Choice executives see first signs of conversion wave
Choice executives see first signs of conversion wave
07 AUGUST 2020 9:24 AM

While total new franchise agreements were down year over year in the second quarter of 2020, Choice Hotels International’s conversions since the start of the pandemic are climbing above its historical average, which executives say is in line with past downturns.

ROCKVILLE, Maryland—Despite seeing the U.S. hotel demand lowpoint in mid-April, executives at Choice Hotels International were pleased the company outperformed competitors in its key segments during the second quarter.

During a conference call to discuss Q2 earnings performance, Choice executives also shared their expectations for conversion rate, their conversations with franchisees about fee deferrals and their outlook for when the first signs of recovery might begin to show.

Choice reported domestic revenue per available room fell 49.6% year over year to $26.27 during the second quarter. Occupancy declined by 37% to 39.1% and average daily rate dipped 19.9% to $67.21. But President and CEO Pat Pacious said Choice’s RevPAR performance outpaced the overall industry by more than 20% during the quarter, and more than half of the company’s domestic portfolio exceeded 50% occupancy in the final week of July.

Brand conversions
Through the first half of 2020, Choice awarded 151 new domestic franchise agreements, which is down 42% from the first half of 2019. However, 80% of the 2020 agreements were signed since the start of the pandemic in mid-March and two-thirds of the agreements were for conversions. As of 30 June, Choice’s total domestic pipeline exceeded 980 hotels and 78,500 rooms.

CFO Dominic Dragisich said Choice’s conversions activity since mid-March was slightly above the company’s historical average, but it could increase, just like it did during the last downturn.

“In the Great Recession, we actually saw that 80% to 90% of our openings actually came from conversions,” Dragisich said. “So what you saw this year, it was slightly above historical (averages) but especially over the course of the last two months in particular as COVID-19 has become more widespread, you've actually seen that number of conversions begin to tick up a little bit more than even that that two-thirds rate that you've seen, historically speaking. And again, going back to the Ascend properties and Comfort being bigger conversion engines for us now that that transformation is complete, we see more revenue-intense conversions happening, as well. So we're very, very optimistic about that.”

Pacious said Choice is better-positioned heading into this downturn than it was a decade ago.

“The difference I think this time around, relative to past downturns, is just our portfolio mix is a little bit different, where we have stronger brands going into this downturn,” he said.

Discussions with franchisees
Several months into the pandemic, fewer Choice franchisees are asking for deferrals on annual franchise fees, Pacious said.

“The numbers we gave in the first quarter around the number of hotels that took us up on that offer really hasn't changed,” he said. “What's really been promising has been the significant performance we've had on the top-line revenue to our franchisees in the month of May and June in particular for the quarter and that's continued into July. We're not having anywhere near those level of conversations that we were having back in the April timeframe.”

Dragisich added the fee deferrals were negotiated to be paid back later.

“We were very strategic and surgical, but we were also very long-term-focused in nature. … You don't know if there's going to be another crunch in terms of where the franchisees are, so what we did is we deferred some portion of the entire yearly fee that would be recovered then in years two and three rather than there being this cliff, so to speak,” he said.

Choice is also continuing to find ways to advise its owners on cutting operating costs.

“In addition to a targeted and strategic fee deferral program, we sought to help further improve on owners’ profitability by optimizing the operating efficiency of their hotels,” Pacious said. “While this has been one of our core focuses for years, the pandemic has further accelerated some of our efforts. For example, we rolled out offerings, like grab-and-go breakfast, housekeeping on demand and contactless check-in that not only keep pace with rapidly changing guest expectations and enhance the safety of travelers and on-property associates, but also lower franchisees’ total cost of ownership.”

Pacious said he is taking an active role in advocating for hotel owners for more aid from the U.S. federal government in the next wave of coronavirus relief spending. This week, Pacious participated in an American Hotel & Lodging Association speaker series with U.S. House of Representatives Speaker Nancy Pelosi.

“There's two things (owners) want: One is liquidity, and the other is liability protection,” Pacious said. “A lot of the liquidity issues are obviously related to the use of PPP funds and the recapitalization of that program. Secondly, there's things that are in the tax code that could be really helpful for industry around either CapEx or operating expenses relative to cleaning supplies, things that owners are going to have to do to adapt to the new environment. And there's a significant amount of things in the tax code that can be done to actually encourage, particularly business travel, to get consumers back on the road again.”

He said the need for liability coverage is something that extends beyond the hotel business.

“This is something that is not just in the hotel space but across businesses large and small, to provide that safe harbor protection, so you don't have lawsuits that are literally putting the businesses that we've struggled so hard as a country to keep alive putting them out of business over liability related to the pandemic,” he said. “Business-interruption insurance does not include pandemics, and so the small business owners and hotel owners around the country are not able to rely on that.”

Recovery outlook
The timing and shape of recovery could take many forms, Pacious said. Until then, Choice hotels are poised to operate above the break-even point during the pandemic, he added.

“We are planning for the recovery to continue to be sporadic and regional even if an increased wave of the pandemic were to return in the fall,” Pacious said. “There are several factors we believe would mitigate the impact on our business and that we are closely monitoring. First is the duration and scope of any travel restrictions, which seem to be getting geographically narrower and localized as the pandemic wears on. Importantly, 96% of our portfolio is comprised of select-service hotels that do not have bars or restaurants, which have been a particular focus of restrictions across the country.”

When asked about his outlook for the third and fourth quarters of 2020, Pacious pointed to the uncertainty around the next federal stimulus package, if and when schools reopen and what level of sports activity will return in the fall.

“All of those at this point are unknowns, but they do have a potential if they go in the right direction to take our occupancy and RevPAR numbers and continue to move them in a direction that would outperform our expectations, or they could have a deleterious effect and do the opposite¬¬,” Pacious said.

Q2 performance
Choice reported a net loss of $2.4 million in the second quarter. Adjusted earnings before interest, taxes, depreciation and amortization was $41.1 million, down 60% year over year, according to the company’s earnings release.

Dragisich said Choice has a comfortable amount of cash on hand and assumed less debt than anticipated during the second quarter.

“As of the end of June 2020, the company has over $725 million in cash and available borrowing capacity through its revolving credit facility and has maintained a consistent liquidity position over the last three months,” Dragisich said. “In fact, despite the worst impact of the pandemic being incurred during the second quarter, the company's net debt only increased approximately $31 million, much lower than we initially expected. We continue to believe that our current liquidity position is more than adequate to weather the current environment.”

As of press time, Choice’s stock was trading at $87.49 per share, a 15.3% decrease year to date. The New York Stock Exchange Composite was down 9.5% for the same period.

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