Show me the money

It's like in the film, says one analyst at a leading investment bank - "Show me the money." He's referring to Tom Cruise's fortune-seeking sports agent, Jerry Maguire. Like Maguire, when an analyst values any company these days, their main interest is cash; hotel stocks, like those of almost every other quoted company today, are valued on their earnings growth.

This is problematic for hotel companies, which are a cross between operating companies and property investments. And never more so than in the past six months.

According to research from investment bank UBS Warburg, hotel companies have underperformed the UK market by 20% since the beginning of the year. The market is attributing a low value to these particular companies for a variety of reasons, including rising domestic interest rates, concerns about oversupply and the general shift of money in favour of telecoms, media and Internet stocks.

This is because expectations for hotel companies - the multiples used to ascertain a valuation - are historically low, despite a trading picture that is far from gloomy.

Many UK hotel companies are trading at a value that is lower than the book value of their hotel portfolios and shareholders' funds. This value is expressed as net asset value (NAV) per share. Jarvis Hotels, for instance, floated in 1996 at 175p. Today its shares are worth 97p, compared with an NAV of 219p. Thistle Hotels, equally, is trading at a considerable discount to NAV. The valuation of the hotels in the accounts implies an NAV per share of 231p; in fact, the company is trading at a value closer to 130p.

Not surprisingly, some voices have begun to question the value the market is putting on hotel prices. Jarvis Hotels is one company that has suffered. Whatever measure is used - earnings, cash-flow or asset-based - Jarvis is trading on a very low valuation, despite maintaining high levels of profitability.

Jarvis has taken steps to try to improve its share-price performance, from buying back its own shares to selling off 10 of its smaller hotels. However, it has ruled out exiting the public stage - a route that is now being taken by some quoted property companies, and some asset-rich companies that have recently seen their shares trade at discounts of 30-45% on their NAV.

The comparison with the quoted property sector illustrates that lacklustre share performance is not confined to the hotel sector. Bricks and mortar generally are out of fashion, as are many other previously strong sectors such as retail and utilities.

Steven Young, finance director at Thistle, explains the impact he believes this has had on his company's share price. "Companies with a significant property content have historically been valued on a mixture of earnings and asset growth potential," he says. "Current valuations seem to be based more on earnings than asset growth, which is possibly a reflection that the market thinks property prices have peaked or that there are more fashionable assets to invest in, such as technology."

Thistle has so far paid out about £180m to shareholders in special dividends, thereby reducing its equity, in a bid to improve its share price. It is also looking at how to reduce its exposure to bricks and mortar and has struck a deal with Morrisons, a developer, to build 10 provincial hotels. The joint venture means that the hotels are financed with a mixture of equity and debt.

However, Thistle is unlikely to sell and lease back its 52 (out of 60) freehold properties. As Young points out, changes to accounting standards mean that, in the next couple of years, lease liabilities will appear in full on a company's balance-sheet. While companies can take some steps to improve their share price, many directors realise that the market's valuation must sometimes be accepted with a degree of equanimity.

David Michels, chief executive of Hilton Hotels and a respected operator in the industry, is focused on achieving long-term value for shareholders. A relative newcomer to the Hilton helm, he puts the market's rating of his stock in perspective. "The problem is that the analysts are always looking for the next recession. The industry is accused of being cyclical, but it's not. Despite their gloomy pronouncements, there has been no sign of a downturn," says Michels, adding that across the UK, industry earnings are mostly rising. "Hotels are a long-term business," he says. "It takes three years to build a hotel, so it can't be a short-term business."

Michels knows all about steering a long-term path. When he became chief executive of Stakis, its share price was about 24p, and when he left the job it was closer to 750p - though he admits it took almost 10 years to get that far. "As a chief executive," he says, "you are always under pressure to perform. But if there is pressure on you to perform immediately, it's time to get out."

Fashionable businesses

Michels' view is that there is little point bemoaning the fashion for dotcom or telecoms stocks. At the end of the day, most businesses are fashionable for a time - one day the market will return to hotels. "I don't believe that hotels are viewed as differently [from other stocks] as people in the business claim," he says. "Our job is to be at the top of the list of our competitors, not to compete with other sectors in the FTSE."

Alan Parker, managing director of Whitbread Hotels, says that the trend to assess companies on the basis of their earnings is unlikely to persuade UK hotel companies to turn their backs on holding assets in favour of management contracts, like groups such as Scandic Hotels. "We're an asset-owning company and we will continue to be so," says Parker.

Only part of Whitbread's revenues comes from hotels, and the poor performance of its share price has more to do with the company's failure to pull off a deal with Allied Domecq last year. "There has been an ebbing of support since last autumn, which we haven't really recovered from," Parker admits.

The company is endeavouring to convince shareholders that it can recover. Occupancy percentage rates are in the mid-80s at Marriott hotels in London and the mid-90s at Travel Inns. Both are seeing real rate increases against last year. "We believe our share price should be higher and we believe the market will recognise this," says Parker.

So it comes back to a waiting game. Curiously, transaction prices for hotels remain high, especially where there is a perceived shortage of supply, as there is in London. Consequently, some discount to NAV looks likely to persist for the foreseeable future. Indeed, for some of the sector's worst-performing companies, investor indifference might only be shifted by one thing - consolidation in the sector.

Thistle and Queens Moat have both been tipped as prime candidates for takeover bids, but the sector as a whole should benefit from any corporate activity.