Investment opportunities are created when the market underestimates a business’ long-term earnings power. In the case of Accor SA, one of the largest global hotel operators and owner of some of the industry’s most well-known brands, we believe that investors are overlooking a strategic transformation that has significantly improved the quality and long-term prospects of the Company. As travel recovers in the aftermath of pandemic-related disruptions, we think that Accor’s earnings are likely to grow faster than many are assuming. For these reasons, we own Accor in our Global and International Value strategies.
Accor was founded in 1967 and for much of its history expanded in an undisciplined fashion in hotel ownership and other travel adjacent segments. This was capital intensive, and the returns earned on this capital were poor. Unsurprisingly, the strategy delivered disappointing results for shareholders – over the past twenty years an investment in Accor delivered a total return of 82% (3.0% p.a.) vs. the MSCI World ex-USA Index of 263% (6.7% p.a.).
Approximately 15 years ago Accor began a long – and at times uneven – journey towards improved performance. First, the Company sold or spun off its non-hospitality businesses. Several years later, the Company addressed the lack of breadth in its portfolio by acquiring leading brands in the upper-upscale and luxury segments. Finally, in 2018 the Company took the most important step in its transformation, selling a 70% stake in its owned hotels and converting to an asset-light management company model.
We like this remaining business. Hotel brands deliver higher occupancy and room rates to owners while reducing costs. For example, consider customer acquisition. Independent hotels have become increasingly reliant on online travel agencies for bookings. This is an expensive distribution channel, with powerful intermediaries taking advantage of their position to steadily raise commissions. Branded hotels address this challenge by leveraging their scale to reduce fees, and by offering the potential for increased direct bookings (websites, apps, loyalty programs, etc.).
Today, about 55% of hotels globally are branded, but 90% of hotel new builds are brand affiliated. This is a clear signal of the value proposition. Previously opened independent hotels are also increasingly turning to branded management companies to improve operating performance (a process referred to as conversion). Branded hotel operators are taking market share, which is driving revenue growth above GDP. We believe this type of growth potential for Accor could be achieved with minimal capital spending, resulting in strong reinvestment economics and very good free cash flow generation. As a result of these favorable attributes, hotel management companies tend to trade at high valuations.
Accor is well positioned to potentially benefit from these favorable industry trends. The Company owns 33 hotel brands that span the entire value spectrum. These include some of the largest and most recognizable brands – especially outside of the United States – in their respective segments, including Fairmont, Raffles, Novotel, Mercure, and Ibis. They are winning their fair share of new builds and conversions around the world which has driven growth in room count.
While Accor laid the groundwork for better results several years ago, the Company’s turnaround was short-circuited by the Covid-19 pandemic. In early 2020, travel ground to a halt and hotel occupancy plummeted. For exposed businesses, earnings expectations declined and share prices collapsed. While the near-term outlook at the time was indeed grim, at Hotchkis and Wiley we take a longer-term perspective, recognizing that sometimes share prices overreact to temporary developments. After all, a business’s intrinsic value is the discounted sum of all future cash flows, not just those from the next year or two. Through this lens, in the summer of 2020 Accor shares looked attractive, and we began buying, confident in both the strength of the Company’s balance sheet and the resiliency of Accor’s business model.
Today, we see that despite substantial evidence of a rebound in travel, expectations for Accor have still not recovered. Estimates for revenue per available room and earnings show a prolonged journey just to get back to pre-pandemic levels (whereas the market is assuming faster recovery at peers). As a result, Accor’s share price performance has stagnated, and the valuation discount to the market and to competitors has widened considerably.
On the other hand, we believe Accor has the potential to deliver better top-line growth and stronger operating margins. This will drive increases in earnings per share and free cash flow ahead of expectations. Given our more optimistic forecasts, the shares look undervalued. Management seems to agree and has committed to return 50% of free cash flow to owners via dividend payments and share repurchases.
CHART 1: H&W EPS Estimates vs. Sell Side
Some of our favorite investments are businesses that are underachieving their potential, with the market price embedding continued weakness, but where we have identified through independent research a likely path to better operating performance. Accor fits this profile, and we are optimistic that an investment in its shares today has the potential to deliver attractive results.