InterContinental Dividends

When growth slows, you should stay away from travel-related stocks, or so says an investing axiom.  That category includes airlines, car rental companies and hotels. With the International Monetary Fund warning about the potential for an “economic derailment,” you’d think travel would be taking a beating, but you couldn’t prove that with travel stocks.

Although operating revenue was virtually flat for U.S. airlines last year thanks to lower fares, traffic grew 4.4% while fuel prices plunged. As a result, the 10 publicly traded U.S. airline stocks collectively earned $23.2 billion before taxes last year, a 6% year-over-year increase. Global passenger traffic was up 6.5% in 2015. That’s not too shabby for a “weak” year.

ihg graphicData from the International Air Transport Association also shows that premium traffic, which are business- or first-class fares for primarily business travelers, also rose 4.5% last year. Premium traffic is expected to rise at least 3% this year, with overall global passenger traffic likely to gain at least 7%.

You’re probably thinking that I’m going to hit you with an airline stock recommendation, but I’m not. We think the real money to be made is when all those travelers reach their destinations.

You Gotta Sleep

Everyone needs a place to sleep at the end of the day. And although airlines can post some pretty impressive profit margins in good years, such as when fuel costs are down, those margins are usually more luck than certainty. Hoteliers, on the other hand, have much better control over their cash flow, especially if they enjoy serious economies of scale.

There are about 15.5 million hotel rooms worldwide and InterContinental Hotels Group (NYSE: IHG) controls a big block of them, supporting its 3.5% yield. With InterContinental’s roughly 744,000 rooms in more than 5,000 hotels spread across 100 countries, analysts reckon that the company controls about 5% of existing rooms worldwide. Based on expansion plans, that share will grow to roughly 15% over the next decade or so.

You may wonder how a single hotelier can hold so much clout, especially if you don’t recognize the InterContinental name. But consider its brands; Holiday Inn, InterContinental, Crowne Plaza and Staybridge should all be familiar to the regular business traveler. InterContinental’s growing Kimpton and Hotel Indigo brands are probably better known to millennials, and you might recognize EVEN Hotels if you’re a health nut.

Lifestyle Hotels

Call me a traitor to my generation, but I actually had to look that last one up. Catering to the health-and-wellness set, the fare in EVEN’s restaurants runs along the lines of brown rice and tofu, and the hotel even offers in-room gyms as an amenity. I, on the other hand, think of steaks and cream sauces, along with bourbon and cigars on patios, as selling points. To each their own, I guess, but I plan to enjoy my travels to whatever extent my LDL and triglyceride levels will allow.

While natural eucalyptus fiber bedding might not be my cup of tea, InterContinental knows there’s a market for that and many other differentiating experiences. The novelty of InterContinental’s brands is one reason why they are some of the most sought after in the industry; quality is another. To ensure that travelers continue rating the brands favorably, the company has no qualms about dumping some of its total room count if they’re not up to par.

Roughly three-quarters of InterContinental Groups rooms are operated under franchise agreements and just over a quarter of those are under management contracts with the group. That makes the hospitality group extremely “asset lite,” in that it doesn’t actually own most of the properties it collects revenue from. In fact, more than 95% of profits are from fees.

The upside is that the arrangement generates extraordinarily high returns on capital, typically in excess of 25%, while the company’s net income margin has averaged better than 30% over the past five years. Earnings have also grown well in excess of revenue, averaging 36% and 2%, respectively, over the same period. Revenue grew 8% last year alone, with profits up 11% while earnings per share shot up 19%.

That growth has been a boon for income investors who have realized 9.8% dividend growth over the past five years and gotten a 10% boost in 2015’s dividend alone.

The hotel group also declared a $1.5 billion special dividend in a show of strength in what many still perceive as a shaky economy.

With travel expected to remain strong this year and next, we believe InterContinental can keep growing. At the same time, the hotelier continues to expand those brands that cater more to millennial travelers. Add all of that up and we should see strong dividend growth for years to come.

Buy InterContinental Hotels Group under $45.

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