Fitch Ratings has affirmed Starwood Hotels & Resorts Worldwide Inc.'s (Starwood) ratings as follows:
--Issuer Default Rating (IDR) at 'BB+';
--$1.5 billion senior unsecured credit facility at 'BB+';
--$2.7 billion of senior unsecured notes at 'BB+'.
The Rating Outlook is revised to Positive from Stable.
The affirmation and Outlook revision reflect the strong recovery in lodging demand trends, which continues to gain traction and has exceeded the expectations of Fitch and most industry observers heading into 2010. Further, given the highly cyclical nature of the industry, the ratings incorporate Fitch's macro-economic outlook, which calls for annual U.S. GDP growth of 3.2%-3.3% from 2011-2012, with world economic growth at 3.0%-3.3% over the same time frame. Finally, the ratings reflect management's continued efforts to support its balance sheet, the repositioning of its timeshare business, and the company's financial flexibility and publicly-stated commitment to return to investment-grade over the next 12-24 months.
The Positive Outlook incorporates Fitch's expectation of a multi-year lodging upcycle, Starwood's continued focus on debt reduction, and the longer-term transition to a more 'asset-light' business model. Given Fitch's current outlook and Starwood's business risks, a return to investment grade is predicated on sustaining core lease-adjusted leverage under 3.25 times (x) (excluding financing profit and debt) and consolidated lease-adjusted leverage under 3.75x (including financing profit and debt), which is achievable by 2012. As of the end of 2010, Fitch calculates core lease-adjusted leverage of 3.8x (excluding financing profit and debt) and consolidated lease-adjusted leverage of 4.2x (including financing profit and debt). Although not expected, ratings could be pressured and/or Outlook stabilized if economic trends deteriorate meaningfully, or management shifts its stated financial policy.
Fitch's base case continues to incorporate an improving macro-economic recovery characterized with elevated unemployment levels through 2012. However, lodging companies are more heavily weighted to the corporate sector and Fitch expects continued positive trends relating to corporate profitability and corporate liquidity, providing support to business travel demands.
POSITIVE INDUSTRY OUTLOOK
Following the trough revenue per available room (RevPAR) decline of 17% in 2009, U.S. industrywide RevPAR grew 5.4% in 2010, but remains 14% below the 2007 peak. Fitch's base case currently assumes further RevPAR growth of 5%-7% in 2011 and similar growth in 2012. U.S. supply growth decelerated to roughly 2% in 2010 and is expected to slow further to below 1% in 2011-2012, substantially below the recent peak of roughly 3% in 2009 and the long-term historical average annual pace of about 2%. As a result of the favorable supply-demand outlook, hotel property-level operating performance should improve significantly in 2011-2012. Timeshare contract sales declines have subsided, development pipelines have been downsized, and the ABS market has been accessible resulting in a more favorable free cash flow (FCF) outlook for that segment.
Importantly, pricing power has returned earlier than expected, as the industrywide average daily rate (ADR) has been consistently positive since mid-June of 2010. Initial demand stabilization in late 2009 was driven by leisure travelers who were attracted by lower prices, leading to flattening occupancy. Beginning in early 2010, more profitable business transient demand has improved and drove the better than expected demand recovery. Although the outlook for U.S. consumer spending remains constrained, the financial health of the corporate sector has improved significantly, which relaxed the pressure on business travel demand. More recently, group business (typically about 35%-40% of the customer mix for full-service hotels) has shown encouraging improvement in the latest quarters, as booking windows are beginning to extend and pricing is strengthening, providing more sustainability, visibility, and traction to the demand recovery.
STARWOOD'S OPERATING OUTLOOK
Domestically, Starwood has the greatest exposure to the luxury, upper upscale, and urban market segments. Through 2010, industrywide RevPAR performance in these segments has outperformed the broader hotel market. Fitch believes that the outperformance of these segments is likely to continue in 2011. Hotel demand internationally, in which Starwood has the greatest exposure relative to its peers, has been stronger than the U.S., with the sharpest pace of recovery in Asia. Fitch expects Starwood to continue to focus its growth initiative internationally. The majority of Starwood's development pipeline is targeted outside the U.S., with the largest focus in China and India.
As a result, Fitch believes Starwood's 2011 RevPAR performance is likely to outperform the broader U.S. market. Starwood's same-store company-operated worldwide RevPAR outlook indicates a 7%-9% increase in 2011 (relative to Marriott, whose systemwide worldwide RevPAR outlook indicates a 6%-8% increase in 2011), as well as, a three-year CAGR of 7%-9% through 2013 for its worldwide systemwide hotels on a constant dollar basis. The three-year outlook outlined by Starwood in December of last year represents the first time the company has offered such a long-term outlook since 2006, reinforcing management's confidence in the outlook and visibility of the business.
As occupancy continues to improve and reach pre-recession levels, Fitch expects Starwood and the industry to benefit from positive operating leverage as future RevPAR growth will be more driven by price increases, leading to property-level margin expansion, particularly with respect to Starwood's portfolio of owned hotels, and strong increases in incentive management fees. Since the end of the second quarter of 2010, industrywide ADR has been consistently positive, with the luxury, upper upscale and urban segments outperforming the broader market.
LIQUIDITY AND BALANCE SHEET PROFILE
Starwood significantly reduced its debt load over the past two years, resulting in a 2010 year-end recourse debt balance of $2.9 billion, compared with $4 billion in 2008. Including $494 million of non-recourse securitized debt, which came on balance sheet at the beginning of 2010, total debt was approximately $3.4 billion at end of 2010.
Starwood's liquidity profile is solid, with over $750 million of unrestricted cash at the end of 2010 and approximately $1.3 billion of availability under its $1.5 billion credit facility due 2013. The company's maturity profile is manageable, with roughly $600 million in notes due 2012 and annual maturities of $450 million-$550 million thereafter through 2015.
As asset prices recover more meaningfully, Fitch expects the company to continue to execute its asset light business strategy by continuing to divest its portfolio of owned hotels, which may generate additional liquidity, but is not explicitly incorporated into Fitch's forecasts.
FREE CASH FLOW OUTLOOK
Excluding the impact of the $245 million in tax refund, Fitch estimates that Starwood generated over $250 million in FCF for 2010. While Fitch expects Starwood's future FCF profile to be bolstered by the continued execution of the company's asset light strategy, completion of its Bal Harbour development, and a less capital intensive timeshare business, Fitch also expects Starwood to be more offensive with its capital allocation, with focus returning towards capital investments, potential acquisitions and shareholder friendly initiatives. In the near term, FCF will also be impacted by the remaining development at Bal Harbour, in which the company expects to spend another $200 million to complete the project, with $150 million occurring this year. In addition, Fitch is cautious in its FCF outlook when considering potential cash proceeds from the Bal Harbour development, in which closings on the two condominiums are expected to begin in the fourth quarter of 2011, with the opening of the St. Regis Hotel in 2012.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria & Related Research:
--'Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps' Jan. 7, 2011;
--'Global Economic Outlook' Dec. 20, 2010;
--'Evaluating Corporate Governance' Dec. 16, 2010;
--'Corporate Rating Methodology' Aug. 13, 2010;
--'Operating Leases: Updated Implications for Lessees' Credit' Aug. 13, 2009.
Applicable Criteria and Related Research:
Operating Leases: Updated Implications for Lessees' Credit
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=462222
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646
Evaluating Corporate Governance
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=581405
Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=588285
Global Economic Outlook: No Major Surprises in Global Recovery
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=589165
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