Over the past six months, Choice Hotels has been a great trade, beating the S&P 500 by 9.7%. Its stock price has climbed to $111.19, representing a healthy 15.9% increase. This run-up might have investors contemplating their next move.
Is now the time to buy Choice Hotels, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think Choice Hotels Will Underperform?
We’re happy investors have made money, but we’re swiping left on Choice Hotels for now. Here are three reasons you should be careful with CHH, plus one stock we’d rather own.
1. RevPAR Hits a Plateau
We can better understand Consumer Discretionary - Travel and Vacation Providers companies by analyzing their RevPAR, or revenue per available room. This metric accounts for daily rates and occupancy levels, painting a holistic picture of Choice Hotels’s demand characteristics.
Over the last two years, Choice Hotels failed to grow its RevPAR, which came in at $47.45 in the latest quarter. 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 relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 8.8%, below what we’d expect 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).
Unfortunately, Choice Hotels’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
Choice Hotels doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 15.4× forward P/E (or $111.19 per share). While this valuation is reasonable, we don’t see a big opportunity at the moment. There are better stocks to buy right now. We’d suggest looking at an all-weather company that owns household favorite Taco Bell.
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