Rating Update: Stock Rating D-Negative (11/11/19)-Extended Stay America Inc (STAY).

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BUSINESS

Extended Stay America, Inc., together with its subsidiaries, owns, operates, and manages hotels in the United States. As of May 31, 2018, it had 599 hotels and approximately 66,000 rooms, as well as managed 27 hotels under the Extended Stay America brand. It serves customers in the mid-priced extended stay segment. The company also relicenses Extended Stay America brand to unaffiliated third parties. Extended Stay America, Inc. was founded in 1995 and is headquartered in Charlotte, North Carolina.
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INVESTMENT RATING

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STAY is expected to continue to be an important Value Builder reflecting capital returns that are forecasted to be above the cost of capital.

STAY has a current Value Trend Rating of D (Negative).
With this rating, PTR’s two proprietary measures of a stock’s current attractiveness are providing inconsistent signals. STAY has a neutral Appreciation Score of 45 but a poor Power Rating of 23, with the Negative Value Trend Rating the result.

STAY’s stock is selling below targeted value. The current stock price of $14.45 compares to targeted value 12 months forward of $15.
This neutral appreciation potential results in an appreciation score of 45 (55% of the universe has greater appreciation potential.)
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STAY has a Power Rating of 23. (STAY’s poor Power Rating indicates that it only has a higher likelihood of achieving favorable investment performance over the near to intermediate term than 23% of companies in the universe.)
Factors contributing to this poor Power Rating include: the trend in STAY’s earnings estimates has been unfavorable in recent months; and recent price action has been unfavorable. An offsetting factor is is currently in a modestly favorable positi.

INVESTMENT PROFILE

STAY’s financial strength is high. Financial strength rating is 81.
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Relative to the S&P 500 Composite, Extended Stay America Inc has moderate Value characteristics; its appeal is likely to be to investors heavily oriented toward Income; the perception is that STAY is higher risk. High historical growth is a positive for STAY. Relative weaknesses include: high financial leverage, low expected growth, and high earnings variability. STAY’s valuation is low: high dividend yield, moderate P/E ratio, and low price/book ratio. STAY has unusually low market capitalization.

CURRENT SIGNALS

STAY’s current operations are strong. Return on equity is rising, reflecting: and rising tax keep rate.

STAY’s current technical position is very weak. The stock price is in a 4.4 month down move. The stock has declined 20.2% from its prior high. The stock price is below its 200 day moving average which is in a downtrend.

ALERTS

Recent minimal negative changes in fundamentals have affected Extended Stay America Inc (NASDAQ: STAY): the consensus estimate for December, 2019 decreased significantly.
The stock is currently rated D.
On 11/11/19, Extended Stay America Inc (NASDAQ: STAY) stock enjoyed a major increase of 11.7%, closing at $12.15. However, this advance was accompanied by below average trading volume at 80% of normal. Relative to the market the stock has been weak over the last nine months and is unchanged during the last week.

CASH FLOW

In 2018, STAY generated a very significant increase in cash of +$152.4 million (+101%). Sources of cash were much larger than uses. Cash generated from 2018 EBITDA totalled +$587.7 million. Non-operating sources contributed +$1.2 million (+0% of EBITDA). Cash taxes consumed -$42.1 million (-7% of EBITDA). Withdrawal of investment from the business totalled +$114.1 million (+19% of EBITDA). On a net basis, debt investors removed -$261.6 million (-45% of EBITDA) while equity investors withdrew -$247.0 million (-42% of EBITDA).
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STAY’s Non-operating Income, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by stability for the Extended Stay America Inc Peer Group. In most years, STAY was in the lower quartile and top quartile. Currently, STAY is slightly above median at +0% of EBITDA (+$1.2 million).

STAY’s Cash Taxes, %EBITDA has experienced a minor downtrend over the period. This downtrend was accompanied by stability for the Extended Stay America Inc Peer Group. In most years, STAY was in the third quartile. Currently, STAY is below median at -7% of EBITDA (-$42.1 million).

STAY’s Business Re-investment, %EBITDA has enjoyed a volatile overall uptrend over the period. This improvement was accompanied by a similar trend for the Extended Stay America Inc Peer Group. (Since 2015 Business Re-investment, %EBITDA has accelerated very sharply.) In most years, STAY was in the second quartile and top quartile. Currently, STAY is upper quartile at +19% of EBITDA (+$114.1 million).

STAY’s Debt Investors, %EBITDA has experienced a volatile overall downtrend over the period. This downtrend was accompanied by a similar trend for the Extended Stay America Inc Peer Group. In most years, STAY was in the third quartile and lower quartile. Currently, STAY is substantially below median at -45% of EBITDA (-$261.6 million).

STAY’s Equity Investors, %EBITDA has enjoyed a volatile overall uptrend over the period. This improvement was accompanied by a similar trend for the Extended Stay America Inc Peer Group. In most years, STAY was in the third quartile. Currently, STAY is substantially below median at -42% of EBITDA (-$247.0 million).

STAY’s Change in Cash, %EBITDA has experienced a volatile overall uptrend over the period. This improvement was accompanied by stability for the Extended Stay America Inc Peer Group. (Since 2016 Change in Cash, %EBITDA has accelerated very sharply.) In most years, STAY was in the second quartile. Currently, STAY is substantially above median at +26% of EBITDA (+$152.4 million).
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STAY’s Cash, %Revenue has experienced a downtrend over the period. This downtrend was accompanied by stability for the Extended Stay America Inc Peer Group. (Since 2016 Cash, %Revenue has experienced a very sharp recovery.) In most years, STAY was in the second quartile. Currently, STAY is slightly above median at +24%.

