InterContinental Hotels Group

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

IHG is a global hospitality company that franchises its brands and manages hotels on behalf of third-party owners, with a weighting towards more resilient domestic non-urban markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

IHG’s core business model involves franchising its hotel brands to independent owners and managing hotels on their behalf. This model provides a fairly stable stream of revenue through fees, largely insulated from the volatile operating costs of direct hotel ownership.

Business Overview

IHG operates in the global hospitality industry, which has shown long-term growth potential, but is also characterized by periods of disruption. The company’s revenue is primarily derived from franchising its various hotel brands—including InterContinental, Holiday Inn, and Crowne Plaza—and managing hotels for third-party owners, although they do own some directly managed hotels. The geographic distribution of IHG’s revenue is diverse. While they don’t seem to disclose regional earnings or net profits, they operate on a global scale and operate hotels around the world. Per their 2022 annual report, The Americas represent 55% of gross revenues, EMEA 34%, and Greater China 11%. IHG’s model leads to significant variation in profitability across regions. They try and have more operations in resilient, non-urban markets, which limits the impact of urban economic shocks.

IHG’s strategy focuses on creating and maintaining brands that command consumer loyalty and drive repeat customers, emphasizing quality, experience, and a strong loyalty program.

Competitive Landscape

The hospitality industry is very competitive, with a landscape of both large global players such as Marriot and Hilton, and also many smaller chains and independent hotels. This leads to intense rivalry and price competition. IHG competes on brand recognition, customer loyalty programs, and the ability to provide consistent quality across all its hotels worldwide. The company is also focused on leveraging technology to deliver the desired experiences, such as through their app. They also look for high-quality, attractive properties. The business model is centered on franchising, where IHG gives a brand, distribution, and loyalty system to the hotel, and the local hotel operates it, manages staff, and owns the property. This significantly lowers the capital required to run the business. While direct ownership of hotels might provide greater control over the hotel property and offerings, IHG instead focuses on a franchise model. This provides them a scalable system where the brand can scale at the pace the markets grow, and also a relatively protected revenue stream since their revenue is generated from fees, not operations. The company tries to create demand for their hotels and attract higher paying customers through marketing programs and incentives.

Financials

IHG’s performance, like much of the hospitality industry, was severely impacted by the COVID-19 pandemic, but they have since recovered from those lows. Looking at financials in the Annual Report of 2022, we see that the firm increased the operating profit year-on-year by a significant percentage. It reported a 68% increase in operating profit and a more than 50% increase in overall revenue. However, this should be taken in context of 2021 being a very poor year due to the COVID downturn, and the rebound in 2022 is largely compared to that low level of sales. The adjusted EBITDA also increased over 62% year-on-year for 2022. The company’s adjusted earnings per share for the year increased to 3.065, nearly double that of 2021. Their earnings have significantly improved and are above 2019 levels, which shows they have rebounded from COVID. This has been helped by the opening of new hotels and rooms, as well as an increase in demand and traffic for hotels. Their group revenue increased significantly with higher system-wide revenue, and global revPAR recovery to 2019 levels.

IHG saw revenue growth of more than 50% in 2022, with an equally significant increase in operating profits. This was largely due to the rebound from COVID, and the improved performance of the global hotel industry.

The company’s cash flow has generally improved as business has increased, with a 40% increase in cash from operations. The company is also continuing to engage in debt repayments and share buyback schemes. They have generated a total of 13.6 Billion USD in cash over 2022, and are paying out 85% of the free cash flow as dividends. The company’s balance sheet shows debt of 9.1 Billion USD, and cash of 2.9 Billion USD, which seems like a reasonable state of affairs as the ratio of debt to revenue is pretty low in 2022. The company is operating a fairly stable business, with good prospects for expansion in emerging economies, and growth in the global hotel industry.

Although the company has stated a goal to increase its leverage, the current high revenues and operating profit can help maintain its financial stability. It is key to keep track of its debt repayments and future leverage targets to see how the balance sheet will evolve.

Moat Assessment

Rating: 3/5 (Narrow Moat)

IHG possesses a narrow moat, primarily derived from:

  1. Brand Recognition: IHG has a well-established portfolio of brands that enjoy significant recognition and customer loyalty, allowing them to charge a slight premium. However, this brand recognition is less powerful than that of other major players, and in markets with significant competition this advantage might not hold up.

  2. Loyalty Program: IHG’s loyalty program, while robust, is not as robust as others in the industry, making its switching costs lower than desired.

  3. Economies of Scale: The company operates a large portfolio of properties, which has the potential to create efficiencies for the company in marketing and business operations. It can reduce cost per customer and potentially add more value per customer.

