Slowdown not meltdown: PwC podcast on the forecast for the UK hotel sector

 

Welcome to this PricewaterhouseCoopers’ podcast.  Today we’ll be discussing the issues around our latest UK Hotel Forecast as featured in the latest edition of our publication Hospitality Directions Europe.  I’m Stephen Broom and joining me are Robert Milburn, UK Hospitality & Leisure Leader, and Liz Hall, Head of Hospitality Research and Editor of Hospitality Directions Europe.

In our final podcast in 2007, we said that although we were forecasting slowing growth for 2008 and 09, there were storm clouds gathering regarding the credit crunch, making the market very difficult to read.  So I thought it maybe useful for our listeners to understand what actually transpired when the storm clouds broke and what impact this is likely to have on UK hotels’ future performance.  Robert?

Well Stephen in September we said that there was a need for caution rather than alarm, and that the credit crisis appeared to be one of liquidity rather than solvency, and by and large this remains the case.  So we’ve titled our forecast this time “UK Hotels – Slowdown not Meltdown”, because we shouldn’t lose sight of the fact that as we sit here today we have just seen 4 years of consecutive revenue per available room (rev par) growth for the UK as a whole between 2004 and 2007, and the trend line for the most resent 3 years is plus or minus 6%, making this an almost unprecedented period of stable rev par growth.  Now we’re predicting two more years of relatively good growth albeit at a more subdued rate.  I say this slightly with my fingers crossed because the financial markets do remain hard to read and what’s especially difficult to fathom is the likely knock on effect into the consumer or real economy.  So far the impact has been mainly on the deals market with limited but creeping impact on trading, and certainly from discussions that we’ve had with operators, confidence remains remarkably strong.  The question is how long will this last?  What will happen if corporates and consumers really tighten their belts?  Which is why we have taken the unusual step this time of preparing a down side scenario to sit along side our baseline forecast for 2008 and 2009. 

We’ll talk again in a moment about the likely impact of all this change on UK hotels, but first Liz, can you put us out of our misery and tell us how 2007 ended for the UK hotel market and reveal the numbers behind the latest UK hotel forecast?

2007 ended with more records broken and London in particular storming ahead, but as Robert has said, this time we are forecasting very much as slowdown rather than a meltdown, albeit quite a severe slowdown considering the growth rates that were experienced last year.  So we are looking for continued rev par growth but at a different pace to that that was experienced in 2006 and 2007.  This growth is driven by ADR gains with virtually no volume changes, indeed London may see marginal occupancy declines in 2009.  For the UK, rev par growth for 2008, we expect 4.1%, that compares to 6.5% last year.  For 2009 we are looking to 3.6% growth.  This is driven by ADR growth this year 3.8%, and next year again 3.8%.  For the provinces, this year rev par growth of 3.2%, again that compares with 2007 4.1%.  For next year rev par growth should hit 3.2%, which is not a huge amount above inflation.  This is driven by ADR growth this year of 2.8%, rising slightly to 3.1% next year.  For London, quite a different story, we don’t expect any more double digit growth.  2008 could still see 6% rev par growth, but that’s a sharp drop compared to the 11% last year.  In 2009 this slips further to 4.4% and it’s driven by ADR growth of 5.5% this year and 5.0% in 2009.  For the other cities that we forecast for, Birmingham expected to benefit from a cyclical upswing in conferences and exhibitions this year, Manchester still attracting new hotel developments which are impacting on some of the older tired hotel offerings in the city, Edinburgh, it has a large financial services sector but we still expect that the range of commercial demand in the city will buffer its hotel stock.

So that’s the figures behind the forecast.  What I would like to discuss next is the likely impact you think this slowdown will have?  Clearly it will probably have different implications across the segments of the industry and indeed across the different business models that now exist.  For example, the challenges facing the asset like brand managers or the new breed of hotel property owners will be very different.  It’s an interesting point to note that for some new entrants to the property owning market in particular this slowdown will be a first time experience. 

Let’s focus on one important area, the deals market.  Last time Robert you said the deals market was heading South.  Can you give us an update on this?

Yes it certainly went South for the winter and appears to be staying there for the foreseeable future.  I think the rules have changed rather than the game and as the extent of the US crisis is still an unknown fear, the key issues that are likely to depress deal activity centre around the re-pricing of risk, rising cost of debt and a tightened underwriting climate.  Some recent deals have staled in light of downgraded performance levels, and some because of the higher cost of debt combined with more cautious lending parameters.

I am certainly seeing a more cautious approach from lenders.  Last year loan to value ratio was as high as 80% combined with some racy valuation multiples spawned some highly leveraged deals.  What we are now seeing is LTV’s returning close to their long term average of around 65%.

From a consumer point of view as well it’s not going to get any easier for hotels.  Consumers are going to continue to demand great products and vote with their feet if the product’s found to be wanting.  Lack of confidence, economic issues, all these factors are going to make the battle for the consumer pound and indeed the corporate pound all that more difficult.  I think also getting to grips with how consumers choose, buy and recommend products is going to be important too.  For example in an age of social networks where around 11 million adults are believed to be signed up to social networks, tapping into the so called recommendation generation is going to be crucial. 

So what I would like us to discuss next is why we think this will be a slowdown and not a meltdown and what some of the factors are behind our thinking?

Well Stephen I think it is fair to say that the sector is generally in good shape, in fact probably in better shape than it’s ever been before.  As I mentioned earlier we’ve had 4 years of very stable growth, we’ve seen focused management and we’ve seen a lot of investment in product.  We have also seen far more sophisticated revenue management systems being embedded during this period, and importantly companies have successfully fought back to regain control over pricing of their inventory on the Web. 

I think strong locations will also be key and will buffer some operators.  A range of commercial and leisure demands in good locations will really help operators leverage rate over the next 18 months.  But living in a carbon footprint aware world also means tighter budget and travel policies and I believe city centre hotels may benefit over out of town locations.

And of course the other part of the equation is supply in the UK.  We can’t really ignore the fact that supply is impacting some markets and some cities.  New competition where it is an issue will hold down occupancies and could impact room rates.  Quite often it hits the older, slightly tired room stock in these cities.  However from our talks to hoteliers and from our own research we found that in general many hoteliers feel that supply is still lagging demand, and the rate at which new supply has come on line, has not created a huge problem in most centres, especially in somewhere like London.  Another aspect is rising construction costs and land prices in many areas, this has probably helped to suppress some new supply coming on, and the credit crunch too, it may stop some new projects that haven’t yet attracted finance and this could be a good thing for the sector’s long term prospects and it could actually overt a sharper fall in revenue per available room.

Finally Robert, you mentioned an alternative down side forecast scenario, can you give us a flavour of just how nasty things could get?

Yes Stephen our more pessimistic scenario is underpinned by GDP growth of 1.4% this year and 1.6% in 2009.  On this basis, provincial performance holds up better as rev par slows only slightly to 3% in both years.  In contrast London slows much more sharply, slipping to just 2.5% rev par growth this year followed by 2.8% in 2009.  This will certainly make life a lot harder for hoteliers, but perhaps less so for those who have passed off at least some of this risk to owners as part of their asset light strategy.

Well thank you Robert and Liz for sharing your thoughts with us on the outlook for the UK hotel sector over the next 18 months.  You can download a copy of the forecast as well as two other new articles at pwc.com/hospitalitydirections.   The first article entitled “Meeting Expectations” explores the latest trends and outlook for the UK specialised conference and meetings sector.  The second article entitled “Here to Stay”, looks at the outlook and drivers impacting sustainability in the travel and leisure sectors.  Thank you for listening.