The future is looking surprisingly rosy for hotels and lodging companies. In S&P Global Ratings' view, although the pandemic dealt an enormous blow to the industry, just three years after the first lockdowns were implemented, hotels and lodging businesses in Europe, the Middle East, and Africa (EMEA) have almost recovered their pre-2020 creditworthiness. Our scenario analysis shows that even if interest rates rise higher than we expect, nearly all the issuers that we rate would prove resilient. However, it's not all plain sailing; hotels and lodging companies depend on their customers' discretionary spending power, so if cost-of-living pressures worsen, issuers will also feel the bite.

Pent-Up Demand For Travel Boosts Recovery

Since lockdowns began to ease, tourism has flourished, leading to strong demand for leisure stays and boosting hotels' and lodging companies' creditworthiness. As a result, we have upgraded many issuers in the past 12 months, returning the ratings to pre-pandemic levels, with two-thirds of the issuers that we rate carrying a stable outlook. We rate three issuers in the 'CCC+' category, of which two--eDreams ODIGEO S.A. and Hotelbeds (HNVR Midco Ltd.)--have a positive outlook. Although we do not anticipate that traveller volumes will fully recover to pre-pandemic levels before the end of 2024, we observe that companies have been able to charge higher prices without putting off customers--demonstrated by hotels now charging higher average daily rates (ADRs) than reported in 2019, and increased per capita spending for theme parks. Additionally, hotel and lodging companies tightly managed their costs during the pandemic, which is bearing fruit amid high inflation. As such, their margins are recovering and they are exhibiting solid free operating cash flow (FOCF) generation despite the higher capital expenditure required due to investments that were postponed during the pandemic. We expect ADRs and occupancy rates to remain resilient, or fall only marginally in 2023.

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Past Low Rates Enabled Aggressive Financial Policies

The EMEA hotel and lodging industry is characterized by aggressive financial policies, which benefited leisure companies during the low interest-rate environment following the 2007-2008 financial crisis. This tendency toward heavy capital structures is driven by the fact that most of these companies have relatively high margins and free cash flow conversion. These characteristics also tend to attract private equity sponsors. As such, the sector remains highly leveraged, exemplified by the median of our S&P Global Ratings-adjusted debt to EBITDA for our rating universe reaching 6.9x in 2022 and expected to fall only marginally toward 6.7x in 2023. The sector's median FOCF to debt was 3.1% in 2022, which we expect to slightly increase to 3.7% in 2023. All the companies that we rate have financial risk profiles in our highly leveraged category, except for Accor and Intercontinental, which we assess as having a significant financial risk profile.

Little Impact From Rising Rates

We do not expect interest spikes to weaken hotel and lodging companies creditworthiness, even though, in most cases, their capital structures are highly leveraged and their debt is floating in nature (except for Accor, InterContinental, and eDreams). We performed a scenario analysis to test the resilience of issuers' credit quality in the event of further interest rate rises. For our analysis, we increased the base rate by 50, 100, and 200 basis points. We concluded that, even if base rates rose by 200 basis points, issuers' creditworthiness would not weaken materially. This is due to the limited impact of an interest rate increase on FOCF or on interest rate coverage. A drop in leisure demand driven by a further squeeze on households' discretionary spending would cause a greater deterioration in issuers' creditworthiness, although this is not our base case.

We note that most rated issuers have implemented an active hedging strategy for 2023 and 2024 to protect themselves against EURIBOR/SONIA rises above 3.0%-3.2% through interest rate caps and swaps. The exceptions are Travelodge (Thame and London Ltd.) and Awaze Ltd., which could therefore be more at risk. Additionally, issuers with sizable cash on their balance sheets could partially offset the higher cash interest expense through interest income on liquid bank deposits.

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Refinancing Risk Looms For Some

Though the risk of an escalating benchmark rate has stabilized since October last year, the volatility in the spreads--dictated by fears of a recession, persistent cost inflation, and weakening consumer demand--still represents a widespread risk, especially for lower-rated companies, over the next two years.

The debt maturities of most hotel and lodgings issuers are skewed toward 2025 and 2026, which allows them to expand into the existing capital structure even with a higher cash interest burden, as long as demand for rooms remains robust.

Accor and InterContinental are facing debt maturities in 2024; as these companies have wide access to equity and debt capital markets, we do not expect them to struggle to refinance these. In contrast, U.K.-based holiday park operator Richmond UK Holdco, rated 'CCC+', is the only issuer at the vulnerable end of the rating scale, as it faces a sizable maturity in 2024.

