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Best of Ghost Mail: The Power Of Pricing Power

Written by Finance Ghost | Sep 25, 2023 10:00:00 PM

If there’s one lesson to learn from inflationary conditions, it’s that pricing power is what separates successful companies from those that struggle. Our local hospitality segment has dished up a perfect example. 

There are very few (if any) investors out there who haven’t been caught out by the incredible macroeconomic volatility that we’ve experienced since the onset of the pandemic. Interest rates crashed as central banks scrambled to inject some life into the economy. As the pendulum swung the other way, inflation came through and central banks reacted by raising rates as quickly as they had cut them.

As painful as this experience has been for many investors, the long-term benefit is immense. In the space of just a few years, the exposure to these extreme cycles has delivered a learning opportunity that normally takes many years to play out.

One of the key concepts that came through this year is pricing power. Comparing Southern Sun to City Lodge is a wonderful way to see this in practice. 

Balancing pricing and demand

Just like an airline, a hotel needs to try and optimise the mix of room occupancy and pricing. If prices are always dropped in desperation, then customers will just wait for the drop and book at the last minute, putting the hotel out of business. But if pricing is too stubborn and rooms are sitting vacant, that also ends in disaster.

Somewhere in the middle is the truth. The economics of a hotel are difficult to manage, as the substantial layer of fixed costs means that profits move sharply in response to a change in room revenue. This is both the allure and the danger of this industry, making it absolutely critical that hotel groups focus on both occupancy and pricing.

For some reason, the market seemed to focus on the occupancy rate as the pandemic started to lift, rather than the combination of occupancy and pricing. This simply doesn’t make sense. At an extreme, it’s possible to achieve 100% occupancy at very low pricing. That doesn’t make it a great investment though, does it?

The type of hotel makes a difference

The pandemic has left a lasting impression on our lives in both good ways and bad ways. Undoubtedly, there is a hunger among consumers for travel and experiences. Lockdowns were an excellent reminder that life is indeed short and that opportunities can be fleeting, so there is a strong desire to get out there and make the most of the good times.

In a business context, video calling is now a widely-accepted alternative to in-person meetings. As someone who used to take the red-eye flight from Cape Town to Joburg on almost a weekly basis, I can fully understand why many people would rather get on a Zoom call than on a plane. It’s obviously much cheaper, too.

You can probably see where this is going. Leisure-focused hotels are booming and business-focused hotels are coming under pressure. The former can increase pricing in response to inflation, as consumers are desperate to get out there and enjoy themselves. The latter simply cannot, as there’s a point at which business travel becomes so expensive that even the most important meetings only become viable in online format.

Taking a Sho’t Left

There’s a further benefit for local leisure hotels: the weak rand. Not only does it bring more tourists to our gorgeous country, but it forces locals to seek out lekker experiences rather than faraway experiences. That’s great news for local tourism, as more money is spent here than taken overseas to be spent in London or Paris.

But again, the business-focused hotel groups aren’t seeing this benefit.

Choose your hospitality fighter

The City Lodge management team has done a great job of trying to pivot the business in response to a change in trends. The focus on food and beverages is paying off, but it can’t offset the reality of pricing being below 2019 levels. With inflationary pressure in costs, that’s not great news even if occupancies have recovered.

In stark contrast, Southern Sun is running well ahead of 2019 in terms of pricing. This isn’t the case across the entire footprint, with the more basic hotel offerings struggling. This is confirmation that City Lodge is a victim of consumer trends rather than anything else.

It’s been a choppy year for both share prices, with Southern Sun recently pulling well ahead based on latest earnings.

Although I’m generally bearish on hotel groups because a lucrative return on assets is hard for them to achieve, I would choose Southern Sun if I were forced to choose between the two. I just can’t see the structural drop in demand for business travel ever improving, which means destination hotels will always have better pricing power than cheaper hotels. In a time of heightened inflation, that makes it an easy choice for me.

 

 

Sources –Finance Ghost 

Follow @FinanceGhost 

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