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

Hi, everyone. Next up, we have Choice Hotels International. And I'm joined by President and Chief Executive Officer, Pat Pacious. Pat, thank you for joining us as always.

Stephen, great to be with you all.

We've been talking to everybody about the past year and what a difference the year has made. I would say that the Choice has actually been one of the few kind of battle-tested franchise concepts out there. But this period was still more pronounced in terms of the severity than any other downturn in history. How has the experience changed? How you think about positioning Choice Hotels maybe long term beyond thinking about just the recovery?

Yes. I think it's been a real, I think, just a reinstatement of the importance of the asset-light model, pure-play franchising, midscale, focus on drive to markets, all of the things that we've been focusing on for 80 years as a company, really came to serve us very well over the last 15 months. And where we sit today, travel's back in a big way. We have the strongest revenue-performing Memorial Day weekend the company has ever had. Saturday Memorial Day was actually the single highest revenue day in the company's history. And the weekend RevPAR was 12% higher than that same weekend in 2019. Our May RevPAR was only down about 4%, which is similar to what we saw in April compared to 2019. Again, better than our expectations. And while the whole industry is performing very well, even in the weekend of Memorial Day, we continued to take share from our local competition. Our RevPAR index numbers increased 275 basis points for the week, and then this past weekend, we actually grew RevPAR 18% compared to the weekend following Memorial Day back in 2019. As we're looking forward, that demand pattern is continuing. If you look at July 4 weekend, we're outpacing our Memorial Day performance as well. I think as you look at our business and look at our brands, we're already seeing RevPAR exceeding 2019 levels year-to-date for our economy segment. We're very close to approaching that 2019 levels in our midscale brands. And our extended stay segment in the second quarter already, our WoodSpring brand, which is our largest extended stay brand, is already up over 10% versus 2019 levels. And our Cambria brand, which is on the upscale side, again, impressive year-to-date results of 16% point share gain versus our local competitor. So across our portfolio, we're seeing a lot of strength relative to our competition. And it's really, I think, as we look forward, going to benefit as a company on the other side of this pandemic.

Well, maybe we'll dig in a little bit there. I mean maybe you could say that when things aren't broken, you don't have to fix it. I guess from a hotel operations standpoint, how has labor, marketing, things like breakfast, are these being reimagined based on the experience that you had or based on what feedback you get from consumers? Or what are the -- some of the biggest changes on the hotel operations front?

Well, as a franchisor, we focus on unit economics. So we're not just focused on driving top line revenue, but we've been focused on the total cost of ownership of our franchisees, where -- we're always focused on it. But I would say a lot of the key things we were focused on before the pandemic got accelerated as a result of it. So take driving down labor costs in our hotels, we've been using technology to drive that cost down. We've been -- we were already piloting a program when the pandemic started to do housekeeping on request, so not weekly or nightly housekeeping rather. And the pandemic only accelerated that. Franchisees have adopted it, guests have adopted it, and we have our technology that's helping our franchisees manage the labor at their hotels. We've seen a change in breakfast, going to more of a grab-and-go option, which guests seem to like, particularly in midst of the pandemic. And so some of these changes that we were sort of piloting before the pandemic, I think, are here to stay from the standpoint of driving more cost for our franchisees. The second thing is we continued to invest in our tools to drive higher revenue to our hotels. We have a state-of-the-art revenue management tool that is in the process of rolling out right now. That's helping our owners drive rate at a time when demand is starting to rebuild. And we're also using a lot more promotion tools, a lot more digital tools to help our franchisees really price their hotel rooms at the right price point in their local markets. And that's really driving, I think, this RevPAR index thing, the share gain that we're seeing across our portfolio of brands.

You also mentioned that you're always focused on the profitability of your owners. How has things like charge-outs and the way you think about marketing to the broader group evolved or even have contract structures changed? And does that vary at all by the type of property or brands that you're servicing?

Yes. We haven't seen anything that was, I would say, changed as a result of the pandemic with regard to how we're pricing our franchise agreements. The relationship we've had with our franchisees has always been strong. We have one of the highest franchisee retention rates in the industry on any given year. About 2/3 of the new contracts we award are to the existing franchisees. So it tells me they're coming back for more. But the pandemic was actually an opportunity for us to strengthen the relationship we have with our franchisees. We certainly were involved in advocating for them to get PPP and EIDL loans. We helped them sort of understand how to access that capital through training through our online platforms. And the focus on improving their NOI and GOP margins has been something that we've been focused on, not just before the pandemic, certainly, during it, really dried down those operating expenses. And you mentioned that everybody is talking about the headwinds for our owners today are labor, lumber and lending, if you're looking to build a new hotel. And so we've really been focused on that labor issue as doing the best we can to help drive down cost of running one of our hotels. And that's really, I think, going to benefit because many of those cost savings are here to stay. But I think that's really going to help improve the operating margins for our owners as we move forward.