PROFITABILITY

STAY’s return on equity has improved very significantly since 2011 although it experienced a sharp decline after the 2015 high.
A major analytical focus for STAY is a very strong positive trend in pretax operating return a significantly offset by very strong negative trend in non-operating factors.
The productivity of STAY’s assets rose over the full period 2009-2019: asset turnover has enjoyed a very strong overall uptrend.
Reinforcing this trend, pretax margin enjoyed a very strong overall uptrend that decelerated very sharply from the 2016 level.
Non-operating factors (income taxes and financial leverage) had a significant negative influence on return on equity.
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STAY’s return on equity is at the upper quartile (14.3%) for the four quarters ended September, 2019.
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Operating performance (pretax return on assets) is above median (5.2%) reflecting asset turnover that is above median (0.29X) and below median pretax margin (17.6%).
Tax “keep” rate (income tax management) is slightly above median (83.9%) resulting in after tax return on assets that is at the upper quartile.
Financial leverage (leverage) is upper quartile (3.28X).

GROWTH RATES

There are no significant differences between Extended Stay America’s longer term growth and growth in recent years.
Extended Stay America’s historical income statement growth and balance sheet growth have diverged. Revenue growth has paralleled asset growth; earnings growth has exceeded equity growth.

Annual revenue growth has been 4.3% per year.

Total asset growth has been -0.5% per year.

Annual E.P.S. growth has been 30.6% per year. (More recently it has been 8.9%.)

Equity growth has been 5.4% per year.

Extended Stay America’s consensus growth rate forecast (average of Wall Street analysts) is -6.8% — substantially below the average of the historical growth measures.
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Relative to the Extended Stay America Inc Peer Group, STAY’s historical growth measures are erratic. E.P.S. growth (30.6%) has been at the upper quartile. Revenue growth (4.3%) has been slightly above median. Equity growth (5.4%) has been slightly above median. Total asset growth (-0.5%) has been substantially below median.

Consensus growth forecast (-6.8%) is lower quartile.
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PRICE HISTORY

Over the full time period, Extended Stay America’s stock price performance has been highly stable and significantly below market. Between December, 2013 and November, 2019, Extended Stay America’s stock price fell -45%; relative to the market, this was a -67% loss. Significant price move during the period: 1) December, 2013 – January, 2016: -51%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of -7.9% is lower quartile relative to the S&P 500 Composite.
In addition to being lower quartile relative to S&P 500 Composite, current annual total return performance through October, 2019 of -7.9% is lower quartile relative to Extended Stay America Inc Peer Group.

Current 5-year total return performance of -4.8% is lower quartile relative to the S&P 500 Composite.
Through October, 2019, with lower quartile current 5-year total return of -4.8% relative to S&P 500 Composite, STAY’s total return performance is lower quartile relative to Extended Stay America Inc Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, STAY’s overall valuation is normal. The highest factor, the ratio of enterprise value/revenue, is above median. Ratio of enterprise value/earnings before interest and taxes is below median. Ratio of enterprise value/assets is below median. Price/earnings ratio is near the lower quartile. The lowest factor, the price/equity ratio, is near the lower quartile.
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STAY has a major value gap compared to the median valuation. For STAY to rise to median valuation, its current ratio of enterprise value/revenue would have to rise from the current level of 3.92X to 5.08X. If STAY’s ratio of enterprise value/revenue were to rise to 5.08X, its stock price would be lower by $8 to $22.
For STAY to hit lower quartile valuation relative to the Extended Stay America Inc Peer Group, its current ratio of enterprise value/revenue would have to fall from the current level of 3.92X to 3.77X. If STAY’s ratio of enterprise value/revenue were to fall to 3.77X, its stock price would decline by $-1 from the current level of $14.

VALUE TARGETS

STAY is expected to continue to be an important Value Builder reflecting capital returns that are forecasted to be above the cost of capital.
Extended Stay America’s current Price Target of $15 represents a +7% change from the current price of $14.45.
This neutral appreciation potential results in an appreciation score of 45 (55% of the universe has greater appreciation potential.)
With this neutral Appreciation Score of 45, the low Power Rating of 23 results in an Value Trend Rating of D.
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Extended Stay America’s current Price Target is $15 (-3% from the 2018 Target of $16 but +7% from the 11/11/19 price of $14.45). This plateau in the Target is the result of a -2% decrease in the equity base and a -1% decrease in the price/equity multiple. The forecasted flat growth has no impact on the price/equity multiple and the forecasted increase in cost of equity has a very slight negative impact as well. More than offsetting these Drivers, the forecasted decline in return on equity has a very slight negative impact.
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PTR’s return on equity forecast is 14.6% — in line with our recent forecasts. Forecasted return on equity enjoyed a dramatic, erratic increase between 2011 and 2018. The current forecast is significantly above the 2012 low of 4%.

PTR’s growth forecast is 3.0% — in line with our recent forecasts. Forecasted growth enjoyed a dramatic, erratic increase between 2011 and 2018. The current forecast is below the 2016 peak of 7%.

PTR’s cost of equity forecast is 8.4% — in line with recent levels. Forecasted cost of equity suffered a dramatic, variable increase between 2011 and 2018. The current forecast is above the 2011 low of 6.3%.
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At Extended Stay America’s current price of $14.45, investors are placing a positive value of $1 on its future investments. This view is consistent with the company’s most recent performance that reflected a growth rate of 3.0% per year, and a return on equity of 14.7% versus a cost of equity of 8.4%.
PTR’s 2020 Price Target of $15 is based on these forecasts and reflects an estimated value of existing assets of $13 and a value of future investments of $3.

About John Lafferty 54938 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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