Hotel stocks: A season of comfort

Frontline stocks such as Indian Hotels, EIH and Hotel Leela have gained between 10-16%

Hotel stocks across the market cap spectrum saw sharp gains for the second consecutive day and significantly outperformed the market. While frontline stocks such as Indian Hotels, EIH and Hotel Leela have gained 10-16 per cent, the next tier of stocks such as TajGVK, Royal Orchid and EIH Associated also ended with double-digit gains with some of them touching their 52-week highs. Most of these companies had seen an improvement in operational performance in the September quarter and the Street is expecting further gains in occupancy and average room rates going up.

Sumant Kumar of Elara Capital highlights three trends, which have had a positive impact on the sector and have, therefore, resulted in the current rally. On the operational front, there has been a 250-300 basis point improvement in occupancy over the last couple of quarters for the sector, while average room rates have gone up by about a per cent. Further, the pace of demand growth outstripping supply continues to be robust and is gathering pace in the current financial year. According to STR Global Reports, an international hotel consultant, supply growth for the first half of FY16 was at four per cent while demand grew by 11.1 per cent. Supply growth was in the range of 3-7 per cent across key cities. Finally, given the pace of growth in occupancy, Sumat Kumar believes that room rates are likely to move up going ahead.

  Ankur Bhatia, executive director of the Bird group, says there has been increase in occupancy in Tier 2 markets as well with demand shifting from the unorganised sector to branded hotels and this trend will continue. Increase in meetings, incentives, conferences and exhibitions (MICE) in key cities have also led to the demand for rooms. Expect the positive trend to continue in the coming quarters, he adds.

Notably, demand is expected to continue outstripping supply growth in the coming years. Elara Capital estimates that the Indian hospitality industry’s demand and supply is likely to grow at a compounded annual growth rate of about 8 per cent and 5-6 per cent, respectively, over FY15-18. The higher demand growth will be on the back of MICE segments, rising foreign tourist arrivals and the recent steps such visa on arrival for 150 countries.

Binaifer Jehani, director, CRISIL Research, too expects good growth for room rates in FY16 with aggregate Revenue Per Available Room (RevPARs) across the 12 key cities and tourist destinations in India to increase by four per cent to reach Rs 4,400 propelled by a 200 basis points improvement in average occupancy. Over the longer term (till 2018-19), the RevPARs for premium hotels in India are expected to increase at four per cent annually to Rs 4,900 in 2018-19.

The pain point, according to analysts, is the high debt due to organic/inorganic expansions both at the larger and smaller companies. In the large cap space, Hotel Leela is most leveraged, while analysts believe that debt on the books of Indian Hotels is manageable and should come down post the restructuring exercise the company is undertaking.

The operational performance in the September quarter of the hotel majors also gives some pointers of things to come. For Indian Hotels, consolidated operating profit grew by four times year-on-year to Rs 62 crore, margins jumped by 447 basis points to six per cent led by higher occupancy and operating leverage.

Similarly for EIH, operating profits grew 34 per cent year-on-year to Rs 38 crore, while margins grew 297 basis points to 12.6 per cent. While EIH turned profitable in the quarter with earnings of Rs 11 crore from a loss of Rs 1.3 crore, for Indian Hotels adjusted losses came down from Rs 91 crore to Rs 37 crore. 

While stock prices have run up significantly post the recent rally, analysts are positive on the prospects of the sector. Investors, however, should await a translation of improved operational metrics on the financials before taking an exposure to this cyclical space.