In your interim remarks, you talked about these really strong trends being back above 2019 levels. I guess how do you think about the trajectory beyond this recovery period as you think about different segments of demand or even different layers of chain scales?

Yes. I think, overall, the 3 key trends we're looking at that are really positive in the long term is: road trips had been on the rise for the 5 years before the pandemic hit. And certainly, the last summer was a big year for road trips. This one is going to be even more so. Because of the inability to travel internationally, I think a lot more Americans are going to be on the road. Secondly, we're seeing a lot more baby boomers retire. There's some research done by Pew around the people in their sort of mid-50s to early 60s and many of them are considering retiring. That number has doubled what it was in any given year. And I think as people look at their -- the value of their home, the value of their stock portfolio, they may be more encouraged to retire sooner than expected. And those -- when people retire, and they're not traveling on their corporate accounts, they're staying in our hotels. They're staying on their own dime. So that's another trend we're looking at. And then, finally, is this work from anywhere. I do think the Zoom mentality, while we're all a little bit tired of it, there is going to be a residual effect where you're going to be able to work from anywhere and not always be in an office 5 days a week. And again, that's going to allow people to travel in those nontraditional day -- midweek days and travel for a -- from a leisure perspective. So again, I think all 3 of those are trends we're looking at that I think will feed business into our hotels for the long term.

I mentioned that I was in Mexico about 1.5 weeks ago. If I got stuck there for quarantine purposes, I may have had the beach behind me as we are hosting this. Joking aside, last quarter, you outlined expectations for acceleration in unit growth in various segments. Remind us of where your pipeline stands in various subsegments? And how you're seeing demand evolve as things reopen for the development pipeline?

Yes. So our development pipeline reached about 943 hotels. That represents about 77,000 rooms at the end of the first quarter. The highlights are really our extended stay segment. We had a huge amount of interest in that segment. There's about 310 projects in that part of our pipeline, mostly in our WoodSpring brand, but also our Suburban brand is up about 10%. And our -- we're seeing that sort of increase year-over-year, the extended stay pipeline, by about 3%. So that represents about 1/3 of it. Our upscale part of our pipeline is about 120 projects there. Our Cambria brand is expected to accelerate its unit growth this year in our Ascend Hotel Collection, which is a soft brand. It's the largest in the industry, continues to really, really do well, and particularly, in the time of pandemic, the independent hotels really looked to be part of a larger system. We do expect that to continue. And now when you look at our core midscale, there's about 475 projects there. That's about half of our domestic pipeline, the Comfort family, there is about 260 of those hotels. So what's really exciting about midscale is we got the Comfort Inn refresh done right at the end of 2019. And what's benefiting Comfort is all this sort of demand that's showing up in our hotels is really getting to see the refreshed Comfort Inn. Comfort grew by 2% last year. We took a significant amount of RevPAR share gain last year, and I'm really excited that a lot of new consumers are going to come back in to experience the new Comfort. I think that's going to help us in the long term as well.

I guess you put a bunch of the pieces together, but what's the right range of room growth that you think about targeting longer term?

Yes. We've been -- we think we'll be back in that sort of historical 3% to 4% unit growth. If you look at rooms growth, even in the first quarter, and what we -- if we took our economy segment out, we're already growing north of 3%. So we are really focused on growing in this more revenue-intense segments: extended stay, midscale and upscale. They're -- on a per unit basis, they drive more royalty revenue to the company. In many cases, there are larger room counts, higher RevPAR, higher RevPAR markets as well. So that's really where our focus is, is on those 3 separate segments. As the per -- on a per unit basis, their relative contribution is significantly higher. So that's kind of how we're thinking about it moving forward.

So just to be clear, the 3% to 4%, is that the royalty fee growth or is that room growth? And then the royalty fee is actually better than that in terms of the translation to fees?

Yes. So that's a unit growth number of 3% to 4% where we expect to be. From a royalty rate perspective, what we call our effective royalty rate, that number touched just above 5% in -- for our domestic hotels across our system. And we do expect to see probably single-digit basis point growth in our effective royalty rate as well. Again, some of that is share shift mix. We're selling more extended stay hotels where we do less discounting. Comfort, as I said, is back. And we've raised our effective royalty rate over directly for all of our brands in the last 3 years. So from a pricing power perspective, as our value proposition is improving for franchisees, we're able to drive a higher effective royalty rate at the time.

