Douglas Jack – buy Domino’s UK shares for the long-term: Peel Hunt leisure analyst Douglas Jack has issued a ‘Buy’ note on Domino’s UK’s shares with a target price of 400p (currently 283p). He said: “Domino’s shares are on their lowest price-to-earnings ratio rating in 13 years, even though franchisee Ebitda per store has risen from £102,000 to £164,000 in the last three years. Although first-half like-for-like sales are likely to be low, we expect trading to bounce back in late 2017E and 2018E and would use weakness to buy into the company’s long term model, substantial cash flow and capacity to re-rate. Our above-consensus forecasts continue to assume 3% like-for-like sales growth for the UK in 2017E. However, this is reliant on an improvement in second-half as we expect first-half to be weak (at 1% to 2%) due to a 10.9% comparable, second quarter’s heatwave, and no acceleration in the roll-out of many initiatives: Apple Pay is expected by the end of summer (not July), with App improvements expected during the second half. Franchisee cost saving initiatives, including GPS tracking (which should also enhance the customer experience), are due to start their roll out in the second half. This is slower than we would like, but management want these initiatives to be 100% right before roll out commences. However, we believe the company’s advertising has improved since early May. Providing more emphasis on value deals, it should have generated greater traction than the two previous campaigns. Domino’s should pass on £5m of extra food costs to franchisees this year, having passed on £16m of food cost savings over the last two years. After a 4% increase in labour and delivery costs, we estimate franchisee Ebitda per store should be £160,000 in 2017E if like-for-like sales rise by 3%, and £154,000 if at 2%. For Domino’s, each 1% fall in UK like-for-like sales cuts earnings per share by just 1%. Franchisees are motivated to drive like-for-like sales due to having high operational gearing. Bundle deals (which have grown to be circa 80% of orders) generate higher average ticket value and encourage greater order frequency, which is good for franchisees. With more store splits, franchisees are now able to reduce local store marketing costs per store through scale economies. We are holding our forecasts which assume UK margins fall by 60 basis points even though they have never fallen before; and expansion (paid for by franchisees) should add 8% to sales, relative to which many costs are semi-fixed. New stores/supply chain centre should drive scale economies in production, distribution, advertising and marketing, as well as spreading central costs. In our view, the best way to invest in Domino’s is to buy on weakness and hold for the long term. We believe some bearish comments have ignored: the company’s huge competitive advantages; the potential of new initiatives; and the scale of cash flow (£1.1bn could be returned to shareholders over the next eight years). The UK’s trading/rating should recover: the US and Australian businesses operate in more saturated and just as technically- advanced environments, yet they are now generating double-digit like-for-like sales and have price-to-earnings ratings that are multiples of that of the UK.”

Jamie Rollo – London hotel market looks strong: Morgan Stanley analyst Jamie Rollo has reported a positive outlook from a field trip that examined the hotel market. He said: “We saw hotels and senior management from Whitbread (Premier Inn, UK’s number one operator/brand), IHG (Holiday Inn, UK’s number three brand, global number three operator), Accor (Ibis, UK’s number four and Europe’s number one operator), and citizenM (three hotels in London). The areas under discussion were recent trading (particularly after the recent terrorist attacks), industry supply growth, capital allocation, online travel agents, and alternative accommodation channels.

1. Strong London trading and a confident outlook: All the hotels we saw have been running at 85% to 90% occupancy, and the outlook from the general managers was very positive. While the recent terrorist attacks led to a brief demand hit, this has very quickly returned to normal with no real impact on trading, forward bookings or cancellations. This was a different tone to Merlin Entertainments’ recent caution, but hotels have a higher mix of corporate demand and domestic leisure, which tend to be more resilient than international leisure. The operators put this strength down to sterling weakness (boosting both inbound tourism and UK ‘staycations’), and stronger corporate demand, but all were surprised by just how strong London has been this year. Occupancy for the London hotel market has averaged 78.9% year-to-date (+300 basis points), a record figure in absolute terms, and this has led to strong pricing with room rates +6.5%, leading to revpar +10.7% to end May. Trading in the UK regions has also improved, with year-to-date occupancy of 74% (+100 basis points) also a record figure, and revpar +4.6% year-to-date. In real terms, versus the 2008 peak, London hotel rates are 1% higher and the UK regions are 10% lower. Premier Inn performed much closer to the midscale and economy segment in its first quarter to 1 June with +3.1% revpar, generated its first occupancy increase in three years, and sounded positive on the outlook. We are increasing our Whitbread earnings per share forecasts 1% as we move our revpar assumption from +1% to +2% this year. IHG generated 12% revpar growth in London and nearly 8% in the UK in its calendar first quarter, outperforming the market, and it showed us how it is seeing strong outperformance in its recently remodelled Holiday Inns (Generation 4 for Express, Open Lobby for Holiday Inns). Accor saw 9% revpar growth in the UK in the firat quarter, also outperforming. The UK is under 10% of revenue for IHG and Accor versus nearly 100% for Premier Inn.

