Choice Hotels International, Inc. (CHH) Earnings Call Transcript & Summary

This is Stephen Grambling at Goldman Sachs with our next session for the Travel and Leisure Conference. Thanks for sticking with us until the afternoon on day 2. We don't think you'll be disappointed as Choice Hotels is really the only asset-light franchise model that has been battle-tested, and they're once again showing how they can relatively outperform in what is a difficult environment. And with us today, we're very excited to have Pat Pacious, President and Chief Executive Officer. Pat, thanks for being with us.

Great. Thanks for having me, Stephen.

So on the point of Choice being the only franchise model to be public through the last recession, can you walk us through the unique attributes of the model that enabled it to be resilient during that period? And what similarities, differences investors should draw on this unprecedented time?

Yes. Because we're the only pure-play, both asset-light and franchise only, model out there in the lodging sector, our franchise model has us focused all the time on franchisee return on investment. And so we look at the world not just as delivering consumer demand to the top line but also what's the total cost of ownership of running one of our franchises, so that focus on ROI in times like this where you've really got challenges on the top line. If you look at our brands and the strength of those brands, they are well-known brands. We're a company that has not sort of loaded up in a lot of brands all in the same segment. We've looked at preserving the value of our brands. And if you look at what we've done most recently with our Comfort Inn brand, refreshing that entire brand just within the last couple of years, it's really set us up for strength -- a position of strength as we've gone into this unprecedented downturn. I think as a company, because we are asset-light, we really do focus on new programs that we put into our franchises around, does this really drive consumer demand? Does it drive a return on investment? And we also have been pretty pragmatic in where we put our hotels location-wise. And I think those aspects that focus on return on investment, not having too many brands all at the same price point in the same location, and our strategy of preserving our brands over time has always helped us in this downturn. We're a company that's been around for 80 years. This company survived the gas crisis. It survived Black Friday, survived 9/11, the global financial crisis. And a lot of that has come from our focus on our owners' return on investment and a continued focus in the long term about investments that bring long-term value to our shareholders.

And you alluded to really investing on behalf of your owners. And with states reopening and trends perhaps finally poised to stabilize and maybe even reaccelerate from here, what are some of the biggest challenges your owners face to reopen? And how have you really helped them to be better positioned on the upswing?

Yes. So we've been really in a recovery phase since the first week of April. So we're -- we've been in recovery phase for about 8 weeks now since bottoming out. The system occupancy bottomed out at about 28% in the first week of April. As of last -- or well, the week ending May 17, our system-wide occupancy was above 40%, which is exceeding the industry by about 500 basis points. And the reason for that is we've been really focused. We -- when this occurred, our entire team got redeployed to focus on driving top line revenue and finding the demand that was out there. So we picked up a lot of business that was COVID-19-related response business, everything from National Guard to traveling health care workers, to housing COVID-19 asymptomatic people. Across the board, our owners stepped up and met that need. And our team here at corporate was really designed to focus at driving -- finding that new business that was out there and driving it into our hotels. The second thing we did was we focused on liquidity for our owners. Their largest expense is their debt service followed by their utilities, their payroll, their taxes. So we were very much in the forefront of advocating for small business relief loans. You know it today as the PPP and the EIDL loan program. As a company, we were advocates at the administration level with Speaker Pelosi and the leadership in the Senate as well as the Treasury Secretary to really be a voice for the small business owner in the hotel space. The hotel space is made up of a variety of different investors, but 90% of our owners are franchisees qualified as small business owners. We had some challenges in the old SBA loan programs, and so we advocated very heavily to disaggregate. So if an owner had an investor in their property who was over the traditional limit for SBA, they usually are not allowed to borrow against the asset. And that aggregation rule was changed as part of the -- what became the CARES Act and the PPP loan. And then the second thing we did is we stepped up educating our owners on how to access that capital, and about 70% of our hotels ended up applying for either a PPP or an EIDL loan. People asked us, "Why not 100%?" And I think that other 30% is either in our extended-stay brand segment, which has been very resilient and run relatively high occupancy throughout the whole downturn, or they are long-term owners who've already paid off their mortgage. We have a significant number of those in our portfolio as well, where debt service is not a problem for them. Plus a lot of our owners do not lever up their assets in a significant way where a shock like this puts them in severe distress. So about 70% needed the loan. Some of those may not use it, may give it back as we get closer to recovery, but those are the types of things that we did as a company to really focus on our owners' liquidity position and also to focus on driving top line revenue and finding the share of business that was out there. And so a lot of hotels in the industry did close. But even at the worst of this, 90% of our hotels remained open. And as of last week, 97% were open, and that number has probably gone higher as we open an additional 70 hotels this week. So for the most part, the system's opening rates are back to where we were prior to the COVID-19 pandemic.

