Bangalore calling

IPO REVIEW

Royal Orchid Hotels is betting on the growth in the technology sector to drive its performance. The IPO seems reasonably priced compared to listed peers.

The initial public offering(IPO) from Royal Orchid Hotels Limited is among the few from the hospitality sector.

The company plans to raise between Rs 102-Rs 112 crore through an issue of 68.2 lakh shares at a face value of Rs 10 in the price band of Rs 150-Rs 165.

The hotel industry has seen an uptick in the last one year with the increasing inflow of tourists. Occupancy rates have soared as have Average Room Rate (ARR). Royal, which has hotels primarily in and around Bangalore, is expanding into other cities and proposes to use the funds raised for this purpose.

With India expected to post a gross domestic product growth of around eight per cent, in the next couple of years the hotel industry too is likely to see strong growth.

According to the ministry of tourism, foreign tourist arrivals in India, which were a little less than 25 lakh in 2002 rose to 33.70 lakh in 2004. Tourist arrivals for 2005 was estimated to be around 42.58 lakhs by Hospitality Valuation Services.

Thus, the demand for hotel rooms should see an increase.

In fact, the growth in the past couple of years too has been strong with average occupancy on an all India basis rising from 53.20 per cent in 2001-02 to 59.70 per cent in 2003-04 and 69.40 per cent in 2005.

Bangalore had an average occupancy of 79 per cent in the first half of FY2006 from April to September and Hyderabad had an occupancy of 80 per cent during the same period.

Further between 2000 to 2004 the growth in the supply of rooms (in all categories)was a mere 1.92 per cent. This has reduced the demand-supply gap considerably.

Business travellers both, domestic and international, form a considerable chunk of the clientele for hotels in India. Nearly 47 per cent of the client base for the year 2004 was from this class according to the Federation of Hotel and Restaurant Associations of India (FHRAI).

Business to business
Royal's focus is on business class hotels, with nearly three-fourths of the revenues contributed by this business segment. The leisure segment contributes a minuscule one-two per cent of revenues, the remainder being contributed by food and beverages (F&B) revenues.

Currently, the company operates four hotels in Bangalore. It plans to utilise the issue proceeds to expand its operation in Pune and Hyderabad. The company will is investing in a subsidiary to operate a hotel in Hyderabad and intends to purchase 51 per cent equity capital in Maruti comforts and Inn Pvt Ltd.

Now the company is developing new facilities in Pune. The Pune facility would have 100 rooms and is expected to commence in October 2006.

Further the company is investing in a subsidiary Royal Orchid Hyderabad Pvt Ltd which would operate a hotel in the city. This facility has an existing facility of 72 rooms.

Royal's average occupancy was around 80 per cent for FY 2005, excluding its new venture Royal Orchid Metropole, which was commissioned in October 2004. The flagship hotel, classified as a three-star hotel, had an occupancy rate of 81-82 per cent.

According to the management, the hotel has completed the procedures to be rated as a Five Star Hotel and the company has applied for the same. In FY05, the average room rental hovered in the range of Rs 4,500 to Rs 6,000 per room compared with Rs 2500 to Rs 4000 in FY04.

Own or lease?
Royal owns the Hotel Royal Orchid in Bangalore while other properties are either taken on lease like Royal Orchid Metropole, or being managed by the company like the Royal Orchid Central.

The company intends to continue with the same business model in the future too. It also proposes to enter into joint venture arrangements with property owners which would reduce the initial expenditure towards acquisition and development of property.

Besides, Royal is also taking pursuing greenfield ventures, which take an average of 18 months for the property to become operational. To reduce the long lead time, the company also intends to grow through acquisitions. However, the strategy will be to have hotels in prime locations.

Royal's strategy of predominantly leasing hotels rather than buying properties should allow it to manage its operations with a smaller amount of debt. Besides, it would be a hedge in times when the business cycle starts reversing.

Royal has intentions of expanding to other major cities and targets a pan-India presence in the long term. To achieve this, the company has initiated development of properties in Hyderabad and Pune and is exploring opportunities in other major metros.

The company has a number of food and beverage outlets in its existing hotels such as Limelights, Geoffrey's, Paparazzi and Pinxx . In FY 05 nearly 21 per cent of the revenues were contributed by food and beverages and 76 per cent from the room revenue, while the remainder came from other service charges like banquet halls and conferences. 
 

FINANCIALS
(In Rs crore)	FY05	FY04	% change
Net sales	56.99	35.01	62.78
Other income	1.19	0.91	30.77
Total Exp	32.04	23.27	37.69
Operating profit	24.95	11.74	112.52
OPM (%)	43.78	33.53	1025bps
Net profit	12.98	4.35	198.39
NPM (%)	22.78	12.43	1035bps

In FY05, the topline grew by 62.78 per cent to 56.99 crore from Rs 35.01 in FY04. The operating profits improved by 112.52 per cent to Rs 24.95 crore from Rs 11.74 crore. The bottomline improved by 198 per cent from Rs 4.35 crore to Rs 12.98 crore during the same period. For the half year ended September 2005 the company achieved profits of Rs 8.38 crore on total sales of Rs 35.34 crore.

Hi-tech focus
The hospitality business in Bangalore city has flourished due to its status of IT hub. Its further expansions are also planned in Pune and Hyderabad which are relying on the tech growth story.

Obviously, the company will dance to the tunes of the tech industry. If the tech growth slows, the company's business will be hit. But then, that may not be as big a concern as the only a fifth of its revenue comes from the IT segment as of now.

The business is also highly susceptible to event-related risks. Any unforeseen event, such as a terrorist attack, a war with a neighbouring country or an epidemic, may have an adverse impact on the travel and tourism industry, thereby affecting the performance of the company.

The company had gone through the bad phase in 2001-2002 on the backdrop of such events. It suffered a loss of Rs 2.36 crore in FY02 due to the slowdown.

The annualised earning per share of the company based on the profits for the half-year ended September 2005 is RS 8.20. At the higher price band of Rs 165 the company commands a price to earnings (P/E) of 20.12x and at the lower end of Rs 150 the same is 18.30x.

Compared to the industry composite P/E of 34.2x the issue seems to be reasonably priced. Further in its category among the listed entities Kamat Hotels with similar revenues as that of Royal commands a trailing 12 month P/E of 26.57x.