The Long and Short
A value proposition in Choice Hotels
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Choice Hotels’ (CHH: Baa3/BBB-) intermediate debt trades wide to the rest its low ‘BBB’ lodging peers such as Host Hotels & Resorts (HST: BBBB-/BBB) and Hyatt Hotels (H: Baa3/BBB-/BBB-). The additional spread likely compensates for risk of debt-funded acquisitions. But management has recently abandoned its pursuit of Wyndham Hotels and appears more likely to take a more measured approach to M&A with limited targets likely to trigger downgrades. Furthermore, two of CHH’s three outstanding debt securities offer step-up coupons if the issuer were downgraded below investment grade. CHH notes appear to offer good value relative to their peer group and attractive overall spreads for investors seeking low ‘BBB’ yields in the intermediate part of the curve.
Exhibit 1: CHH intermediate debt trades wide to ‘BBB’ lodging peers
Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications only
Although growth remains a priority and CHH remains acquisitive, the conclusion of the Wyndham Hotels & Resorts (WH: Ba2/BB-/BB+) pursuit appears to have taken the prospect of a highly leveraged transaction off the table, with no immediately visible candidates for a target of substantial size. Management appears more likely to continue to pursue smaller, strategic bolt-on acquisitions with more manageable impacts to its overall credit profile and the ability to pay down a modest, temporary increase in leverage.
In late 2023, CHH proposed an acquisition of competitor WH that would have valued the target at an enterprise value of $9.8 billion including the presumed assumption of $2 billion in outstanding. CHH’s enterprise value at the time was only about $7.3 billion, so the merger would have been highly transformative, potentially putting the company’s investment grade ratings at least temporarily at risk. S&P responded by placing the BBB- on watch negative, though the details of the financing mix of debt versus equity were never fully communicated. Moody’s did not place their Baa3 rating on review but acknowledged that the uncertainty was likely a credit negative that could put the rating at risk. Ultimately, the deal never materialized. WH shareholders voted down the proposed merger and CHH formally withdrew its proposed offer in March of this year, after which, S&P revised the outlook back to Stable.
Last month, CHH issued a 10-year senior note raising $600 million that helped shore up the company’s liquidity profile. The proceeds were earmarked to pay down a $500 million term loan due later this year, with at least a portion of the remainder likely to help pay down the $353 million outstanding on the company’s revolving credit facility. CHH still has an additional $647 million available to it on the revolver through 2029 as well, plus a small cash position on the balance sheet. The next senior public debt maturity is not due until 2029 ($400 million). Both the new 10-year notes and the 2031 maturity notes contain coupon step language in the event that CHH is downgraded below investment grade. Bondholders will receive an additional 25 bp of coupon for each rating notch below investment grade by either Moody’s or S&P, maxing out at a combined 200 bp.
CHH debt leverage has risen moderately over the past year, but still appears to be in the proper range to avoid risk of potential downgrades by the rating agencies. At mid-2023, the company’s gross debt/EBITDA stood at approximately 3.0x. As of the end of the first quarter of this year it had increased to just under 4.0x. Leverage is still somewhat elevated from the purchase of Radisson Americas for $675 million back in August of 2022. However, the ratio stands to improve shortly, with CHH having already pre-funded the $500 million term loan maturing later this year. Moody’s has indicated that they would not consider a downgrade of the credit unless their measure of leverage moves over 4.25x for a sustained period of time. S&P has also stated that they would likely maintain the stable outlook as long as net leverage remained in the target range of 3x to 4x, and likewise would give CHH 12 to 24 months of flexibility to get leverage back into the target range if it pursues a debt-funded acquisition.
CHH operates by franchising hotel chains and generates the vast majority of revenue from franchise royalty fees paid by its franchisees. This differs considerable from several of its lodging peers that operate more like REITs or owners of the individual properties. This also helps create more stable earnings, cash flows and profit margins even as leisure and business travel trends ebb and flow over time.
The company franchises approximately 7,500 locations and roughly 625,000 rooms total across its network. CHH has expanded internationally with about 20% of its hotel network outside the US. CHH’s brands under its franchise arrangements include the following categories: Economy segment – Econo Lodge and Rodeway; Midscale segment – Comfort, Quality, Clarion, Sleep; Upscale – Cambria, Radisson and Ascend; and Extended Stay – WoodSpring, Everhome, MainStay, and Suburban. While CHH has expanded into these different categories, the Choice and Quality brands remain the core of their operating model and account for 50% of their hotels in the US. Many of their brands are “drive-to-destination” locations and therefore less susceptible to downturns in air travel. The company is also less reliant on business travel than some of their higher-end peers, and therefore less susceptible to the secular headwinds in that segment of the market as well.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.