That's all great color to jump off. On the owners' business model on the balance sheet, you mentioned that you were helping them with liquidity. Do you think that they're going to change the way that they think about managing their own balance sheets longer term after things reopen?

I think for the most part, our owners are fairly conservative with regard to leverage that they put on their assets. A lot of the equity that's in them is from friends and family. Most of their lenders are regional lenders that they have decades-long relationships with. So I think from the standpoint of them getting overextended, that's not something we see in any great numbers here in our system. I think from an operating perspective, we are going to see them work with us on how do we reduce the total cost of ownership of one of our franchises. Prior to the COVID-19 hitting, labor cost was going up significantly and we were already working with our owners on ways to drive that down, things like housekeeping on demand. We're seeing more and more guests not want someone in their room. This was true prior to COVID-19, and it's probably going to be, I would think, accelerated or more high level of adoption on the other side of it. The fewer rooms you have to turn, the lower your operating costs are. And that labor and payroll cost, housekeeping is a big element of that. The other area is breakfast. Many of our hotels offer free breakfast. That has had to change in light of COVID-19, going to more prepackaged items and getting away from breakfast buffets. That's another area we're working with our owners on to provide them with the flexibility to do what's right in their market but also look for ways to cut down in cost, both the labor cost and the F&B costs that are associated with a free breakfast option.

And then on the last call, you discussed some fee deferrals. Can you remind us how -- at least provide some clarity around this in terms of the percentage of owners who might be requesting relief? Do you anticipate more support? And where do those buckets fall into? Is that the system fund? Is it the royalty fees itself?

Sure. So about 12% of our owners have engaged with us in requesting fee deferral. We did not do a blanket or programmatic, across-the-board approach. We took more of a look at the local asset, the owner, what condition they were in financially. And it allowed us to apply the fee deferral to the owners that were in most need. So again, we were focused on strategically doing it where it was needed. As I mentioned, 30% of our hotels didn't need government relief. So not everybody needed fee deferral either. We did focus early on in extending brand program deadlines, eliminating or reducing some of the fixed fee programs that we have. And then on the fee deferral program, the idea there was to focus on our owners' liquidity so that they wouldn't have to pay us today but, over the long term, could pay us back when they were capable of it. That really helped us get through the first couple of weeks of this. As the occupancy levels and the RevPAR has been building for the last 8 weeks, the need for that program has been significantly diminished. So as I said, about 12% of our owners took us up on that program. And so we've -- it's still an ongoing program if needed, but it's not something that is in very high demand the way it was a couple of weeks back.

That's interesting. And turning to pricing, how are you working with owners to appropriately set pricing? And what are you seeing in initial behavior across different segments and different regions?

Yes. So what's different about this downturn is we have a very robust revenue management team in place that we didn't really have 10 years ago. So that team has been very focused on keeping up with what is happening in each market. At the county level is really where we've had to track travel restrictions, what's allowed, what's not, what is opening back up and when those timing -- when the timing of those events are occurring, so everything from rescheduled graduations to the opening of theme parks to the types of demand drivers that our owners are going to need to be aware of. So we, first of all, stayed on top of what's happening in our local markets and making sure that our owners are aware of that. In some cases, that helped owners who had suspended operations for 14 days to decide, "Hey, let's open up a week early." So we've been very focused on that aspect of it. The second is rate integrity. And in these downturns, what you see is discounting with the hope of driving demand that's not there. So our -- what I've been really pleased to see is in the RevPAR drop that we've seen, 2/3 of it has been occupancy and only 1/3 of that has been rate, and that's held fairly true week to week. So our owners have not dropped rate to chase demand that wasn't out there. And so that rate integrity is going to be really important on the way back up. The other aspect that we're focused on is making sure that our owners are looking out at the channels that they're taking business from so that they are again not dropping rate onto distressed third-party sites, which is a very short-term game and you end up losing customer access, you end up losing a lot of the data you have on your consumers by doing that. So we've been really pleased with the response from our owners and particularly the 2,000 hotels we have in our system that are getting direct revenue management help from us here at corporate.

