La Quinta Holdings Inc. (LQ) is a new buy for Northlake clients. The company owns, operates, and franchises midscale and upper-midscale select-service hotels located in the U.S., Canada, and Mexico. LQ currently trades at an attractive valuation in comparison to its peers, and has several potential catalysts that should help drive the stock to a higher valuation. Catalysts include: (1) a growing pipeline of hotels under development, (2) upcoming initiation of capital return to shareholders, and (3) the potential tax-efficient sale of its owned hotel assets. Beyond the attractive valuation and potential catalysts, LQ’s near-term operating results should benefit from lower gasoline prices, its single-brand focus, and its largely domestic portfolio of hotels. We believe shares of LQ can reach $29.50 as these catalysts help narrow the valuation gap to its peers, representing upside of approximately 25%-30% from the current price of $23.00.

LQ currently trades at 11.3x 2015 EV/EBITDA and 9.8x 2016 EV/EBITDA, while its peers trade on average at levels closer to 14x 2015 EV/EBITDA and 12x 2016 EV/EBITDA. The discounted valuation could partly be due to concerns about declining oil prices since LQ has a large footprint in Texas. However, LQ has consistently explained that lower gasoline prices are a net positive to their business. While the company sees some softness in their oil-centric properties in Midland, Odessa, Victoria, and San Angelo, this is offset by continued strength in Dallas, San Antonio, Austin, and other Texas markets. Furthermore, 70% of LQ’s new hotel pipeline is outside of Texas. Additionally, LQ is considered a “drive-to” hotel, and the company expects to see an increase in driving travel due to lower gasoline prices.

The discounted valuation may also be due to the fact that LQ is not as diversified as some of its competitors, who each own and manage multiple brands. We see the single-brand focus at LQ as an advantage. According to Goldman Sachs, LQ franchise owners are critical of companies where multiple brands compete for similar client bases. This means LQ franchisees don’t have to compete with “sister brands” encroaching on their protected territory.

Looking more closely at the catalysts that should help narrow the valuation gap between LQ and its competitors, LQ has a robust pipeline of over 17,000 rooms compared to 41,500 rooms currently in their system. As these new rooms begin to open, LQ will increase their penetration of key hotel markets throughout the United States. According to J.P. Morgan, LQ is present in less than 70% of Smith Travel Research’s US tracts while its peers are present in 90%+.

Regarding the second catalyst, management has announced that LQ plans to begin returning capital to shareholders once the debt-to-EBITDA leverage ratio drops below 4x. We agree with analysts who project that LQ should announce capital return plans towards the end of this year in the form of dividends, share repurchases, or both.

The final catalyst is that LQ plans to sell some of its owned hotels in a tax-efficient manner. This could provide value to shareholders by highlighted the discounted valuation ascribed to the company’s remaining owned hotels, as properties are sold at a premium.

One final benefit for LQ shareholders comes from the company’s largely domestic portfolio of hotels. Most of LQ’s peers own and operate hotels around the world, while LQ is concentrated in the U.S. Investors may revalue LQ relative to its peers that have significant overseas hotel properties that will negatively impact their earnings due to foreign exchange rates.  LQ is largely protected from this issue.

LQ is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake regulatory filings can be found at www.sec.gov.  LQ is a net long position in the Entermedia Funds.  Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies.  Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s investment management company.