The market is distinctly unimpressed with first-quarter results from hotel operator Millennium & Copthorne (MLC), with the shares down 3.2% to 537p. Analysts don't like the cautious outlook statement and flag a real risk that earnings could soon be downgraded.

Millennium & Copthorne has reported a 34.7% drop in pre-tax profit to £16.9 million. This is despite revenue only falling 3.6% to £169.2 million.

Before we delve deeper into the numbers, it is worth understanding how operational gearing can flatter or depress a business like hotels, airlines and manufacturers. They all share a common theme in having predominantly-fixed costs.

Using a hypothetical example, let's say a business makes £100 million revenue a year. It costs are £70 million. Therefore operating profit will be £30 million.

But what happens if revenue drops by 5% to £95 million. The costs stay the same at £70 million and it makes £25 million operating profit - a 16% drop.

If revenue falls by 10% to £90 million, costs stay level at £70 million. That means operating profit has declined to £20 million operating profit. So you can see how a 10% drop in revenue equates to a massive 33% drop in operating profit - and thus understand how predominantly fixed-cost businesses can suffer on the slightest dip in trading.

The opposite happens during good times, making these businesses thrive. The mathematics show that a 10% rise in revenue (to £110 million) can generate a 33% in operating profit (to £40 million).

We can apply this lesson to Millennium & Copthorne as a reduction in the number of people staying at its hotels has clearly hurt earnings. This is but one of several factors weighing down the numbers, as follows:

Refurbishment took 100,000 room 'nights' out of actionGeopolitical tensions in Korea affected trade at its Seoul Hilton siteBad weather conditions deterred travellers in Europe and the USSingapore operations affected by slowing economy, restraint on corporate travel budgets, increasing supply of competitor hotel rooms and reduction in foreign labour quotas which is putting pressure on costs

Millenium & Copthorne has so far invested £58 million of a £240 million three-year programme within its core hotel estate. Panmure Gordon reckons it is too early to forecast the impact this will have on earnings. 'The global hotel market (outside of the US) remains somewhat depressed due to the economic slowdown in Asia and the difficult economic backdrop in Europe,' comments the broker.

Its remarks about geographical differences in market strength are illustrated by Marriott International's (MAR:NYSE) first-quarter results, published yesterday. It reported a $51 million rise in operating income to $226 million, citing robust North American takings and strong demand from business travellers. The greater New York area contributes an estimated 10% to Marriott's earnings.

Millennium & Copthorne's shares trade on 18.2 times forecast earnings and EV/EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation) of 9.3 times, cites Panmure Gordon. It calls this valuation 'aggressive' given poor return on invested capital and has a 'sell' rating on the stock. Liberum has a 'hold' rating and says the stock will only remain attractive to 'very' long-term shareholders.

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