STOCKS: China Lodging Offers Comfort for Investors

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Bottom line: China Lodging looks like a good long-term bet to become a leading Chinese hotel operator, drawing on an alliance with France’s Accor in its ongoing transformation to become a manager and franchisor of major brands.

China Lodging transforms

Chinese insurer Anbang is making headlines this week with its surprise and intense bid for US hotel giant Starwood (NYSE: HOT), but an equally exciting hospitality story is happening behind the scenes with the quieter transformation of homegrown hotelier China Lodging (Nasdaq: HTHT). The US-listed hotel operator rose to early prominence with its chain of low-cost Hanting hotels, which have become a mainstay for China’s growing legions of budget-conscious travelers.

But more recently the company, also known as Huazhu, has signed a major tie-up with French hotel giant Accor (Paris: AC), owner of the better-known Sofitel and Ibis brands. That move, a first-of-its-kind for a homegrown Chinese hotel brand, should help China Lodging improve its operations and give it a potential entree onto the global stage.

At the same time, China Lodging is also shifting from its traditional business model as a hotel owner to a more western model of managing hotels and franchsing its brands for other property owners. Such a model has been quite successful for names like Marriott (NYSE: MAR) and Hilton (NYSE: HLT), since it avoids the big risks associated with property ownership. Such a strategy also requires far less capital than developing and buying real estate, making expansion much easier, faster and far less costly.

Investors who follow the industry have been quietly rallying behind China Lodging. The company’s shares now trade at an all-time high, nearly doubling over the last year. That’s no easy task in the current climate, where China’s economy is showing rapid signs of slowing and the main Shanghai composite index is down 18 percent over the same period.

China’s young stable of domestic hotel operators is rapidly consolidating around China Lodging and 2 other players: Jin Jiang (HKEx: 2006; Shanghai: 600754) and Homeinns (Nasdaq: HMIN). Following its recent rally, China Lodging is now worth about $2.2 billion, or roughly the same as Jin Jiang. Homeinns isn’t far behind with a market value of $1.7 billion, though the company is also in the process of privatizing from New York.

China Lodging made headlines in late 2014 when it announced its tie-up with Accor. (previous post) The deal was quite far ranging, anchored by an equity swap that saw China Lodging sell 10 percent of it to its French partner. In exchange, Accor handed over management for much of its China portfolio to its new local partner. Part of that saw the pair form a joint venture to manage Accor’s high-end Sofitel and Pullman brands.

I had been predicting such an east-west alliance for a while, since many of the biggest western operators are quite bullish on the China market. But lack of suitable Chinese partners was a major obstacle to such tie-ups, and Accor’s choice testifies to China Lodging’s position as one of the few promising names in the eyes of western operators.

Transforming Company

That Accor tie-up was part of China Lodging’s broader strategy of becoming a professional hotel manager and owner of brands that it could franchise to property owners. The results of that drive were apparent in its latest quarterly results released just last week.

Those results showed that China Lodging’s profits nearly tripled to 130.6 million yuan ($20 milllion) in the fourth quarter of last year, even though its revenue grew at a much slower 16 percent to 1.6 billion yuan. (previous post) The company now gets about 20 percent of its revenue from its hotel management and franchising business, compared to 15 percent a year earlier.

That means there’s still plenty of room for margin improvement, as the company de-emphasizes its older business of leasing buildings and then converting them into hotels that it operates under its various brands. By comparison, Jin Jiang has focused more on property acquisition, including a major purchase of a European hotel portfolio last year.

In one strange twist on that story, media also revealed earlier this month that Jin Jiang had quietly purchased around 12 percent of Accor’s shares, possibly in the open market without Accor’s knowledge. (previous post) That move could pose one potential risk to China Lodging, which could ultimately see its own Accor alliance come under pressure if Jin Jiang tries to use its new stake to form a more strategic tie-up with Accor.

Investors are clearly still most impressed by China Lodging, whose shares now trade at a price-to-earnings (PE) ratio of 36 following their recent rally. That amount is well ahead of Jin Jiang’s 22. It’s less than Homeinns’ lofty 42, but that figure is at least partly due to the bid price in Homeinns’ ongoing privatization. At the end of the day China Lodging stock could be a bit pricey right now for short-term buyers, but looks like a strong play to potentially become China’s premier hotel operator over the next decade.

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