Now conversions have been a particularly strong area of the -- of development. I guess how do you think about the sustainability of that trend? And how do you think about differentiating Choice when you think about those conversions?

Yes. So our portfolio has a great mix of both new construction brands and conversion brands. If you go back to the Great Recession, the company relied more on those conversion growth as hotel lending became more scarce. And we're already seeing that this time around. If you look at our pipeline today, about 27% of that is conversion hotels; another 13% is new construction that's actually under construction; and the rest are waiting to in that sort of planned phase for ground breaks. But as I look across our portfolio today, we have the Ascend Collection, which we didn't have 10 years ago in a meaningful way. Clarion Pointe is a midscale brand, pure-play conversion, that's doing quite well. We're already at 30 of those hotels. So we have some brands in our portfolio today that we didn't have 10 years ago. And it gives our owners more options. And then in our extended stay segment, we have a nice mix of WoodSpring, which is all new construction, plus 2 extended stay conversion opportunities with Suburban and MainStay. And we just introduced right before the pandemic began, Everhome Suites which is going to be a midscale new construction product in the extended stay segment. The interest level in that is very high. Certainly, the pandemic really reinforced how resilient the extended stay segment is. It does well in good times. And it does well when times aren't so good. And so the interest level in that is growing well -- doing well also. So when we look at our portfolio, we really have an engine that can drive our unit growth during times when our top line lending is scarce, and we rely more on conversions. And we also have a nice portfolio of new construction brands to take advantage of hotel lending does return to continue to grow those brands.

Since you referenced the extended stay category, both earlier in your remarks and then again here, help us assess the longer-term drivers of demand in this category and how do we think about the long-term footprint for extended stay as a category?

Yes. I think it's -- in our segments in midscale and in economy, and that's really where our focus is on the extended stay side of the house. The demand drivers there are really people who are -- need to be in a market for a period of time. And I think what you're going to see with this post pandemic is people who are going to live in maybe a different place where their home office might be. So we are going to see some of that type of travel where you're going to see business travel where people have to be in a market for multiple weeks, but they don't want to live there. I think we could see with an Infrastructure Bill, hopefully, getting passed in the country, construction, logistics, those types of demand drivers also drive business into midscale and economy extended stay hotels. So that the demand there, the new drivers are strong. But just looking at the supply and demand overall for extended stay is showing a significant misalignment. If you go back to 2019, about 18% of our room nights in the U.S. and all across the U.S., it was about 18% of those room nights were for an extended stay of 7 nights or more. Probably, about 9%, the supply is purpose-built extended stay. So we really have this gap between customers who want to have like kitchen in there, want to have some space to move around, but not enough product out there to serve those -- that need. And so from a supply and demand perspective, that's also a real positive for developers who are considering building an extended stay hotel.

And then going back to the development opportunities, I know that you have a pool of capital that you've been allocating towards key-money or plan to allocate towards key-money to drive some growth. How is that changing coming out of the pandemic? And how do you evaluate deploying this capital?

Yes. We always look at really placing that capital again around those more revenue expense royalty intense units that can bring long-term revenue stream to the company. I don't think the pandemic has changed that deployment of money significantly. A lot of it has to do with new build as well, a lot of money is spent on new build. And as you're waiting for hotel lending to return, those are -- those 2 usually move in tandem. We do key-money on large-scale portfolios that want to come over, multiunit deals and the like. And we have used key-money in the past to put -- to incent ground breaks to move forward faster. But when we look at -- as the pandemic going to change that in a significant way, I don't see that as a significant driver, particularly because this snapback is occurring quick. And I think the underwriting of these assets is going to return quickly. And I think the banks are going to be back to lending more quickly than we've had expected. Particularly in the extended stay segment, particularly in the limited service hotel segment, both of which Choice is a significant player in. So I do think that hotel lending is going to come back for the segments that we're growing the highest compound annual growth rate in. So I think we're going to see our development numbers come back sooner than maybe other parts of the segment.

You noted the renovations that had happened kind of pre-pandemic in the Comfort brand. On the last call, you talked about the Rise & Shine prototype. What is the newest or latest iteration of this prototype? And what has been the reaction from existing owners as they assess whether they want to push their own capital to push refreshes?

