Don’t be influenced by hotels group’s rich valuation: it still has plenty of scope to grow

Investors tempted to lock in hefty profits by selling shares in Intercontinental should resist as the company’s solid finances put it a good position to make further gains

Our recommendation to buy Intercontinental Hotels Group (IHG) in March 2020 has proved to be a valuable tip.

Although the company’s shares temporarily declined in the immediate aftermath of our advice as the full effects of the pandemic became clear, they have subsequently soared and their capital gain since our original recommendation amounts to 83pc.

This is 53 percentage points greater than the FTSE 100 index’s capital return over the same period and it is IHG is trading on a price-to-earnings (P/E) ratio of about 26.

This may naturally encourage some investors to sell their holding and to lock in a hefty capital gain. After all, a higher P/E ratio generally means there is less scope for an upward rerating and capital returns may be more limited in future.

Furthermore, a P/E ratio of 26 is relatively high for a FTSE 100 member – even while the index is continually flirting with new record highs. However, in Questor’s view, the shares still offer plenty of scope for capital growth.

Certainly, there is now a reduced margin of safety as investor sentiment is far more buoyant than it was in the early days of the pandemic. But with the company forecast to grow its bottom line at an annualised rate of over 13pc in the next two financial years, its valuation is not as demanding as it may appear at first glance. Indeed, IHG is a high-quality business that deserves a premium valuation vis-à-vis other FTSE 100 companies.

Its portfolio of hotels is extremely diverse in terms of geographical location and price point, which reduces overall risk, while its solid financial position leaves it well placed to overcome the highly changeable demand that is a feature of the travel and leisure industry.

For example, the company’s net interest payments were covered more than 20 times by its operating profits in its latest financial year. It also has a loyal customer base that provides it with a degree of consistency as regards its financial performance, and substantial pricing power.

The company’s recently released first-quarter update showed an increase in its average daily rate of 2.3pc.

When coupled with a modest rise in occupancy, revenue per available room (Revpar) increased by 2.6pc versus the same period last year.

This was down on the growth rate of 7.6pc it recorded in the previous quarter and was largely due to a poor performance in the Americas.

The region’s growth rate was negatively affected by the timing of Easter, which contributed to a decline in Revpar of 0.3pc.

However, IHG’S performance in the Americas has improved since the end of the quarter and with US inflation likely to gradually fall to the Federal Reserve’s 2pc target, longstanding pressure on discretionary incomes is likely to ease.

Add to that likely upcoming interest rate cuts and the outlook for the country and wider region is poised to improve significantly.

Similar changes to monetary policy in response to falling inflation, as well as a continued rise in global air passenger numbers amid growing economic optimism, are also likely to act as positive catalysts on the company’s long-term performance in other regions.

IHG’S large pipeline of new rooms further enhances its financial prospects. It opened 6,300 rooms in the first quarter of the year but has a development pipeline of 305,000 new rooms that are due to open in the coming years.

They will increase its total number of rooms by around 32pc, which should have a positive impact on sales and profitability. Changes to the way the business administers its loyalty programme also have the potential to boost profits.

And with this year’s $800m (£629m) share buyback programme only 30pc complete at the time of the company’s results earlier this month, its shares have several clear catalysts that suggest further capital gains.

Therefore, investors should not be dissuaded from holding, or indeed buying, IHG after its significant share price gains prompted a relatively rich market valuation.

The company’s solid financial position, clear competitive advantage and upbeat growth prospects mean it can continue to outperform the FTSE 100 over the long run.

Questor says: Buy Ticker: IHG

Share price at close: £78.02

‘Rising air passenger numbers and growing economic optimism are likely to act as positive catalysts’