.

November 11, 2011

I'm a little sceptical here as well.  I haven't looked closely in the numbers, but here are a few things to think about.

Being in the hotel business, I know that IHG doesn't necessarily have the best reputation as a franchise.  They've been making attempts recently at trying to duplicate the popular boutique concept that Starwood has implemented with mixxed results and have alienated a large % of their franchisee base with some of their tactics and their new requirements  & renovations which have been questionable to be effective.  (But doesn't make their stock a bad buy at the right price)

Although the hotel industry is rebounding, there have also been reports recently about slower hotel growth in hotel nights being booked which means less hotels being built = less franchisees.  I noticed that the company was trading at 13 times "earnings".  

http://www.travelweekly.com/Tr…..s-in-2012/

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I do know that real estate is still in a bit of a lull.  With many mortgages coming due in 2012 and 2013, there are going to be more defaults coming on line in the coming year in all real estate classes.  However, I do have a positive outlook for the future and I think the industry is going to recover slowly rather than the quick turnaround that everyone was expecting as the industry is still in the process of deleverging.  Volume sales of real estate has been increasing in the industry while prices are falling over the last few years.  What this means for hotel franchises…. is that until prices of real estate drops to levels where it makes sense for developers to start building new hotels, I don't see large growth in the industry just yet.  It takes an average of 2-3 years for a new hotel to be built ground up which means approximately 2-3 years before the franchise expects to see increased revenue from new franchisees.

They derive a lot of their revenue on franchises fees which are based on a % of hotel revenue.  Hotel revenue has rebounded with the recovery of the economy which is where most of their growth has come.  The revenue will continue to grow as the economy continues its recovery and hotel rates and occupany recover to normal levels.

The one problem I see again is IHG losing market share to its competitors such as Starwood.  But I like the industry as a whole.  

Those look like the noncurrent numbers. See note 19 in the 20-F. I'm reading $722m and $668m for 2010 and 2009 respectively.

Regardless, the company claims that they pay their trade payables within 45 days (I mistakenly first read that as for the entire accounts payable but it only applies to a portion). The trade payables are $113m. So what's the average pay time for the rest of their liabilities? Even if we go with your ~90 day number we have to assume the others are paid on a much longer term basis. Some of that is explained in Note 19:

Other payables includes $531 million (2009
$470 million) relating to the future redemption liability
of the Group’s loyalty program, of which $92 million
(2009 $86 million) is classified as current and
$439 million (2009 $384 million) as non-current.

It appears that "the Group's loyalty program" is some sort of customer rewards program of some sort but I'm not entirely sure. It accounts for another $92m in current liabilities. I could understand those liabilities being estimates on timing of when they get used so that would be part of the picture.

I have no idea what the nature of their other liabilities are and why that's resulting in such a high DPO. The only thing that makes it look good is its relative consistency over time.

Post edited 9:14 am – November 26, 2011 by somrh

nell said:

@infinitee00:

1. The company has a current ratio <1

I would look into quality of current liabilities (tax, trade payables -> no big short term debt!).

Negative working capital is actually a sign of strong bargaining power!

If they have good credit they may be relying upon a credit facility to meet short term obligations as well. Essentially they might be living paycheck to paycheck so to speak but that may not be a concern.

Their DSO runs high (around 90 days) and their DPO runs very high (a bit under 1 year). This has been relatively consistent over time.

Although there is one peculiararity and that is in the quarterly numbers of Dec 06 and Dec 07, DPO into the 40 day range. So perhaps they make all of their liability payments at the end of the year (and makes the annual statement numbers look lower). They didn't do this for 2008 onwards.

Looking at their most recent 20-F I'm not seeing too much disclosure as to what they are (granted I didn't look long). The bulk of the current liabilities are attribted to "Trade and notes payable" which under Note 19 says: "Trade payables are non-interest-bearing and are normally settled within an average of 45 days."

So DPO should be in the 45 day range yet my calculations are in 300 day range. I'd probably have to look more to make sense out of it. Is there any more disclosure on this?

@infinitee00:

1. The company has a current ratio <1

I would look into quality of current liabilities (tax, trade payables -> no big short term debt!).

Negative working capital is actually a sign of strong bargaining power!

2. Goodwill+intangible makes up for ~75% of the total equity.

Goodwill is low in relation to equity and i dont see a serial acquirer. Intangibles are more accounting

gimmick for brand, trademarks etc. Im pretty sure that IHG brand is worth more than

stated balance sheet values.

3. LT Debt to equity > 3, LT debt to tangible equity even larger ( is that correct?). They earn enough FCF for this to not be a big concern but given the amount of leverage they have it is not surprising that they have such a high ROE.
I dont care much about their ROE but more about cash-on-cash returns. Cash roic is quite high and thats a very nice signal.

If one puts their cash generating power in relation to their net debt of $644m (Q3/2011), im not worried about debt levels at all.

As one can clearly see from their cash flow statements they use their cash wisely (paying down debt, dividends, buybacks).

4. Also revenues have been pretty much flat and range bound in the last 5 years.

Last 5 years IHG was involved in a corporate restructuring. They changed their business model from a properties

owner to a franchisor and management company. Therefore revenue numbers are really not comparable.

5. Anythoughts on why this should be a good investment going forward? 

- Take cheap ownership in the largest franchiser, manager, and owner of hotels in the world, as measured by total rooms, with more than 4,400 hotels and 440,000 rooms in more than 100 countries in its system.

- Profit from population growth ("Wikipedia: ..Current projections show a continued increase in population with the global population expected to reach between 7.5 and 10.5 billion by 2050..")

6. What do you think are the major risks? 

- Macro issues.. China goes bust etc. ..but if one really believes in an end of world scenario one  shouldnt invest at all ;-)

- Currency issues

References:

1. Q3 Financial results: http://www.ihgplc.com/files/re…..ts11Q3.pdf

@jae: No. A REIT is required to distribute 90% of their taxable income while IHG is free to reinvest in its business at fantastic cash returns (like Yum Brands, but its alot cheaper) ;-)

Overview:

InterContinental is the largest franchiser, manager, and owner of hotels in the world, as measured by total rooms, with more than 4,400 hotels and 440,000 rooms in more than 100 countries in its system. The company's portfolio of brands include the largest midscale hotel brand, Holiday Inn and Holiday Inn Express, and two of the largest upscale brands, InterContinental and Crowne Plaza.

Business Model:

+ Brand name with pricing power

+ Recurring fee business model

+ Significant switching costs for its property owners

+ Long dating contracts (> 10years)

Valuation: 

Conclusion:

Maybe im missing something, but it looks like a no-brainer ;-)

Best wishes..