The moat is vulnerable to changes in customer preferences, the emergence of new brands or business models, and economic downturns.

Risks to the Moat and Business Resilience

Several risks could potentially erode IHG’s competitive advantages:

  1. Economic Downturns: The hospitality sector is highly susceptible to economic fluctuations, which can sharply curtail consumer demand and profits.

  2. Increased Competition: New hotel brands or business models in the emerging, low-cost hotel sector could disrupt IHG’s market share or lower the premium they can extract from customers.

  3. Technology Disruption: Travel apps are starting to replace booking in hotels, and new technologies may reduce prices, and reduce the importance of brands or large hotel chains, diminishing IHG’s network effect.

  4. Global Financial Conditions: Currency changes, and the overall global economy, impact profitability.

Despite these risks, IHG demonstrates moderate resilience:

  • Franchise Model: Their asset-light franchise model makes them more resilient to downturns than heavily debted, asset-heavy hotel brands.

  • Diversification: The company’s global presence helps diversify its revenue streams across regions. They are also focusing growth in resilient, non-urban economies which reduces the impact of urban economic shocks.

  • Strong Management: Management has shown a successful track record of implementing new strategies to grow the company.

IHG’s main source of resilience comes from its asset-light, franchise model, making them more resilient to economic shocks than some competitors.

Understandability

Rating: 2 / 5 (Somewhat Easy to Understand)

The core operations of IHG are fairly straightforward to understand. However, there are several moving parts that make it complicated for the average investor:

  • The company’s complex accounting. They report and follow both GAAP and IFRS accounting guidelines, which can be difficult to understand.
  • The company operates globally in a variety of markets, and currencies, which requires understanding foreign exchange rates and macroeconomic forecasts, and also makes it difficult to get a handle on where the revenue and profit comes from.
  • It also has a number of subsidiaries and joint ventures that are difficult to fully understand unless you spend time understanding their business operations.
  • Their expansion involves a lot of new acquisitions and contracts, the details of which aren’t publicly provided, and the impact they’ll have on the financials are hard to analyze.

While the basic operations are understandable, nuances like international operations, franchising agreements, financial reporting of subsidiaries, and complex accounting make for a higher rating.

Balance Sheet Health

Rating: 3 / 5 (Moderate)

The company’s balance sheet shows the following:

  • The company had long-term debt of £7.3 billion, against £2.4 billion in cash for the 2022 year. While this doesn’t look great at the face, it also shows they are capable of handling their debt responsibilities for the near future. They also have shown intent to decrease leverage over time.

  • They’ve decreased net debt from £3.5 Billion to £3.1 Billion.

  • IHG has a high degree of intangible assets and goodwill related to acquisitions, which can potentially create problems during economic downturns if these assets decrease drastically in value.

The company’s balance sheet is reasonably healthy, but it requires monitoring. They have high debt, which exposes them to high levels of leverage risk in the case of an economic downturn. However, it’s also good to note that they have been focusing on growing revenue and profits from operations.

Recent Concerns and Controversies

  • Russia-Ukraine War: IHG had a material exposure to Russian operations, and although they have since ended operations and are looking to divest their Russian business, any future developments related to the region, and Russia’s invasion of Ukraine, may impact the company.

  • Inflation and Economic Downturn: The company faces high inflation rates that can impact revenue and operating profits, as customers’ ability to travel, and therefore book more hotels, may decline.

  • Competition: The hotel industry has intense competition both from traditional hotels and from upstarts. They must continuously innovate to offer competitive products.

Management’s Response: In their most recent earnings calls (for 2022), management has frequently talked about:

  • Growth in demand and traffic in all geographies, even China post-COVID opening.
  • Their focus on the higher end luxury brands, which bring in more revenue.
  • Their focus on a franchise model, which lowers their capital expenditures and risk.
  • Their focus on reducing costs and improving operations.
  • Their intent to increase leverage back up to historic levels, and continue returning free cash flow to shareholders.

The management is clearly very focused on the long-term growth prospects of the business and are taking actions to ensure value creation over the long-term. They expect margins to continue to grow along with increasing revenues, which in effect will continue to increase their earnings power. They plan to rebalance their debt structure and reduce capital expenditure costs.

In summary, IHG is a reasonably stable hospitality business, but one that is still not immune to the cyclicality of its industry. They have brand power and a reasonable operating framework, but it requires monitoring for its debt loads, exposure to external factors, and competitive threats. The company is making efforts to improve profitability and growth prospects, but the stock requires careful analysis.