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According to a report from the experts at global consultants Pricewaterhouse Coopers, the UK hotel sector is flourishing. 2004 was ‘exceptionally’ strong, 2005 was ‘encouraging’ and the latest forecasts conclude that moderate economic growth in the UK will drive further gains for the hotel sector in 2006.

Business visitors are returning to most major UK destinations, long haul business class flights to Britain are improving and room occupancy (which had been in decline between 2000 and 2003) seems to have turned the corner. Sector expert TRI Hospitality Consulting maintains average room occupancy in the UK rose 0.6 percentage points to 70.1 per cent in the quarter to April 2006, with an average room rate up 3.2 per cent to £77.5.

Although still early in the year, revenues per room are rising, providing evidence, according to TRI’s managing director Jonathan Langston, that ‘the hotel industry is still enjoying improved sales, albeit at a slower rate than in the past couple of years’.

The problem for investors, however, is that the downturn in the first few years of the millennium was exploited to the full by the opportunists in the private equity sector.
Indeed, such was the scale of the private equity raid on the sector (a raid fuelled by the low cost of raising debt) that KBC analyst Peter Joseph exclaims that ‘there is no hotel sector any more’. As Joseph points out, Jarvis, Thistle, Hanover, Granada and others have all fallen into private hands.

So what’s still on offer?
Despite Joseph’s sweeping statement, there is still a small band of listed operators that offer investors the promise of improved earnings, merger and acquisition opportunities and asset sale possibilities.

At the upper end of the Full List sit the likes of InterContinental, with a market capitalisation of £3.9 billion, and Millennium & Copthorne Hotels (M&C), valued at
£1.2 billion.

InterContinental, the mammoth hotel division of what was Six Continents group, owns the ubiquitious Holiday Inn and Crowne Plaza brands. In total it owns, manages, leases or franchises 3,600 hotels worldwide and remains a firm favourite of many heavy hitters in The Square Mile. The consensus forecast is that the group will post earnings of 38.18p from £233.2 million profits this year, putting the shares on a p/e ratio of 24.6, justified maybe, but pricey nevertheless.

With 91 directly-owned hotels to its name, Singapore-based M&C might be much smaller, but it is still the 40th largest hotel group in the world. It is expected to produce profits of £92.3 million and earnings of 19.76p this year, giving it a p/e of 20.2.
However, broker Citigroup clarifies that the shares are not ‘obviously cheap’ and are ‘unlikely to make much progress in the short term’. It does add though that M&C is ‘likely to extract value’ from selling off some of its individual assets.

Elsewhere on the Full List, De Vere Hotels, owner of 35 hotels including the Belfrey golf course complex, is in a bid situation. Currently priced at 798p, De Vere received an offer of around 750p per share in March this year, although management has held out and a bid in the region of 850p is believed to be in the offing from another private bidder. Broking opinion differs on the value of the company. Two of the main bulls which rate the shares worth buying are Oriel and WH Ireland, the latter believing 900p a share is fair value.

Shore Capital reckons the approach for De Vere, whose hotel assets are currently valued at 13.3 times 2006 forecast earnings, ‘highlights the continued attraction of
hotel assets’.

Hotels on the side
Fully listed Marylebone Warwick Balfour (MWB) has its fingers in a number of different asset-laden pies. Of most relevance here is the simple fact that it owns a majority share of the 16-hotel strong, uber-chic Malmaison hotel chain and a hotel investment division. Its other interests include a 57 per cent stake in Liberty, London’s pre-eminent retail store and 68 per cent of business centre operator MWB Business Exchange.

Having been loss-making for the last four years, chief executive Richard Balfour-Lynn explains MWB’s strategy now is ‘to realise cash for shareholders by the end of 2007’.
Liberty and Business Exchange have been floated on AIM already and are trading above their listing prices and the group recently sold its subsidiary Park Lane Hotel Ltd to a private investor for £105 million cash. Balfour-Lynn says the other assets, including Malmaison, will similarly be floated or sold for cash.

With the shares at 188p now, house broker KBC Peel Hunt has a target price of 223p, a 19 per cent premium to the current price. For Malmaison, the largest constituent of group value, KBC thinks ‘the next eighteen months to two years offer the greatest potential for uplift in value’ and that there is potential for more from a trade, leveraged or private sale.

Malmaison – together with its sister brand Hotel du Vin – is expanding from the 1,288 rooms of its 16 current sites, for which £105 million of equity and debt capital was recently raised. Management expects to have 20 hotels by the end of 2007 and 25 within three years. Bedroom occupancy is steady – and above the norm – at 81 per cent and average room rates are £103 at the nine Malmaison hotels and £111 at the seven HdV.

Dawnay & Shore’s tax incentives
Offering indirect access to a 20-strong estate of regional hotels, AIM-listed Hotel Company is a tax-exempt investment company that was set up to offer shareholders exposure to Dawnay Shore Hotels’ portfolio, in which it holds a 49.9 per cent stake, the other 50.1 per cent being held privately. Dawnay Shore was set up by financial services house Dawnay Day and stockbroker Shore Capital.

One element of the strategy, says Dawnay Shore’s chief executive Charles Prew, who has 47 years’ hotel industry experience from kitchen porter upwards, is to utilise the property expertise of Dawnay Day to expand the portfolio by adding hotels and by creating extra rooms in existing hotels. A recent independent valuation of the estate led to a 24.5 per cent increase in net assets to 195p a share.

