Less Than Stellar Earnings Fail To Stall Hilton as Industry Rises

By DANNY KING

Staff Reporter

Not even a rough-sailing second quarter could stop Hilton Hotels Corp.’s stock from rising with the tide that also has lifted the shares of competitors.

The prospect of a business-travel recovery to pre-9/11 levels has drawn investors to all the larger hotel stocks, and Hilton is a prime beneficiary.

At a closing price of $16.22 a share on Sept. 30, Hilton stock was up 28 percent through the first three quarters of the year.

Competitors Starwood Hotels & Resorts Worldwide Inc., up 47 percent, and Marriott International Inc. (up 32 percent) did better, but Hilton’s performance topped Host Marriott Corp., which rose only 21 percent.

The stock gains have occurred despite a less-than-stellar performance for Beverly Hills-based Hilton.

Forced to cope with a drop in business travelers, Hilton responded in the second quarter by booking a higher percentage of leisure groups to fill its rooms. With leisure groups paying $120 a night, versus about $150 for businesses and more than $160 for corporate accounts, Hilton experienced a 4 percent drop in average daily room rates from the like year-earlier period, while revenues per available room fell by about 7 percent.

With lower room rates cutting into margins, earnings suffered for Hilton, which owns 125 hotels worldwide and manages or franchises another 1,959.

The company reported second-quarter net income of $54 million (14 cents per diluted share), compared with $76 million (20 cents) for the like period a year ago. Second-quarter revenues were down 5 percent, to $983 million.

“The mix of business has shifted since the economy has been down,” said Marc Grossman, senior vice president at Hilton Hotels. “There hasn’t been as much business travel and there have been fewer company meetings.”

Despite its challenges, Hilton has gradually improved its balance sheet by using cash flow to pay down debt.

With operating profits at about 17 percent of revenues for the second quarter (compared with 6 percent and 11 percent for Marriott and Starwood, respectively), Hilton has reduced its debt-to-equity ratio to 2.9 as of June 30 from 4.1 two years earlier.

The company has also hedged its income streams, as 57 percent of its revenues come from owned and leased hotels while the remainder is generated in management and franchise fees.

As a result, Hilton is well-positioned to benefit from the expected increase in travel, as the war in Iraq recedes from the public’s mind and the economy improves, said Marc Falcone, gaming and lodging analyst for Deutsche Bank Securities Inc.

“Hilton did a tremendous job managing the business over the last couple of years amid tremendously challenging operating conditions,” said Falcone, who has a “buy” rating on the stock with a price target of $17. “They really outperformed their peers.”

Bargain stock?

Hilton shares trade at 9.7 times projected earnings before interest, taxes, depreciation and amortization for 2004, versus a 12.5 multiple for the industry, according to a report last month by JP Morgan. Also citing Hilton’s presence in urban markets as a positive factor, JP Morgan upgraded Hilton stock to “overweight” from “neutral” on Sept. 9.

“Hilton’s stock offers the most upside in the lodging sector over an 18-month time horizon,” the report said. “We believe Hilton’s 2005 EBITDA will recover to within 13 percent of peak 2000 EBITDA.”

Like other publicly traded hotel chains, Hilton stock nosedived after the terrorist attacks of 9/11. Trading between $11 and $13 a share during the months prior to the attacks, Hilton stock fell to $6.61 on Sept. 20, 2001, and did not return to the $13 level until March 2002.

More importantly, revenues tumbled 24 percent in fourth quarter 2001 from a year earlier, and have yet to fully recover. Last year, revenues fell 4 percent from 2001, and revenues for the first six months of this year are down about 3 percent from the first six months of last year.

Still, analysts and investors remain optimistic on hotel stocks like Hilton due to the belief that travel activity is on the rise while the supply of rooms will remain flat. The average hotel room revenue in the U.S. for the week ended Sept. 20 was up 5.2 percent from a year earlier, according to lodging industry analyst Smith Travel Research.