Our recommendation to buy InterContinental Hotels Group (IHG) in March 2020 has proved to be a highly profitable move.
Although the company’s shares temporarily declined in the immediate aftermath of our tip as the full effects of the pandemic became clear, they have subsequently soared.
Today, 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. As a result of its index-thumping performance, IHG currently trades on a price-to-earnings (P/E) ratio of around 26.
This may naturally prompt some investors to determine that now is the right time to sell their holding in order to lock in a hefty capital gain.
After all, a higher P/E ratio generally equates to less scope for an upward rerating and means 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 firm’s 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 anywhere near 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-listed companies.
Its portfolio of hotels is extremely diverse, both in terms of geographical location and price point, which reduces overall risk, while its solid financial position means it is well placed to overcome highly changeable demand that is inherent across the travel and leisure industry.
For example, the firm’s net interest payments were covered over 20 times by operating profits in its latest financial year.
It also has a loyal customer base that provides a degree of consistency to its financial performance, as well as 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, this meant that revenue per available room (RevPAR) increased by 2.6pc versus the same period of the prior year.
This was down on a growth rate of 7.6pc recorded in the previous quarter and was largely due to a disappointing 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 set to gradually fall to the Federal Reserve’s 2pc target, longstanding pressure on discretionary incomes is likely to ease.
When coupled with upcoming interest rate cuts, the outlook for the country and wider region is poised to significantly improve.
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 set to act as positive catalysts on the firm’s performance across other regions in the long run.
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 still has a development pipeline of 305,000 new rooms that are set 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.
Similarly, changes to the way the business administers its loyalty programme have the potential to boost profits.
And with this year’s $800m (£629m) share buyback programme being 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 are ahead.
Therefore, investors should not be dissuaded from holding, or indeed buying, IHG after its significant share price gains have prompted a relatively rich market valuation.
The firm’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
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