Will Hurricanes Cloud Investor Judgment?

An overreaction by shareholders to the risks that hurricanes pose to lodging stocks is likely to create stock-buying opportunities in the aftermath of catastrophic storms. That's the conclusion reached by research firm Freidman Billings Ramsey & Co. Inc. (FBR) in a July report titled “Seeking Shelter: An Investor Guide to Hotel Portfolio Exposure to Hurricanes.” Analysts based their finding on a study of 15 lodging REITs.

About 24,500 rooms, or 16% of hotel rooms in the portfolios, are in markets designated by the insurance industry as being at high risk for hurricanes. Despite that limited exposure, the market experienced a sell-off immediately after hurricanes Katrina, Rita and Wilma in 2005. From August through October, lodging REIT prices fell 5% and shares of lodging corporations dropped 9%. By the end of July 2006, however, hotel REITs were up 25% and C-Corporations were up 18% from November levels.

“We find that lodging stocks are more consumer-sentiment driven … even though the fundamentals of the industry are more business-cyclical,” says Gustavo Sarago, vice president and senior analyst at FBR's headquarters in Arlington, Va. “That corrects itself once those fundamentals are reflected in earnings of the assets and in company reports.” That slump after the next wave of severe hurricanes may give savvy investors an opportunity to buy up lodging stocks on the cheap.

That's not to say that hotels are impervious to hurricanes; some portfolios suffered costly losses from storm and flood damage. Strategic Hotels and Resorts, for example, lost approximately 12% of its earnings and experienced a 14% stock decline when Katrina forced the closure of its Hyatt Regency New Orleans.

The swanky hotel had contributed about $19 million in annual revenue, and Strategic is still feeling the loss, says CEO Laurence Geller. But by late July, the REIT's stock was trading 5% higher than its pre-Katrina level. “My stock is probably being disadvantaged by the lack of income, but the rest of the portfolio is doing very well,” says Geller.

It's no surprise that Strategic's other properties are performing well. The hotels that survive a catastrophic storm typically see increased business for several weeks or months after the event, researchers say. Those requiring rooms during the recovery and reconstruction period can include displaced residents, relief workers, or contractors, technicians and other service providers.

“After Katrina, occupancy basically went through the roof,” says Jan Freitag, vice president at Smith Travel Research. In Baton Rouge, for example, occupancy for the first half of 2006 was 81%, up 16.7% from the first half of 2005. Total room revenue for the first half of this year exceeded $102 million, a 45% gain over the $70.8 million Baton Rouge rooms earned in the first six months of 2005.

While he affirms FBR's findings that hurricanes can temporarily boost demand for hotel rooms, Freitag points out that the extra business may be accompanied by increased expenses, reconstruction costs and added wear and tear on furnishings. “They will have higher revenues, but not necessarily higher profits,” he says.

With little new supply expected until mid-2008, however, hotel owners are in an ideal position to raise room rates and profits, Freitag says. In light of those good fundamentals to support long-term growth, Freitag agrees with FBR's prediction that post-hurricane stock dips in 2006 or 2007 will be short-lived.

“Look at Katrina, Rita and Wilma,” he says. “If you had bought on that slump, obviously you'd be better off today.”

POST-HURRICANE REBOUND

Share prices of lodging stocks fell in sell-offs triggered by Hurricanes Katrina, Rita and Wilma in 2005. But by mid-summer those stocks were outperforming their pre-Katrina levels.