Great. And then thinking about the marketing and system fund, what are some of the big buckets of spending that typically go in there? And how are you repositioning the efforts to be more efficient longer term and support the owner base?

Yes. So on the marketing side, like most, we pulled down our marketing when there was no demand out there from a national advertising perspective. We have started in recent days doing more digital, more search, more social marketing, and it's been a very interesting sort of marketplace out there with such limited demand. We've learned a lot that I think is going to be really helpful for us as a company to be more efficient in our spend in that area. We've been waiting for a -- this -- as we've said on our earnings call, this is going to come back regionally, which is, in fact, what we're seeing. So a lot of our marketing is being done today at a regional level. And we'll be waiting for the correct time to bring back more of a national campaign when the time is right. On the system side of the fence, that's another big bucket of spend as a company. And we make those investments for the long term. We are investing today in new systems for revenue management. We are working with machine learning technologies to help us with price setting to help us with where to put our next hotel. So those investments are long term and they are ongoing. We've been in the middle of migrating all of our legacy systems into the Amazon cloud. We just recently put our website and our property management system, 100%, in the Amazon cloud. All of those drive cost efficiencies and redundancy for us, which is going to be really helpful for us in the long term. So we haven't slowed down the spending at all on the system side of the house. We've redeployed some projects on our road map that are more near term and actually accelerated a few of the projects that we were already working on.

That's super helpful. And then turning to unit growth, what are you seeing in the composition of net growth between gross additions separated between new construction and conversion and then attrition rates?

Yes. So our attrition rates, as a company, have always been very low. We have a 98% franchisee retention rate. Even, I mean, through this downturn, we have not seen any change in that. Usually, what happens in these downturns is you hang on to more of your franchisees than normal. On the new development side of the house, we are expecting to see a pickup in conversions, conversion hotels coming over to our brands. In the -- since this all began in the middle of March, we've awarded 70 franchise agreements during that time. 3/4 of those are conversion brands, and most of those will open by the end of this year. So that has not slowed down that part of our business. It's less than what it was last year, but it is continuing to move forward. And we do expect in times like this, given the last 2 downturns, that you do see a flight towards stronger brands. And as a company, we have some very well-known ones. I think our investors really ought to be excited by really 4 brand segments that we compete in. The first is extended stay. Our WoodSpring brand has just done extremely well throughout this crisis. It had a 60% occupancy in April, 70% occupancy in May. And that's a brand from a unit growth perspective that continues to grow. And there's a lot of continued excitement around that brand and continued interest in that from developers who used to develop hotels in other segments. They're giving extended stay as a segment, a new look. We also have our Ascend Collection, which is the largest soft brand independent -- these are for independent, boutique-type hotels that are looking to affiliate with a large chain. And that collection has grown by about 50 hotels per year over the last several years. And during downturns, again, you see independent hotels usually wanting to be part of a larger system. So we're optimistic about the growth of the Ascend Collection. I mentioned the Comfort Inn brand earlier. We finished what ended up being about a $2.5 billion renovation across all 1,600 of those hotels. And that brand is really poised for growth and is one that is well-known to consumers. So we're excited by that. And then finally, our Cambria brand in the upscale segment. That brand won J.D. Power's top ranking last year. So the consumer loves it. We've got a lot of developer interest in building upscale, select service, hotels that sit on a platform that over-indexes on leisure. So it's really well positioned given what we think the consumer travel demand, both corporate and leisure, is going to look like over the next couple of years.

And just following up on that, what are your development partners telling you about construction financing availability and construction costs? And are you seeing any delays, deferrals that might alter the cadence as you think about it over the course of this year and in the next?

