Peak season

SECTOR UPDATE

Occupancies and room revenues are on the rise but near-term growth appears to be priced into hotel stocks.

Foreigners are flocking to India. Whether it is to enjoy the sights and sounds of this country or to do business, India today is a favoured destination. Tourist arrivals between April and August this year were up 26 per cent over last year at 1.15 million tourists.

With the growth unusually high even in the lean season, the hotel industry, the biggest beneficiary of these visits, hopes that the tally for FY05 will touch 3.25 million.

That will be a record for the country which saw 2.8 million tourists in FY04. Already, hotels are full up, especially in cities like Bangalore where rooms were going at around Rs 8,900, a 60 per cent premium in August compared with last year's average room tariff of Rs 5,300.

Therefore, it is not surprising that hotel stocks have had a dream run last year. The run-up in prices has been sharp in the case of Hotel Leela, which has more than doubled to hit Rs 74 from Rs 30 a year ago, and Asian Hotels which, too, has doubled to Rs 220 from Rs 100.

Indian Hotels has seen a rise from around Rs 270 to the current price of Rs 449 while EIH has climbed from Rs 210 to hit Rs 308 before retracing to Rs 250. The markets have applauded the companies' efforts to control cost (particularly on travel and employees) and restructure debt.

For instance, Indian Hotels raised $150 million through FCCBs at a coupon of 1 per cent and a yield to investors of 3.15 per cent for five years. The markets have also anticipated the growth potential given that demand is likely to exceed supply in the short term, driving up average room rates (ARRs). However, analysts feel that the stocks have been rerated and the huge appreciation leaves very little upside in the near term.

As Sunil Agarwal, analyst at Khandwala Securities, says, valuations are no longer compelling, especially since none of the players - except Indian Hotels - has major expansion plans. The P/E ratios for these stocks range between 9x for Leela and 13x for Indian Hotels, on FY06 estimated earnings, which is not inexpensive.

Thus, Agarwal does not recommend buying any of the stocks at this juncture, but suggests Indian Hotels could be bought on declines, at a price of around Rs 400, or 10 per cent below current levels.

Even during the lean season this year, ARRs rose impressively. In August, for instance, ARRs were higher by 11 per cent over the previous year.

In fact, in every month between September 2003 and August 2004, the demand for rooms has been higher than in the corresponding month of the previous year. In August alone, RevPar (a multiple of occupancies and ARRs) grew by 28 per cent and room demand by 23 per cent.

Analysts point out that since the hotel industry's output multiplier at 2.03x means it grows at twice the rate of the economy, investors should keep track of the stocks as the demand for premium hotels should be strong in the next few years, driven by travel and business segments.

Analyses show that a 10 per cent increase in occupancy results in operating profits going up by more than 20 per cent, while a 10 per cent increase in the ARR results in an equal growth in operating revenues and a higher growth in operating profits.

Moreover, though hotels may not be expanding capacities aggressively (except Indian Hotels), there could always be inorganic growth. As Ajoy Misra, senior vice-president (sales and marketing), Taj group, observes, inorganic opportunities are available and are a part of the management's gameplan.

Hotel Leela: Its property in Bangalore city, where demand for rooms has far outstripped supply, has seen ARRs of Rs 11,000 in August compared with Rs 7,000 last year. Thus, Leela could end FY05 with an average ARR for all its properties of around Rs 7,500, resulting in a huge increase in its net profits, which were just Rs 8 crore in FY04.

The average occupancy for the year, the management says, could be around 80 per cent. However, the company has a huge debt burden of Rs 700 crore. According to R Venkatachalam, director (finance), the company is yet to receive outstanding dues of Rs 150 crore from Hudco.

Venkatachalam says efforts are on to bring debt down to Rs 320 crore by FY06, and it is possible that there could also be an increase in the paid-up equity from the current level of Rs 60 crore. Currently, the company has 821 rooms and this is expected to go up to around 881 rooms in FY06 with the Bangalore hotel being expanded.

The management has shelved its proposed venture in Kerala and plans to commission its Udaipur property (which is part of a 100 per cent subsidiary) in FY06-07. It proposes to spend around Rs 30 crore on capital expenditure in FY06 and around Rs 20 crore in FY06.

Indian Hotels: With the Wellington Mews property having been commissioned in Q205, and the IndiOne chain (which is part of a 100 per cent subsidiary) having started operations, Indian Hotels is set to have between 9,500 and 10,000 rooms by FY06.

According to Misra, the company is looking to double the number of rooms from around 8,000 at present in five years. For H105, average ARRs are up 19 per cent y-o-y while occupancies are up at 68 per cent from 61 per cent in H104. The management expects ARRs to be up 15 per cent in H205 over H204.

The higher ARRs and occupancies could, according to analysts, translate into a huge increase in profits and Agarwal explains that the incremental operating profits could be as high as 80 per cent. For instance, in the case of Indian Hotels, he expects earnings of Rs 27 for FY06 (standalone) and Rs 34 (consolidated).