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War, terrorism and the economic downturn have put the hotel sector firmly on the radar screen of bargain hunters, opportunistic investors and corporate asset strippers everywhere. James Crux investigates

For quoted hotel operators, the immediate economic and political outlook is about as bad as it gets. The War in Iraq has reduced travel flows, US tourists are staying at home in the aftermath September 11th and depressed corporate profitability is affecting their hospitality and discretionary spend.

According to a recent in-depth survey from business advisory and accountancy firm PKF, even before the conflict in the Gulf broke out, the possibility of war had already derailed a tentative recovery in the sector.

PKF's research showed that the London hotel market witnessed a 4.3 per cent drop in occupancy to 69.4 per cent in February 2003. Furthermore, the average room rate dropped 2 per cent to £94.08p in the 181 surveyed London hotels, from £96.04 a year earlier. This combined to drag the average daily yield per available room 6.2 per cent lower to £65.29p.

Similarly, in the 698 UK regional hotels explored by the PKF survey, the average daily rate per occupied room slipped from £60.83 in 2002 to £60.46 in February 2003, pulling average daily yields per available room 2.5 per cent south at £40.86.

So what lies ahead? Well, analysts believe European operators have greater exposure to international travel than their US peers and will feel the effects of an Iraq conflict far more keenly. But many also point out that shares in US hotel plays soared after the last Gulf War, and although their European counterparts languished for a some time afterwards, improvements did eventually arrive.

De Vere is solid

One stock rated by City analysts as solid is De Vere Group. A sharp recent decline in the share price to 274.25p values the hotels and health and fitness operator (which hosted the Ryder Cup) at £306 million, a 45.6 per cent discount to net assets of £562.6 million at its September 29 year-end. Square Mile brokers believe there's value to be unearthed from its property portfolio, and there was even prior talk of a bid from Whitbread.

De Vere's final figures (unveiled in December) showed a swing from £18.1 million of losses to pre-tax profits of £38.5 million. Profits before exceptional items were 12.2 per cent higher at £37.7 million. But a reasonably gloomy AGM update in February, in which it warned geopolitical risks were still impacting the UK hotels market and flagged lower demand for its midweek conference business, dampened market spirits.

Nevertheless, Teather & Greenwood has a 'buy' note out on the stock. Analyst Mark Reed predicts profits of £42.1 million for 2003, giving 25.5p of earnings and an 11.8p pay-out for the year. This gives a forward price/earnings ratio of 10.75 and a reasonable dividend yield of 4.3 per cent.

Another fan is analyst Simon Johnson at UBS Warburg, who curiously fancies 'virtually none' of the mid range players in the sector! 'De Vere has been doing very well', concedes Johnson, 'because concerns over the Gulf War have been keeping people at home. Those who would visit hotels in, say, Brussels or Paris have been staying at its UK hotels and the company also has very low London exposure. So De Vere is one of the more defensive stocks in the sector,' he adds.

Petchey's asset ambitions

The lowly share prices of a raft of other smaller players make them attractive asset value plays, a fact not lost on property entrepreneur Jack Petchey, who made his money unlocking value from under-performing property assets and has recently been active in the mid-market hotels arena.

Through his Trefick vehicle Petchey has a 29.62 per cent stake in Jarvis Hotels, a 19.1 per cent holding in Queens Moat Houses and a 29.22 per cent stake in Hanover International, the hotels and conference centres group.

At the interim stage in November, Jarvis Hotels managed to score trading profits ahead of expectations despite the dire market. To 12 October, profits before tax and exceptional items eased off by a mere 2.5 per cent to £11.7 million. But Jarvis recently became the latest in a line of hotel groups to warn on profits, blaming weak commercial business in the UK.

Richard Thomason, the chief executive, says that full year results at trading profit level 'could fall marginally below last year's figure'. In the light of the warning, Simon Johnson at broker and adviser UBS Warburg envisages profits pre-exceptional items and tax of £14 million for the year to March 2003, translating to earnings of 6.2p a share. At 89.5p, the shares offer a prospective yield of 6.3 per cent, though the rating of 14.4 times earnings for 2003 looks a bit high.

