Choice Hotels (CHH): Buy, Sell, or Hold Post Q3 Earnings?

What a brutal six months it’s been for Choice Hotels. The stock has dropped 23.9% and now trades at $96.58, rattling many shareholders. This might have investors contemplating their next move.

Is there a buying opportunity in Choice Hotels, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.

Why Do We Think Choice Hotels Will Underperform?

Even with the cheaper entry price, we don't have much confidence in Choice Hotels. Here are three reasons why CHH doesn't excite us and a stock we'd rather own.

1. Declining RevPAR, Demand Takes a Hit

In addition to reported revenue, RevPAR (revenue per available room) is a useful data point for analyzing Travel and Vacation Providers companies. This metric accounts for daily rates and occupancy levels, painting a holistic picture of Choice Hotels’s demand characteristics.

Choice Hotels’s RevPAR came in at $57.23 in the latest quarter, and it averaged 2.9% year-on-year declines over the last two years. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Choice Hotels might have to invest in new amenities such as restaurants and bars to attract customers - this isn’t ideal because expansions can complicate operations and be quite expensive (i.e., renovations and increased overhead).

2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Choice Hotels has shown poor cash profitability over the last two years, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 8.3%, lousy for a consumer discretionary business.

3. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Choice Hotels’s ROIC has unfortunately decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

Final Judgment

We see the value of companies helping consumers, but in the case of Choice Hotels, we’re out. Following the recent decline, the stock trades at 13.7× forward P/E (or $96.58 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are superior stocks to buy right now. Let us point you toward a safe-and-steady industrials business benefiting from an upgrade cycle.

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