Yes. So those projects that had their financing, those are moving forward, anything that was under construction. We had, early on, a few construction delays as various jurisdictions figured out what's construction and essential business or not. But take our Cambria brand. We have 25 Cambrias under construction right now. I think 3 or 4 had a 2-week delay, but they're all back moving forward. And as I said, anything that was in our pipeline that had financing, those are still moving forward because those owners are still looking at it and saying, "By the time the hotel gets built and opened and ramped, you're going to be on the other side of the downturn that's likely to follow this pandemic." I think on getting new hotel financing, that is something right now that's had a bit of a standstill on the sort of national and regional bank level. We are seeing though that those owners that are able to sort of finance things with friends and family, they still have access to that. Everybody is sort of waiting for asset prices to come down a little bit. And I think over the next 60 to 90 days, as that starts to settle out, you'll see a return to hotel financing being available for good projects, good brands with good sponsors, and we have a significant number of those in our pipeline.

So then turning to the loyalty program, where do you see the biggest opportunities on leverage through this period and keep engaged with the end consumer?

Yes. So a lot of what we were able to do, maybe think about -- the worst part of this in that sort of first week of April, we were running at 28% occupancy. That's a reflection of our loyalty program and the strength of not just the leisure travelers who were out traveling but core segments of corporate travel that traveled throughout the pandemic. So think of logistics companies, construction companies, government business and the like. And so those consumers really gave us an opportunity to show our owners the bedrock of our loyalty program and how important it is in driving their businesses forward. It also gave us an opportunity to attract new business, as I mentioned, the COVID-19 response business. So signing up those folks is something that our teams at our properties have been focused on as well. But as far as the existing consumer, we made a significant number of changes to our loyalty program to upgrade people, to extend their points, and to extend their status and actually allow them to upgrade their status if they give us an additional stay that would not have resulted in an upgrade in prior -- in the prior circumstances. So we have enriched the value of our points program. And I do expect that with the traveler who is out there now, given that we had a little bit of the playing field to ourselves, we know we picked up consumers who told us, "Thank God you guys are open because I needed somewhere to stay and I want to sign up for your loyalty program." So we know in these past 8 weeks, we've picked up additional consumers just by the mere fact of being open and being welcoming for them while they're on the road.

That's interesting. And turning to WoodSpring and Everhome Suites in the extended-stay category, you already alluded to some of the trends there both as it relates to occupancy and development, but what do you think sets your product apart from peers? And talk a little bit -- talk to us about the idea behind Everhome and how big that concept could be.

Sure. So I mean what separates WoodSpring is the fact that it's consistent. It's all new construction. It's a 122-room prototype. The business model is really the secret sauce. It's the GOP margin that's created by running an extended-stay hotel that's purpose-built for that, that is new and that has a labor model that drives a lot of return -- high returns for owners that's really hard to find in the lodging category. So the product is great, but it's also that operating model and the type of business we drive into our WoodSpring hotels that's really important. The company -- Choice has really taken WoodSpring since we acquired it, and we achieved double-digit year-over-year increases in bookings, in revenue, in conversion. So from the standpoint of the health of that business, it's a really strong value proposition for new developers. When we identified the opportunity for Everhome, it really came from the idea that there are locations in the country where the cost of the real estate requires you to drive a higher rate, but developers want to build something that has similar operating margins that we're getting from WoodSpring but that sits on a little bit more expensive real estate. So we really wanted to take our company's historic strength of understanding the midscale consumer and marry that up with the expertise we have now in extended stay. And so that's really where the concept for Everhome came from. Then when you look at the supply/demand, it's really set up nicely for Everhome's success. Only 9% of the hotel supply in the U.S. is purpose-built for extended stay despite the fact that 20% of the room nights last year came from an extended-stay or 7-nights-plus guest. So there's a huge opportunity there for us to build a brand that is purpose-built for that consumer that's out there that's not staying in the product that would be purpose-built for them and then also bringing to it the operating model that we have from WoodSpring to keep the labor costs low and keep the guest experience high.

Great. Maybe turning to capital allocation. You suspended the dividend and buyback for the year. What are you watching for to bring these components back? And how would you prioritize excess cash?