2. Expansion plans seem on track: Premier Inn sounded confident in its 85,000 2020 room target and already has line of sight on this given it has a pipeline of 14,000 rooms and 69,000 rooms currently open. Its openings will be more evenly phased this year than prior years, and we showed that its new space contribution should be superior to its asset light peers with circa 6% rooms growth and circa 8% revenue growth going forward. About a quarter of room openings will be in London which is a positive mix, and it is seeing a very quick maturity of new hotels and maintaining occupancy at over 80% despite high capacity growth. IHG has around 5,000 rooms in its pipeline (on a base of 48,000 rooms), and seemed more focused on increasing revenue from its existing hotels from new room, lobby and restaurant designs. Its new midscale brand launch is unlikely to be launched in Europe. Accor is still looking for a circa 30% hotel increase to 300 hotels in the UK, but it sounded like this could be via acquisition, and it only grew by 3% net rooms last year. According to AM:PM/STR, London has circa 8,500 hotel rooms due to open this year, which would be circa 6% supply growth, but year-to-date supply growth is 2.9%, with some projects delayed, and clearly there is no oversupply issue given record occupancies. The UK regions have circa 11,000 hotel rooms in the pipeline due to open this year, equivalent to circa 3% supply growth, above last year’s 2.0% gross supply growth, but again with no apparent impact yet on occupancy. For the UK hotel market overall, circa 20,000 room openings (assuming the London pipeline all opens) would be 2.9% supply growth this year, above last year’s 2.2%, but circa 5,000 room removals (in-line with 2015 and 2016) would bring this down to 2.2% net UK supply this year, above last year’s 1.5% and the 20 year average of 1.6%. At 78% occupancy, the UK hotel market has much higher occupancy levels than other developed markets (Europe 70%, USA 66%), and half the country’s rooms are unbranded, suggesting plenty of scope for further branded hotel demand.

3. Online Travel Agents: The proportion of global revenue going through Online Travel Agents (OTAs) varies widely at 6% for Premier Inn, 16% for IHG and circa 20% for Accor. Premier Inn now captures a record 88% of bookings directly through its website, and while its low 6% exposure to OTAs has held back its revpar growth in London where tourism has been very strong this year, it sees this business as low quality and would rather build a base of direct customers who will be more loyal and higher margin. IHG launched ‘Your Rate’ last year, and while its direct web mix improved by about 1% to 21.4% (+5%), its OTA mix increased by about 2pts to 15.6% (+13%), suggesting its average digital costs increased (though offline distribution costs fell). Accor does not quantify its distribution mix so it is hard to assess its performance, but the company said that its OTA mix has stopped rising following its €225m digital investment, and that its loyalty scheme, ‘market place’ initiative, and improved systems are all making a difference. We think distribution is Accor’s biggest challenge, and as it converts to being an asset light hotelier, a key step will be proving to hotel owners that its brands and distribution infrastructure offer a more powerful consumer proposition than the OTAs.

4. Alternative accommodation channels: None of the operators thought Airbnb is having an impact on their London hotels, noting occupancy has never been as high, and none sounded particularly worried. The companies said there is little overlap in terms of product, with the average hotel stay one to two nights and mainly corporate, whereas Airbnb is longer duration and mainly leisure. They also noted that recent regulatory changes to stop short-term lets help, and pointed to hotels’ superior security, fire, and safety standards. One hotelier even said that Airbnb is increasing the overall travel market by encouraging more travel, and this could be a positive for hotels. Our research is more mixed, suggesting around half Airbnb’s growth is coming from hotels, and hoteliers need to avoid complacency.

5. Capital allocation: Premier Inn’s capex plans have been moderating, as it has reduced the average cost of its ID4 room conversion programme so maintenance capex has dropped back to in line with development and aquisition, and it is now part funding its heavy expansion capex with a rolling sale and leaseback programme. It is also increasingly focused on efficiency, and a slide in its FY17 results revealed a 220 basis points efficiency saving in Hotels & Restaurants, equivalent to circa £40m. The focus at Accor is its planned separation of its owned and leased hotels in the €6.6bn ‘Booster’ portfolio. The timetable remains to sign in the summer (we assume late summer), and the company seems more focused on maximizing value over extracting cash as it says it is not looking for large acquisitions, suggesting it will sell closer to 50% than say 80% (we model 70%). Either would take the hotels off balance sheet though, and a good headline price helps sum-of-the-parts support (we assume a conservative €6.0bn). This suggests about €4bn cash received (including a new €2bn debt pushdown) rather than the €5bn we model, which post €1bn deleverage should fund a €1.0 to €1.5bn cash return. IHG enjoys an asset light model, but in markets like Europe which tend to be owned/leased driven the hotel competition is also providing the capital (rather than third party owners), making it harder for asset light hoteliers to keep up. 

View on the major hotel stocks: We see Whitbread (Overweight, 4,700p) as a high quality company, with market-leading positions, a strong roll-out story (we estimate circa 8% sales growth from new space), scope for efficiency gains, levers for improved operational performance, and it is trading on a significant discount to its sum-of-the-parts. We nudge up our earnings per share forecasts 1%. We recently downgraded IHG (PT 4300p) to Underweight on subpar space growth and slow revpar growth, and we note waning interest from Chinese mergers and acquisitions, yet the shares trade at 13.3 times 2018 EV/Ebitda and 22 times priice-to-earnings ratio, in line with peers. Accor (Overweight, PT €45) is our top pick in the hotel space – it is enjoying the strongest revpar growth (we recently upgraded forecasts here), we see a positive catalyst from it exiting ‘Booster’ and going asset light, and it has an attractive valuation (12.0 times FY18e EV/Ebitda, 16.5 times price-to-earnings ratio, assuming a €6.0bn gross asset value for ‘Booster’).”