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We don't expect the cost of borrowing to return to pre-2022 lows until at least 2024. Therefore, refinancing risk could represent longer-term pressure on cash flow, sustainability, and ratings. This risk will interplay with macroeconomic developments, consumer demand sentiments, as well as issuer company or owner behaviour. Some may decide to mitigate refinancing risk through gradual debt repurchases, others by incremental amend-and-extend actions that lengthen the maturity by one-to-three years. In some cases, issuers may need a cash injection from their owners, or more dramatically, to trim their debt exposure to reduce their vulnerability and exposure and stabilize their cash flow generation in the future. In short, this risk may disproportionately hit some issuers more than others.

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Methodology

We stressed our 2023-2025 forecasts for all rated European hotel and lodging companies. For the stress test, we added 50 bps, 100 bps, and 200 bps to each of the underlying base rates.

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We assume issuers reliant on U.S. LIBOR during 2022 have switched to the secured overnight financing rate (SOFR) during 2023 and onward.

We believe that the current high interest rates will likely persist into 2024 and that interest rates over the longer term will remain above those immediately before the pandemic, when most of the issuers in our universe put the existing capital structures in place. To gauge the potential impact on our ratings on European leisure and entertainment companies, we ran several stress cases with EURIBOR rates of 50 bps, 100 bps, and 200 bps above our base rate.

We then looked at specific credit metrics, including debt to EBITDA, cash interest coverage, FOCF, and FOCF to debt in each scenario. We derived an estimated impact on ratings by comparing the outputs with the existing downside risk scenarios for each issuer.

Our stress tests--and ratings conclusions--don't account for any mitigating actions that companies and owners could take to enhance cash flows, such as pushing up prices, cutting costs, and raising equity. As such, our stress analysis is not dynamic and can be viewed as conservative. Leisure and entertainment companies generally have limited ability to cut overall costs when revenue declines due to operating leverage, which can hit credit quality faster and harder than rising interest rates.

We incorporate hedging into our base-case company forecasts. The hedging strategy deployed by the corporates in our stress-test universe has been reflected and is a significant factor in our analytical conclusions. We have incorporated each company's hedging position over the forecast horizon and reflected the impact of our stress case respectively. As this information can be confidential, we are unable to disclose these policies on a more granular level. The hedges for some companies will expire before the end of 2024. Our sensitivity analysis assumes that the hedges aren't renewed.

Related Research

• European Lodging Outlook 2023: A Window Is Opening, Feb. 15, 2023
• Industry Top Trends 2023 : Hotels, Gaming, and Leisure, Jan. 23, 2023
• Thame and London Ltd. (Travelodge) Upgraded To 'B-' From 'CCC+' On Strong Trading Performance; Outlook Stable, Jan. 27, 2023
• Hotelbeds Outlook Revised To Positive On Strong Operating Performance; Ratings Affirmed At 'CCC+', Feb. 1, 2023
• Spanish Theme Park Operator International Park Holdings' Amend-And-Extend Offer Reduces Refinancing Risk, Jan. 13, 2023
• Theme Park Operator Motion Midco (Merlin Entertainment) Outlook Revised To Positive On Strong Cash Flow; Rating Affirmed, Dec. 12, 2022
• Parques Reunidos (Piolin Bidco) Outlook Revised To Stable On Improved Earnings Prospects; Affirmed At 'B-', Dec. 7, 2022
• Accor S.A., Dec. 9, 2022
• Accor Outlook Revised To Stable On Recovery In RevPar And Improving Credit Metrics; 'BB+' Rating Affirmed, Nov. 10, 2022
• Roompot (Sandy Holdco) Ratings Remain Preliminary With Regulatory Approval For Landal Acquisition Still Pending, Oct. 31, 2022
• Richmond UK Holdco Ltd. (PdR) Downgraded To 'CCC+' On Refinancing Risk; Outlook Negative, Oct. 21, 2022
• Casper Topco (B&B Hotels) Upgraded To 'B-' On Stronger-Than-Expected Summer Trading; Outlook Stable, Oct. 20, 2022
• InterContinental Hotels Group Upgraded To 'BBB' On Recovering RevPar And Increased Leverage Cushion; Outlook Stable, Oct. 20, 2022
• Spanish Theme Park Operator International Park Holdings B.V. (PortAventura) Affirmed At 'B-'; Outlook Negative, Sept. 28, 2022
• European Holiday Rental Operator Awaze Ltd. Outlook Revised To Stable On Resilient Trading; 'B-' Rating Affirmed, May 16, 2022
• InterContinental Hotels Group PLC, April 25, 2022
• B&B Hotels' Parent Casper Topco Outlook Revised To Positive On Improving Operating Performance; 'CCC+' Affirmed, April 25, 2022
• Thame and London Ltd. (Travelodge) Outlook Revised To Stable On Leisure Sector Recovery; 'CCC+' Rating Affirmed, April 25, 2022