Yes. So the next chapter in the Comfort Inn story is this new prototype. I mentioned, we already have 260 projects in the pipeline for that brand. Now we developed the Rise & Shine prototype with our own. So we basically set out 2 things we wanted to do. We wanted to maintain our position as the lowest cost to build in the upper midscale segment. And we wanted the product to be ready for the customer of tomorrow. And I think what we've arrived at with our prototype from the lowest cost to build, but also providing some of the expected amenities that guests of today and tomorrow really are going to have, we've come together with a nice prototype for our owners to continue to build that next chapter of development for our product, Comfort brand. And so again, this is about -- the interest level is there because owners work with us on that prototype. So a lot of what they requested in it is there. And again, that's kind of the first step of getting the interest level to start getting those new prototypes built and get them over in our Comfort prototype.

As you think about the hotel stay of tomorrow or what customers want tomorrow and being ready for that, has that evolved through the pandemic in a way that you're changing the way that you think about the prototype? Or what are some of the bells and whistles that we would come to expect if we were staying in these properties?

Yes. I think you're going to see, if you look at the Comfort prototype, you're going to see a lot more indoor/outdoor space usage. We have essentially what we're calling kind of front porch type of extension of the lobby outside. Inside, a lot more natural light. The breakfast area is bigger. The furniture is more movable. So if you need social distance at some point in the future, you have the ability to do so. A lot of the fabrics that we pick are easier to clean. So just from the standpoint of everything we learned during the age of cleanliness that we now have -- protocols we now have in our hotels that then has an impact on the type of FF&E that you do and how you think about the furniture in the lobby. And then certainly, with our front desk, doing more contactless check-in, we're piloting a few things on the technology front, again, to make that interaction with the consumer more touchless or less contact. All of those are things that were baked into the new prototype. And again, these are things that we have to sort of plan for. We want the product to be modern, but for a brand like Comfort, Comfort just celebrated its 40th year. We have to make it timeless. So we're not a company that's going to go too far down the trendiness path. That might be trendy today but not so trendy 3 to 5 years from here. So those are all the things that I think that our guests of today are walking the new prototype as well.

Well, on the international front, I realized this is still a low single-digit contributor to EBITDA, whereas peers have been -- some peers have been rapidly shifting their pipelines towards international markets. How are you evaluating the right cadence of growth in international markets? And what would lead you to accelerate growth here? And are there any specific brands that you feel like resonate better overseas?

Yes. As you mentioned, it's a pretty immaterial or modest route to our growth today. From the standpoint of profitable growth, we really think in terms of stronger effective royalty rates, stickier contracts, larger room counts, those are all things that our international teams are focused on. Certainly, the pandemic has really impacted 2 key markets. One is Europe, the other is India today. But on the brighter side, markets like Australia has rebounded very quickly. We've got really high-brand recognition there. We have a lot of scale in that market. And that market is one of the quickest to rebound, very much in line with what we're seeing now in the U.S. And their RevPAR levels are pretty much in line with what we saw in 2019. Europe, as I said, probably the most impacted from a RevPAR perspective. We are focused in that, and we have been before the pandemic, on replacing our existing units with more high quality, more revenue intense and higher room count. A lot of these are moving more into the more dense suburban-type market. But those are some of the changes that we've seen in the long term that we'll earn in our international business. Our big points of presence are in Europe and in Australia from where in the world we play outside of the U.S. And we do think there's opportunity for both of those to grow, not just with the brands we have in those markets today but some of the brands that are starting to pick up here in the U.S. in more extended stay brands are also opportunities for us in the long term to introduce into some of these internationally.

In your opening remarks, you did reference that you're working with your owners to mitigate some of the labor issues that we'd been seeing. I guess can you elaborate a little bit more on what you're seeing out there from a labor shortage or labor pressure standpoint? And how you're working to mitigate these pressures, both in the near term and then longer term?

Yes. I mean we started to see this last summer actually. Maybe as you know, we've been ahead of the industry in RevPAR performance and in occupancy levels. So our owners were already starting to see this last summer. I had the opportunity to try in the big sector [indiscernible] that the $600 was too much when they took the first CARES Act, and we've been pressuring or putting pressure on the legislator not to overdo it. We're still seeing that today. And unfortunately, that goes really through September. And again, our owners have adapted. One, we are limited service hotels. So many of the owners are actually folding their sheets and towels and making the beds in our hotels. They are -- if I look at Memorial Day weekend, they were able to handle the volume that they were seeing. This is a pretty to entreprenurial and static group of people. So they're getting through it. I'm pleased to see some of the states are actually taking those dollars or using them for a retention bonus. If you take a job and work for 90 days instead of getting the unemployment, we'll give it to you as a retention bonus at the end. So there's some interesting things going on at the state level. I think that is in a reaction to some of this. You've got all this demand coming back. You've got all these jobs that are not filled yet. But I think in the long term, we'll see that stabilize. One thing I do think we'll see, though, is because that labor is kind of pick and choose, you're going to see a higher labor cost, again, which is back to why we've been focused on driving down the total cost down as well for our owners because if they do have a higher labor force cost, we're going to have to pass it along to the consumers, and we're going to have to help them find other ways to remove cost from the environment.

