Wyndham Hotels: Attractive Development Pipeline And Capital Return Policy (NYSE:WH)

Summary

This post is to provide an update on my thoughts on Wyndham Hotels & Resorts (NYSE:WH) 2Q23 results and stock. I am recommending a buy rating for WH as the development pipeline remains strong and the capital return story is very attractive. As long as WH continues to execute, I believe this is an attractive investment.

Investment thesis

In 2Q23, WH saw its RevPAR increased 7% to $46.47, leading to net revenue of $362 million and EBITDA of $158 million. While international RevPAR was up 34%, U.S. RevPAR fell 1% year over year. My focus for this quarter earnings was on the development front. In particular, the number of rooms in WH’s pipeline increased by 2k rooms, reaching 228k. It’s also worth noting that Echo Hotels and Suites, its extended stay brand, added 60 new contracts in July alone, increasing the total pipeline to 265 hotels representing 33k rooms, up significantly from the 25k rooms in the end of 1Q23.

Movements within the pipeline deserve attention as well. Midsize and larger deals make up 72% of the total pipeline, according to management, representing growth of 270bps year over year. Additionally, approximately 35% of the total pipeline has begun construction. Remember that in 2022 construction began on the first three ECHO suites hotels, which are scheduled to open in 2H23. As a result, I anticipate that 2024 unit growth will inflect further as these projects open. Given the current financial climate, wherein larger loan sizes are difficult to fund, I believe that WH exposure community banks for new developments will give them a competitive edge in the coming years. This is because capital can be raised more quickly and with less bureaucracy when decisions are made on a smaller scale and with a greater emphasis on individual connections. Finally, international pipeline accounts for 57% of the total, which suggests that WH is taking steps to diversify its revenue away from the US and take advantage of the long-term secular trend in international travel. As a result, while the United States hotel market is normalizing, as evidenced by a return to pre-pandemic levels of RevPAR (as stated by management during the call), I expect international RevPAR growth to more than make up for any declines in the United States.

Financially, WH should have no issues supporting the development of this pipeline as well, given that its leverage ratio has significantly declined from the past. Back in FY18/19, WH net debt to EBITDA was around 5x, and it is now 3x based on the FY23E EBITDA figure. The WH balance sheet is a lot stronger today, which not only supports pipeline development but also allows management to conduct share repurchases. During the 2Q23, WH repurchased $109 million of stock, almost double the $56 million it bought back in the 1Q23. Notably, management recently increased its share repurchase authorization by $400 million, which is around 6% of its current market cap. Looking at WH’s short operating history as a publicly listed company, management has bought back $15 million worth of shares, or around 15% of shares outstanding, over 4.5 years, translating to about 3% per year. With a strong pipeline indicating growth ahead and a strong balance sheet that allows for further leverage, I expect management to continue buying back shares. Let’s also not forget that WH is issuing out dividends that historically yield 2%. Just from buybacks and dividends, the stock would return 5% a year to shareholders.

All in all, I think the equity narrative for WH is clean and easy for the market to digest. WH simply needs to continue executing (building) its hotel according to cadence. This would drive EBITDA and FCF growth, which management could use to return capital to shareholders.

Valuation

I believe the fair value for WH based on my DCF model is 94.13. My model assumptions are that FCF will grow as per WH’s historical performance (using historical EBITDA as a proxy for cash). After the growth years, FCF growth will trend down to 3% as the business becomes more mature. An implied assumption that I have assumed in the model is a 2% share buyback every year, reflected in the discount rate (10% required rate of return minus 2% buyback = 8% discount rate).

Risk

The risk with WH is another incident or pandemic like COVID, which restricts travel. This would have a huge impact on consumer demand and the pipeline development cadence. Recall that during COVID, the stock dropped from $60 to <$20.

Conclusion

In conclusion, WH stock presents a compelling investment opportunity with a buy rating. The robust development pipeline and attractive capital return policy enhance its attractiveness. WH’s strengthened financial position supports pipeline development and increased share repurchases, with dividends further adding to shareholder returns. The clean equity narrative hinges on effective execution and continued cadence of hotel construction.