Yes. So I think what we wanted to make sure is that we look at what's happening on the OpEx side of the house. We're seeing, as I said, 8 weeks of gains in occupancy. We're seeing the sort of health of our franchisee and their cash position improve over time. And so we're really going to be looking for when we start to see something that is more of a return to normal. I mean while we're seeing business build, it's still about -- I mean last weekend was probably about 1/3 below where we should be. And so we have a little bit more to go with regard to recovery and we're also looking at what will happen next. Will there be a second wave? Will there be damage to the consumers' mindset when we get into the fall? We're still waiting to understand how much longer people are going to be working from home. When kids will go back to school, what happens with college sports and professional sports? All those things that are real demand drivers that are -- as you look around the country, you're starting to see casinos open, you're starting to see amusement parks open at reduced capacity. And so a lot of what we want to understand is, are the demand drivers that drive that travel to our hotels also going to be there with us because today, the people who are traveling are going to the state parks and they're going to the beaches, where they're going to see someone they haven't seen in 12 weeks. And so that pent-up demand is absolutely there. And we saw -- the last weekend, which is traditionally the weekend after Memorial Day, is usually less strong. It was actually stronger than our Memorial Day weekend business. So we know the pent-up demand is there and we know it's continuing to grow, but we're not at a point yet where we're able to declare victory or out of the woods yet on this virus. So I think once we have a clear understanding of what that impact is going to be on consumer travel and consumer demand, that will allow us to begin to think differently about some of our traditional capital allocation options that we've used in the past.

And perhaps as a follow-up there, I think in the last call, you referenced reducing CapEx to further improve liquidity. How should investors think about where those savings came from and whether we could see a step-up in the future relative to historical averages? And then also maybe tie in how you think about evaluating deploying key money in the current environment.

Yes. So what we did on the cost savings side of the house is we really took a look at what do we think 2021 was going to look like. So we've cut about 25% of our SG&A cost out of our business in the last month or so. And the idea was to not do this in multiple steps but to really prepare ourselves for what we thought consumer demand was going to look like in 2021. And so that was -- that's an internal forecast we used to really identify what we needed to do on that front. From a balance sheet perspective, we entered this pandemic with a relatively low gross leverage ratio of approximately 2.5x. That's below our long-term range of 3 to 4x. So we felt really good coming into this about our leverage position. We did go back out early, I guess, late last year and retired earlier our maturity that was due this year. So we don't have any near-term maturities coming up. We had refinanced that last November. To create some flexibility, we borrowed down about $300 million of our $600 million out of our revolver. And then we obtained a $250 million term loan as more of an opportunity to provide some cushion if the situation got worse. So we've been -- again, as a company, we've always kept a low level of leverage. We've always kept our options open with regard to having a lot of dry powder if opportunity were to come up. And in this case, the -- it wasn't an opportunity. It was a pandemic that had to be dealt with. So as allocators of capital, we've always been prudent on that front. And so I think as we look forward, what are the costs we would put back into the business? A lot of it would be based on is the consumer back in a meaningful way and does it make sense for us to invest further. But as I said, we really sort of looked out and made a guess on what 2021 was going to look like and adjusted our cost structure accordingly last month.

And we're just about out of time, but one other one just because you referenced the allocation of capital. How are you thinking about consolidation and if opportunities could come up as a result of this as you think about the next 12 months? And how are you thinking about the right areas that you'd want to be looking at for consolidation?

Yes. I think we've always looked at it from where are the gaps in our portfolio that would create opportunity for us. So we don't have a product in the upscale, extended-stay category. We don't play in a significant way in that sort of upper upscale world either. So those are options for us to either acquire something or eventually launch another brand when the time is right. I do think what we'll see is more multiunit packages of assets become available. I think we will see maybe some smaller chains that are looking to affiliate with larger chains. I think when you look at the size and scale that we have, it really allows us to lower the operating cost of an owner of an asset whether they own 1 asset or they own 20 assets. Those are the types of opportunities we saw in the last downturn with the pickup, packages of hotels. So I do think there'll be some of that here in the more near term. I think as far as large-scale M&A, it's really going to take a while for people to begin to understand where valuations should settle out before the bid-ask between a seller and a buyer really get close enough where a transaction could occur.

That makes sense. Well, thank you again for all the time. I know it's end of the day. We will have Brinker's CEO at 4:55, hosted by my colleague, Katie Fogertey. But thank you, everyone, for joining us, and thank you, Pat, for all the time and insight.

Thanks, Stephen. Have a great day.

You're welcome.