Corporate America, after years of spending cutbacks and its own version of austerity budgeting, is finally beginning to loosen the purse strings when it comes to travel budgets. That’s good news for hotel owners and operators worldwide, raising the prospect of rising occupancy rates, revenues and profits. Among those likely to celebrate this trend is InterContinental Hotels Group (IHG.L), owner of well-known chains like InterContinental Hotels, Crowne Plaza Hotel and Holiday Inn. Although the company has its headquarters in the United Kingdom, and European travel spending is weak (reflecting the continent’s economic problems), InterContinental’s European operations make up only 14% of its overall profits while InterContinental is expanding in the lucrative Chinese market. That foray into new territory, combined with an increase in corporate spending, has helped InterContinental post higher earnings. Yesterday, the company reported that its profits in the first quarter doubled to $154 million from $69 million in the year-earlier period, and that is revenues and operating profit also jumped. But is that pattern of strong earnings sustainable? The answer, based on the company’s strong StarMine Earnings Quality (EQ) score of 87, appears to be “yes”.

StarMine uses computer-driven models to analyze the financial statements of thousands of publicly traded companies, and to calculate a proprietary StarMine Earnings Quality (EQ) scores for each of those businesses. Those companies that record the highest StarMine EQ scores are the most likely to be able to sustain their past earnings track record. (For a more detailed explanation of this model, please refer to this recent article about the earnings quality of American Express.) This examination of InterContinental Hotels Groups (IHG) earnings is the next in a series of articles looking at the earnings quality of European-based companies that rank either especially low or high on this quantitative yardstick.

Source: Thomson ONE / StarMine

InterContinental has emphasized strengthening the value of each of its corporate brands. One example is the recent North American advertising campaign featuring ordinary people popping up garbed as surgeons or in other roles requiring tremendous professional expertise, only to reveal that they don’t have any formal qualifications for what they are about to do – but that they were smart enough “to stay at a Holiday Inn Express last night.” The profit margins at InterContinental (represented by the blue line in the chart above) have been rising since January 2010 and stood at 32% as of December 31, 2011. In the just-reported first quarter, operating profit margins dipped slightly, to a still healthy 29%. The operating margins were higher than a year ago in all its geographical areas, but the central division that represents the costs of global functions saw increased expenditures, bringing the operating margin down a notch. If InterContinental can keep these costs in check, look for the operating margins to remain strong.

Those high margins reflect the company’s ability to charge higher prices for its rooms. That is a marked contrast to the rest of the industry (represented by the gold line), where operating profit margins have been falling steadily for the last five years. In March 2012, the industry median operating profit margin was a remarkable 22 percentage points below that of InterContinental. Although InterContinental’s operating margins fell slightly in this period, the median for the rest of the industry fell even more. That gap is a sign that the company’s earnings are likely to be sustainable over the coming year or so.

Source: Thomson ONE / StarMine

As seen in the chart above, InterContinental generates strong cash flow from operations (CFFO), nicely complementing its strong earnings. In the quarter ended December 31, 2011, the company reported net income of $126 million, while its CFFO was even higher, at $189 million. That pattern changed slightly in the first quarter, as InterContinental reported higher net income of $154 million for the period, despite the fact that its CFFO fell to $20 million. Those figures aren’t very worrying. This isn’t the first time that InterContinental has reported sharp declines in first-quarter CFFO: in the first quarter of 2008 and again in 2010, CFFO was slightly negative and significantly below net income. (The red segment of the bars in the chart above represents the amount by which CFFO fell below net income). And yet in these periods, the company reported CFFO that was significantly higher in the remaining quarters of both of those years. Richard Solomons, InterContinental’s CEO, pointed out on his latest conference call with analysts and investors that the first quarter tends to be seasonally the weakest for the company – and yet this year, both revenues and net income were strong. The green sections of the bars in the chart above represent the amount by which CFFO exceeds net income. The more earnings are backed by strong cash flows, the more sustainable they tend to be going forward; after all, the company needs robust cash flows in order to have the capital available for the upkeep and renovation of its hotel properties. That’s why this is one of the factors that leads to InterContinental’s very high EQ score.

Solomons, InterContinental’s CEO, identified a number of factors that he believes will drive the company’s earnings going forward during recent quarterly earnings conference calls. In the immediate future, the company can look forward to a boost in revenue and profits from the London Olympics, as demand for hotel rooms soars and puts pricing power firmly in the hands of the company. InterContinental also will benefit from “increasing levels of disposable income due to growing middle classes and aging populations, growth in airline capacity and demand, increasing numbers of international tourist arrivals, and the growing numbers of people using the Internet around the world” to book their vacation and business travel, Solomons told investors and analysts. (See Thomson Reuters StreetEvents for the rest of the transcript). Add in the growth in the Chinese market, and the company sees its future prospects as being very rosy indeed.

It isn’t just demographics that are buoying InterContinental; for instance, the company has reduced its debt load by a third (from $2.2 billion to $700 million) since 2007. While the global economy gives some grounds for anxiety about the industry, InterContinental will meet any challenges armed with a strong balance sheet and stable earnings. Its EQ score of 87 indicates that the company is likely to continue to see strong earnings in 2012.

 
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