April 10, 2012 Americas: Lodging Equity Research The essentials of lodging investing Industry context This is the place either to start research on this diverse $128 billion industry or to brush up on a specific industry topic. We explain what to look for in a lodging franchise, detail the most pressing questions facing the industry, and discuss operating metrics and profit drivers. Steven Kent, CFA (212) 902-6752 [email protected] Goldman, Sachs & Co. Goldman Sachs does and seeks to do business with Eli Hackel, CFA companies covered in its research reports. As a result, (212) 902-9672 [email protected] Goldman, Sachs & Co. investors should be aware that the firm may have a conflict of Robert Pokora interest that could affect the objectivity of this report. Investors (212) 902-2632 [email protected] Goldman, Sachs & Co. should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non- US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research April 10, 2012 Americas: Lodging Table of Contents Overview: What’s new in this issue 3 From the analyst’s desk: Hotel stocks’ outperformance maybe measured in years not months 4 What could go right? 7 What could go wrong 11 Industry profile 13 Size, segmentation, and history of the lodging industry 14 How hoteliers make money and generate returns 22 Lodging fundamentals 26 We expect the Marriott brand to begin to pick up vs. its peers; Courtyard should benefit from refreshes 33 How big is “big”? Potential earnings power 39 Detailed assumptions and models surrounding our analysis 43 Ways to grow lodging companies 47 Supply is still not a concern in the United States 49 *New* While supply growth is low, the US still represents a great growth opportunity for the brands 54 A closer look at timeshare operations 60 A closer look at timeshare operations 60 A look at hotels from a global perspective 69 *New* Global c-corps and REITs with gateway exposure to benefit from growing Chinese travel 73 A closer look at lodging REITs – One of our favorite ways to directly benefit from the recovery 82 Key industry risks 84 Lodging consumer characteristics 85 Analysis of industry competitors 86 Top 10 brand franchise characteristics 88 What to ask company management 89 Valuation 90 Key earnings drivers 94 Economic and demand indicators 95 Analyzing lodging performance 96 Appendix I: Industry terminology 98 Disclosure Appendix 100 Goldman Sachs Global Investment Research 2 April 10, 2012 Americas: Lodging Overview: What’s new in this issue This revised lodging primer contains several new items, including an analysis and discussion of the following topics: From the analyst’s desk In the analyst’s desk section of the revised lodging primer we explain why we believe that outperformance may be measured in years, not months. While supply growth is low the US still represents a great growth opportunity for the brands In this section we wanted to see what brands were still being built and which ones were able to get the most conversion activity. While there has been and we expect there will continue to be low supply growth in the US it is still a market that should open 75,000 net new rooms over the next three years, and it provides a good opportunity for brands to grow their units through both new builds and conversion. Global c-corps and REITs with gateway exposure to benefit from growing Chinese travel We took another look at the Chinese hotel market on both an intra country as well as outbound level. While it is almost cliché at this point for the large brands to talk about how many hotels they have in the pipeline in China, the fact is that demand is growing extremely rapidly both intra China as well as outbound. We think both the c-corps and REITs will benefit from this trend. Goldman Sachs Global Investment Research 3 April 10, 2012 Americas: Lodging From the analyst’s desk: Hotel stocks’ outperformance maybe measured in years not months In the next few pages we lay out our thesis for continued hotel stock outperformance. After a difficult 2011 when the group underperformed, 2012 is off to a strong start with hotel stocks showing outperformance. In the next few pages we note that the thesis has not changed much, and might even be viewed as boring, but that assessment should not dissuade investors from buying this sector. We are as confident about the group’s potential for outperformance as when we upgraded it in May 2009. The lack of supply and steady demand should lead to continued earnings and alpha growth. Steady should not be viewed as uninspiring Low supply growth We would continue to be broad-based buyers of the hotel sector as we expect demand to almost always leads surprise to the upside while the slow supply growth environment takes away at least half to stock of the historical risk of the sector for the next few years. The lack of supply as a risk should outperformance. not be minimized as we note that hotel stocks have historically trended higher when supply was trending lower (see Exhibit 1). At the same time, demand trends also appear to be improving with steady employment increases in the US, continued solid demand in Asia, and Europe trends coming in slightly better than low expectations. Exhibit 1: Lodging stocks have generally gone higher when supply growth is low Lodging Index includes Marriott, Starwood, Hyatt, Hilton, and Host 900 5.0 Buy stocks when supply is low or growth ...sell stocks when supply growth is is declining... above its historical growth growth 800 4.0 700 600 3.0 500 2.0 400 300 1.0 200 0.0 100 0 -1.0 Nov-91 Nov-92 Nov-93 Nov-94 Nov-95 Nov-96 Nov-97 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 May-91 May-92 May-93 May-94 May-95 May-96 May-97 May-98 May-99 May-00 May-01 May-02 May-03 May-04 May-05 May-06 May-07 May-08 May-09 May-10 May-11 Lodging Index US Supply Growth Source: FactSet, Smith Travel Research, Goldman Sachs Research estimates. In some ways hotels, where our thesis has largely remained unchanged for the last three years, are becoming steady performers, especially relative to the other areas of our Goldman Sachs Global Investment Research 4 April 10, 2012 Americas: Lodging coverage. But we think steady can be good, especially if it means solid appreciation over the next couple of years. This is exactly what we are forecasting as we think the real contrarian call right now is that the lodging cycle will be measured in years not quarters. At the core of our bullish call on hotels stocks is our belief that supply growth will be lower than employment growth. Simply put, more people with jobs versus more rooms opening is good for hotel operations and stocks performance (see Exhibit 2). As this trend plays out portfolio managers should view these stocks as evolving growth/cyclical names with multiple legs rather than a trade. Our view is your should own the cycle as long as it lasts. Exhibit 2: Employment growth is outpacing supply growth yoy % change in US supply (TTM) vs. yoy % change in US employment Employment growth 4.0% outpaces supply growth. 3.0% 2.0% 1.0% 0.0% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 2009 2010 2011 2012E -1.0% -2.0% Based on our GS economic team's forecast for employment and our forecast for US room supply, we expect employment growth to be greater than supply growth throughout 2012. -3.0% -4.0% -5.0% US yoy room supply growth Employment growth yoy Source: Smith Travel Research, Bureau of Labor Statistics, Goldman Sachs research estimates MAR, HOT, IHG, HST, We are Buy rated on Marriott (CL-Buy), Starwood, InterContinental, Host, and LaSalle as and LHO are our stocks that will benefit from this environment and because they are generally favorites. geographically diverse. In addition, these stocks benefit from improving operating leverage given a shift toward more rate-driven RevPAR growth. They should also benefit from expense reductions that were implemented during the downturn, but we admit this is the one part of our thesis that we have seen less evidence of. Although we are intrigued by a number of mid-cap stocks, we have decided to stay on the sidelines on these name as they do not provide the diversity of earnings stream due to geographic or price point concentration. The reasons hotel investing, at its core right now, is maybe relatively uneventful: First, we get supply data going out for the next three years, and currently in North America we are at a virtual standstill (see Exhibit 3-4). Investors do not have to even debate whether a little bit of supply will negatively impact trends or certain markets. It is just not happening. Goldman Sachs Global Investment Research 5 April 10, 2012 Americas: Lodging Exhibit 3: We expect supply growth in the US to remain Exhibit 4: The number of rooms under construction at historically low levels remains at historical lows in the United States US Supply growth over time Rooms under construction in the United States 1 350 We expect supply growth to continue to remain frozen through 9.0% 2012 as growth levels have been near zero since 2011.