Choice’s pipeline more valuable than what it’s replacing

NORTH BETHESDA, Maryland — While Choice Hotels International’s third-quarter earnings had a lot of positive news, with record quarterly revenue and improving full-year RevPAR guidance, President and CEO Patrick Pacious can’t help but look ahead to an even more optimistic future.

“Our strategic focus on more revenue-intense hotels means that the pipeline continues to be of significantly higher value than our current hotel portfolio,” he said.

Choice Hotels International CEO Patrick Pacious

Pacious said that higher revenue contribution is driven by a few distinct factors: one, that hotels in Choice’s domestic pipeline represent a 30% RevPAR premium compared to its current existing portfolio; two, that those new hotels have a higher average effective royalty rate than its current hotels; and three, that the newer hotels have a 40% higher room count per hotel than its current domestic system.

Choice CFO Scott Oaksmith, who was also on the call, said that enhanced royalty rates should keep paying dividends as the company continues to emphasize a bigger push into upscale after its acquisition of Radisson Americas and a huge push into extended-stay midscale brands.

“As we move more upstream, there is a multiplier effect, as the hotels we’re bringing into the system are 20% more valuable than the ones that are exiting,” he said. “As you get that growth in the higher-rated chain scales, there should be an accelerator on the royalty side. If you look at the building blocks for Choice this year, you can still build through those levers.”

Inside the earnings

For its third-quarter earnings, Choice’s total revenue reached $428 million, a quarterly record. The company also raised its full-year domestic 2024 RevPAR guidance by 100 basis points at the midpoint (from -2% to -1%), kept its domestic net-unit growth unchanged (approximately 2%) and also increased its guidance on adjusted EPS ($6.70-$6.87) and adjusted EBITDA ($590-$600 million).

Most of the company’s other third-quarter metrics also finished above expectations, including total gross fees ($151.2 million); effective royalty rate (5.05%); adjusted EBITDA ($177.6 million, a quarterly record); adjusted net income ($106.2 million, a quarterly record) and adjusted EPS ($2.23). Net unit growth was up 1.2% YOY and 0.6% from the previous quarter, with international being the growth driver (+3.8% YOY and +2 % from Q2).

Choice’s domestic pipeline increased to nearly 6,300 hotels, representing 495,000 rooms through Q3, including a 1.3% increase for its domestic upscale, extended-stay, and midscale portfolio year-over-year. The company’s extended-stay portfolio has grown 11.2% YOY. Choice’s international rooms pipeline increased by 21% YOY.

Conversions are also a big part of Choice’s pipeline, and Pacious said they are key differentiators for the company in winning new franchise agreements in a competitive environment. He said that over the past 12 months, Choice has opened 141 conversion hotels, a 17% increase over the same period in the prior year. Pacious also said Choice’s domestic rooms pipeline for conversion hotels grew 68% year-over-year.

“We expect our hotel conversion core competency to continue to be a key growth driver throughout the remainder of this year,” he said. 

Increasing RevPAR expectations

Pacious said Choice’s increased RevPAR expectations (he said October was great as well) were also because of continued positive trends in leisure travel and a renewed strength in corporate transient business demand, particularly in the transportation and government verticals.

As we move more upstream, there is a multiplier effect, as the hotels we’re bringing into the system are 20% more valuable than the ones that are exiting. As you get that growth in the higher-rated chain scales, there should be an accelerator on the royalty side. If you look at the building blocks for Choice this year, you can still build through those levers.

Scott Oaksmith

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Those positive trends, Pacious said, mean Choice is now anticipating a return to positive RevPAR growth in the fourth quarter.

“October was up basically 5% in RevPAR,” he said. “Some of that was hurricane-related... but it was not primarily a hurricane-driven event. We’re seeing strength in a variety of areas outside of the impacted regions. If you look at Texas, Louisiana and New England, those [areas] which are outside of the impact area, they also saw pretty significant outperformance for us regarding our expectations.

While the company won’t issue 2025 guidance until its year-end earnings next February, Pacious sounds optimistic. “When you look at what’s next for the company, it’s really those three key areas,” he said. “It’s the realization of the pipeline with about 30% of our premium hotels sitting in that pipeline. Second is the growth of our international business, which we’ve doubled that EBITDA… And we have a really strong international growth in the third quarter. And then finally, continuing to grow our ancillary revenue business (he noted examples like Choice’s credit card and various partnerships).”

What the analysts said

Analysts at Truist Securities said Choice’s earnings were ahead of consensus expectations, though still light on RevPAR.

“Fee revenue was $3 million light of consensus though this was more than made up for by greater than expected ‘other’ gains and equity in net gain of affiliates income… YOY net rooms +0.4% for domestic and +3.8% for international (global +1.2%). Looking at the various brands, we note that Radisson at -7.8% YOY was a notable underperformer, whereas Woodspring at +7.6% YOY, MainStay at +11.2% YOY, and Suburban at +15.4% YOY were major outperformers.”

Analyst Michael Bellisario of R.W. Baird said the third-quarter earnings were a beat and raise. “Full-year guidance is increasing mostly to reflect the pass-through of the 3Q24 beat, but the implied RevPAR outlook for 4Q24 is well above our forecast (likely includes some hurricane-related boost, in our view),” he said. “Net, net – not the cleanest of ‘beat and raise’ prints, but investor expectations/sentiment remain quite low/negative, in our opinion.”

Other Q3 earnings highlights

• The company repurchased 2.9 million shares of common stock for $352.9 million year-to-date through Q3, representing over 6% of the company’s market capitalization at the beginning of the year.
• Choice opened 190 domestic hotel openings through the third quarter. Of the domestic franchise agreements executed for conversion hotels over the trailing 12 months, there was a 19% increase over the prior year’s comparable period.
• Through Q3, Choice had a total available liquidity of $675.6 million, including available borrowing capacity and cash and equivalents. Over the past year, the company generated cash flows from operating activities of $122.9 million and $236.5 million, respectively.
• Platform and procurement services fees increased 4% to $16.2 million for Q3 2024 YOY.
• Q3 2024 domestic effective royalty rate increased 6 bps to 5.05% YOY.