HILTON: ROOM FOR
STRONG GROWTH

STRONG HOTEL BRANDS

Hilton operates as an asset-light franchisor of its hotel brands and owns very few physical hotel properties. Its 22 brands cover the chain scale spectrum from luxury through midscale to economy. These include the Waldorf Astoria and Conrad Hotels (luxury), Hilton Hotels (upper upscale), DoubleTree by Hilton and Hilton Garden Inn (upscale), Hampton by Hilton and Home2 Suites (upper midscale), Spark (premium economy) and Homewood Suites (extended stay).

Listed on the New York Stock Exchange under the ticker HLT, Hilton is an excellent business, for the following reasons:

• It owns leading hotel brands that have outperformed peers in terms of growth in rooms worldwide.
• It is well positioned, as structural industry growth is driven by a shift towards established hotel chain brands and away from independent hotels.
• Hilton has the ability to capture this growth with little incremental capital or operating investment, generating strong free cash flow.

FRANCHISE BUSINESS MODEL

Hilton franchises its hotel brands to property owners. Capital for new hotel properties is put up by franchisees, including the costs of building the hotel, all property maintenance and all ongoing expenses such as hiring staff and utilities costs. The franchisee pays Hilton a franchise fee for every room night sold, which (keeping it simple) amounts to around 5% of the bill. In return, the hotel owner gets access to a Hilton brand, and the group’s know-how, booking systems and loyalty programme.

Being able to access the loyalty programme with its 180 million members is a key selling point for hotel owners to convert to Hilton brands, as 64% of bookings for Hilton hotels are done directly through the loyalty system. On these directly booked nights, the hotel property owner does not pay a high booking fee to intermediaries such as Booking.com or Expedia.com. In short, being part of the Hilton system is more profitable for a hotel owner than being an independent hotel.

Hilton also offers ancillary services such as hotel management, where it manages some of its hotels when the franchisees don’t want to do so themselves. In this model, the hotel owner remains liable for all costs, including staff and maintenance expenses, with Hilton being paid a base fee and an incentive profit-sharing fee for managing the hotel.

REVENUE AND PROFIT GROWTH

Simplifying it all, Hilton grows revenues as it adds hotels and rooms to the system (volume growth). Also, revenue per room night sold generally goes up in line or slightly ahead of inflation over time (pricing power keeps up with inflation over long cycles). Because the new rooms added each year are very high fee-margin rooms, operating margin rises over time too. Around 96% of group profits are earned by the franchised and managed fee business, which is the group division that is growing – it operates at 78% EBIT margins.

DEVELOPMENT PIPELINE

The key ongoing trend in the hotel industry is a shift away from independent hotels towards brands, for the reasons explained above. Branded hotels are growing their market share in all geographies. By its own estimates, Hilton currently has a 5% global market share of hotel rooms, but a 20% share of all rooms under construction globally. For example, Hilton enjoys a 14% share in its biggest market – the US – but has 23% of all new rooms under construction there. In Asia-Pacific, Hilton has a 2% market share but 24% of rooms under construction. In Europe, a very big hotel market, these figures are 2% and 10% respectively.

The raw numbers on the development pipeline are impressive. As of 31 March 2024, Hilton has 7 626 existing hotels and 1 997 000 rooms, with a new pipeline of another 472 000 rooms. This represents 39% of its existing global estate, to be added to its system over the next five years. Half of these rooms are already under construction. Just to repeat: Hilton is not funding the cost of this expansion – it is the hotel property owners (franchisees) who are building the physical hotels.

WHERE HILTON OPERATES

Around 75% of operating profit is derived from the US, where Hilton has 14% of US hotel rooms. The rest of the profit is split between Europe (9% of earnings), Asia-Pacific (9%), Latin America (4%) and Middle East and Africa (3%). While it is still growing rooms at a healthy rate in the US, more than half the pipeline is outside of the US. As mentioned, in Asia-Pacific, for example, Hilton has a 2% market share of rooms, yet it accounts for about 24% of the region’s total hotel development pipeline (Hilton estimates). This has driven room growth of around 30% a year for the past few years in Asia-Pacific.

VALUATION

The company is trading at just below our fair value estimate of US$203 a share. If the future plays out as we expect, we believe an investment at the current price will deliver high single-digit total returns over time in US dollars. We’re comfortable paying fair value for this exceptional business, initiating a medium-sized position now and potentially building on this in the future.

Investors should note that there are likely to be ups and downs because sentiment around consumer spending does tend to impact the stock price of hotel companies in the short term. However, the company is relentlessly growing its system size over time, driving the intrinsic value higher for the patient long-term investor.

IN A NUTSHELL

As can be seen in the table below, Hilton is a genuine growth business. It is this system-size growth that has driven earnings per share (Sanlam-adjusted) growth of 13.7% per annum over the past five years.

Free cash flows are returned to shareholders mainly though buybacks, with a dividend as well. If all progresses as we expect, Hilton should generate mid-to-high single-digit revenue growth, with growth in operating earnings of at least 10% a year. Share buybacks should then push earnings and free cash flows growth per share higher than 10% over time.