So turning to capital allocation. You've resumed redeploying capital back to shareholders, including the buyback. You also listed consolidation as part of the priority list last quarter. Where are you most likely to be fishing, if you are looking at M&A? And what are the some of the goalposts that people should be thinking about in terms of the size of transactions you'd be willing to pursue?

Yes. We're a company that's always sort of looked at personally saving -- invest in our own portfolio. We did that during the pandemic. We launched Everhome Suites. We launched the prototype [indiscernible] growing. So we always sort of focus on that first. Second is we do look for opportunities. Our most recent acquisition with WoodSpring Suites back in 2018, we're seeing outsized returns with making that acquisition. So we really have been more opportunistic as opposed to let's just whoever is out there, let those buy in to be more strategic and sort of filling out our portfolio. But if I look at the white space in our portfolio, that's kind of where we would look at M&A opportunity. So today, we don't play in the upper -- upscale segment. There's some international opportunities from an entity perspective. There are a few stand-alone brands that are left out there. I do think those are likely to be -- if you just look at the total cost we're running at the top brand, total cost of the brand customers, it's getting harder and harder for stand-alone brands to continue to be on top. And then as a buyer, I'm always looking to do 2 things. One, can I grow the brand that benefits my shareholders? And two, can I improve the ROI for the owner, and that benefits the franchisees? So if we reach those 2 [indiscernible], and certainly, our WoodSpring acquisition has done that. Those are the 2 things that we look for. Not every acquisition that's out there will make sense for us. It has to be the right one for us to fit into our portfolio and the benefit of our shareholders and our brands.

And we only have about a minute left, but I'd love to just hear from you as we pull it all together, how do you think about the bull case from here for Choice as you wrap, pull it all together into above?

Yes. I think this experience we all went through made us a better company. We reduced our SG&A. A significant amount of that is here to stay. We increased the relationship we have with our franchisees, which is already strong. We entered this with probably one of the strongest balance sheets in our industry. We're probably one of the few companies in the lodging sector that didn't have to renegotiate covenant. So I think from the standpoint of the resiliency of this business model, that was big win for us. And then as I said, I think on moving forward, we're going to see a lot of guests come into our refreshed Comfort Inn. We're going to see a lot of guests in the summer experience our extended stay brands. We're going see a lot of guests experience Cambria and Ascend. So all of those are areas of growth. In an interesting way, the pandemic's ultimately going to accelerate, I think, some of our growth expectations as we move forward around both unit growth, margin improvement or we have corporate margin improvement for our hotels. And then also share gains that we're seeing from our -- at the franchisee level as well. So in a very odd way, this experience, I think, has really improved our business for the long term.

As a quick follow-up to sneak in, as we wrap it up, is there any way to quantify or to think about the increase in distribution that's come from direct channels versus leveraging OTAs as it relates to this? And then tying that back to how maybe your margin, and I should say, profitability and return profile for your brands looks like versus a comparable independent property?

Yes. I think that was one of the key things that we saw last year was that direct to our channels business increased significantly. So we were not relying on third parties. Our owners have had rate integrity. Even when demand was lower, they wouldn't chase demand that wasn't there, and therefore, hurt their pricing power. So that's improved. But I just think when you look at overall value prop, we look at Memorial Day weekend scheme, we actually signed up 56,000 loyalty program members that we had. So those are things -- and that loyalty program is now up 39 million, almost 39 million members, that value proposition of loyalty program, business delivery, all of those things have been strengthened during the pandemic. And as we see this return to travel that we're seeing, they're coming through those direct channels and they're coming through that lower cost for our franchisees, which is really going to be a benefit for them in their ROI going forward.

That's awesome. Thank you so much, Pat, and thanks, everyone, for joining us. We will be back with Hilton Worldwide in about 10 minutes. Hope to see you soon in person, Pat. Thank you.

Great. Thank you.