Additionally, Prew points to a number of other strengths of the group. Food margins of 81 per cent he says are ‘the highest in the country’. To help maintain this level of profitability, TV chef Phil Vickery is acting as a food consultant and chefs hone their skills at courses organised by another celebrity chef, Nick Nairn. The group has a leisure club, with 30,000 members regularly ‘charging in’ after quarterly mailings, and a special events department organising tie-ins with such events as motor racing and horse racing. But Prew says inclusion on the many hotel booking websites is a core plank of policy.

Results for 2005 showed Hotel Company delivering a profit of £11.5 million and declaring a 5.8p total dividend. House broker (and part owner) Shore Capital says the dividend yield will increase from the current 3.1 per cent to 3.8 per cent and 5.1 per cent for 2006 and 2007, from profits of £2.5 million and £3.3 million respectively.
Dawnay Shore’s assets are valued at 10.4 times forecast earnings and analyst Greg Johnson claims this is a ‘valuation anomaly’.

Comfort and Clarion calls – and a low p/e
CHE Hotel Europe, a venture from the Official List, operates 59 hotels under such brands as Comfort Inn and Clarion Hotel in the UK, France, Germany and Belgium. In addition it holds the master franchise for Choice Hotels across Europe, excluding Scandinavia, amounting to 285 franchisees.

Results for 2005 showed a turnaround from a £200,000 loss to a pre-tax profit of £600,000 on turnover down slightly to £79.2 million. The company raised £18.6 million, net of costs, at 41p in January, giving it ‘the opportunity, for the first time in many
years, to set forth with a number of growth opportunities’.

A trading statement on 7 June revealed that the remodelling and refurbishment programme of the hotel properties ‘continues apace’ to give the group as strong a base as possible for the all-important autumn business period. However, the combination of this programme (which resulted in five per cent of bedrooms being unavailable for the six months to June) and the slower adjustment to a new sales structure will mean interim results out in October ‘will fall well below our expectations by approximately £1 million’. Chief executive David Cook, who has decided to retire at the end of November, reckons that all the changes and the new management at CHE will enable the group ‘to become one of the success stories of our sector’.

Updated forecasts from analyst Peter Joseph at house broker KBC specify £600,000 profits and 1.6p of earnings for this year, building up impressively to £4.4 million and 5.9p for 2007. This means the shares sit on a racy prospective p/e ratio of 24.4 for this year, but a bargain forward p/e of just 6.6 the year after.

Peel appeals for understanding
April’s full year results from AIM-listed Peel Hotels, which operates nine hotels, saw turnover grow by 19 per cent to £15 million after the acquisition of three new properties in May 2005, but pre-tax profits were flat at £1.2 million. A 0.25p dividend increase to 4.75p was proposed. Chairman Robert Peel complained that cost pressures – an item cited by most in this sector – were significant and energy costs lifted 40 per cent. This, added to ‘the negative effect of [Peel’s] predominantly seasonal acquisitions… changed what would have been a very satisfactory year into a disappointing result.’

The balance sheet showed net debt up £1.1 million to £17.1 million, hoisting gearing to 108 per cent.

Building developments are intended at much of the estate, with five planning applications submitted at the Avon Gorge after the opening of its new ‘wind and waterproof deck’. But expansion plans were vetoed in Newcastle and an appeal is not planned. Chairman Peel sees ‘considerable scope to improve performance’ and aims to keep repaying loans and disposing of non-core assets to achieve earnings growth. A 5.25p dividend is forecast but the shares are best avoided for now though.

Around the Maypole
Further down into the shallow end of the listed hotel pool is Maypole, which transferred to AIM from OFEX in April. A genuine minnow, capitalised at just £1.97 million, Maypole was founded as AJ Leisure in 2003 with one 32-room hotel near Banbury, in Oxfordshire, purchased for £2.15 million. A gastro-pub was bought and then sold as chief executive Alastair McEwen decided to focus solely on hotels, of which two have since been added, both in Norfolk, for £5 million.

McEwen says he founded the company ‘as I have been in the hotel industry all my life, building them up and selling them off, and this time I wanted to set up my own, using all the contacts I’ve built up.’ One of these contacts is chairman Simon Bentley, the ex-chief executive of Blacks Leisure. With Bentley onboard, and McEwan’s other contacts in the food and drink industry, Maypole is carving out an interesting identity for itself.

‘We’re doing “restaurants with rooms” as opposed to “rooms with restaurants” – we’re focused on the food angle. And we’ve created the Maypole brand so that even though the hotels will feel owner-run, when you come to our hotels you know you’ll have a similar experience.’

The three hotels have a total of 97 rooms, with occupancy high at 85 per cent, and McEwen has ambitions of growing the estate to around 12-15 properties. ‘I’m talking to three or four hotels with good restaurant trade at the moment,’ he reports.

Against all of this, investors need to be aware that Maypole’s debts (bank loans, other loans and debentures) stand at around £6 million. Moreover, its AIM admission document highlighted the fact that it had been ‘in breach of its covenants to the Bank of Scotland’, with only personal guarantees (to the tune of £375,000) from Bentley and McEwan convincing the bank that it should waive the enforcement of its covenants to 12 April 2007. There is the risk that the bank will ‘not continue to waive its enforcement’ after this date. High risk.