Hanover International's figures for the half to June were uninspiring, as profits fell to just £0.5 million from £2.6 million on turnover of £14.5 million (£17.2 million) as a prior fire at its Basingstoke hotel, the fallout from 9/11 and problems with a new reservations system hit profitability. As Seymour Pierce guru Luke Ahern opined, 'Everything that could have gone wrong has gone wrong for this business but I'm always optimistic.'

He estimates a £1.9 million profit for the year to December 2002, for earnings a share of 4.2p and a rather high rating of 22.4 times. Yet, net assets at half-time were 204p a share, compared to the current share price of a meagre 94p.

Old Macdonald

Macdonald Hotels looks a solid bet if and when the tide turns. At the February annual meeting Frank O'Callaghan, the chairman, warned that profits would be lower in the first half of the year despite an encouraging first four months. But only a few months earlier, the company (which operates more than a hundred hotels and resorts throughout the UK and Spain) pleased investors with positive annual figures to 3 October and a twelfth consecutive year of positive earnings growth.

Sales including shares from its joint ventures were lifted 29 per cent to £139.7 million and pre-tax profits were boosted 17 per cent to £16.1 million. Generally speaking, its hotels in the South felt the effects of September 11th in the first half of the year. For 2003, analysts at KBC Peel Hunt are going for pre-tax profits of £19.8 million, earnings of 23p and an 8p dividend. This gives an appetising forward rating of 7.8 times and a solid yield of 4.5 per cent.

QMH best avoided

Queens Moat Houses is yet another trading well below net assets. The shares have fallen from 17.25p to 11.25p, for a market value of £44 million. This compares to year-end net assets of £85.8 million at 29 December.

But back in February, the group disappointed investors by reporting a full year pre-tax loss of £3.8 million versus a prior £4.5 million – it trotted out the familiar tale of a slump in tourism and business travel. It said it had renewed a ten-year branding deal with Six Continents on up to 26 hotels in the UK, Germany and Holland. The deal is of major significance because Germany is its cornerstone market – so the re-branding of hotels into Holiday Inns helps it maximise its presence there. But until it returns to profits, the shares are probably best avoided.

Fuller fitter

Fuller Smith & Turner, the beers, pubs and bars firm behind the 'Fuller's Hotels' brand of eight English hotels, recently pleased followers with significantly improved interim figures to September. Although there were mixed results from its managed pubs and bars, the hotels outperformed their sector.

Group pre-tax profits (before exceptional costs) rose by 20 per cent to £7.7 million and earnings were ahead 21 per cent at 20.83p. Chairman Anthony Fuller flagged-up a strong performance by the Beer Company, with profits up 23 per cent – but the group's hotels traded exceptionally well. At this arm, turnover was up 57 per cent and profits were boosted 150 per cent, largely due to the hotels invested in last year being open for the whole of the reporting period.

The existing hotels exceeded expectations, with like-for-like sales up two per cent in what remain tricky markets. Fuller said demand from UK-based business travellers remained robust, with total revenue per available room up 11 per cent to £45 – this was mainly due to the higher room rates scored at the new hotels.

WestLB Panmure analyst Douglas Jack is a fan. 'These guys have done extremely well with the hotels – there were worries about the London openings but they've hit occupancy extremely quickly'. Another facet that pleases Jack is that the business is 'almost 100 per cent freehold, it's a rock-steady number for investors'. For the current year, he has a 'clean' £16.3 million pre-tax and earnings of 45p a share pencilled in, rising to £16.9 million and 48.7p for 2004. Growth is not looking explosive but the company is buying its own shares (which is always good news) and a forward price earnings ratio of 9.6 looks appetising.

Peel provincial appeal

Aim-quoted Peel Hotels is the firm behind a number of provincial UK hotels including the Avon Gorge in Bristol and the George Hotel in Wallingford – acquired last June for £9.4 million in cash from larger owner Grace.

Bossed by Robert Peel, who used to run Thistle, the minor operator has made real strides building profits in recent times – the pre-tax surplus was lifted 15.3 per cent to £1.5 million in its last financial year. More recent interim figures to 1 September showed profits 35 per cent ahead at £989,590 on a 20.1 per cent sales surge to £5.6 million. Revenue per available room crept up by 10.2 per cent on a larger inventory of bedrooms and, at the last count, shareholders funds stood at £13.3 million – a tasty discount to its market value of £10.24 million.