Rolling out the red carpet

SECTOR SCAN

The tight demand-supply scenario for the next three years will keep profitability of Indian hotel companies robust.

If you are planning a holiday in any corner of India be prepared to extend your hotel budget. Average Room Rates (ARRs) have reached unprecedented levels registering a 20-25 per cent growth over the last year.

For example, while earlier, the rates across the country hovered around Rs 6,500 to Rs 7,000, now, they are available at around Rs 10,000 per day. 
 

LOT OF HEADROOM LEFT
Companies	Price (23/06/06)	% chg (y-o-y)
Indian Hotels	1120.60	73.22
EIH	590.00	57.56
Hotel leela	303.35	52.00
Asian hotels	562.35	88.00
Taj GVK	200.40	145.18

However, as an investor if you had kept faith in hotel stocks, then there is good news. Even accounting for a correction in the range of 10-35 per cent post May 10, all the major hotel stocks have recovered smartly and have given phenomenal returns in the last one year.

Says Sageraj Bariya, analyst, Religare Securities, "Hotels stocks are quoting at attractive valuations and can be safe havens to park you r money to get decent returns even for a short span of one year. For long-term investors with a horizon of over three years, the returns would be significant as the benefits from expansion of most of the players will accrue in the long term."

Echoing this sentiment an analyst at a leading retail broking firm says, "Investors can look at hotels and within that Indian Hotels and EIH as they reflect the growth story for the entire hotels sector. At the regional level, Taj GVK and Oriental Hotels are preferred plays."

India is increasingly being looked at by global players to grow their business and domestic tourism is also looking up. Foreign tourist arrivals (FTA) (of which the business class form more than half of the total coming to India), are rising at an unprecedented rate.

After growing 18.7 per cent in the last three years as compared to 8.1 per cent for the world, FTA in India touched 4.07 million, a growth rate of 11 per cent year-on-year in FY06 despite minor hiccups like the bird-flu scare. However, they are still lower than in countries such as Egypt (6.1 mn) and Thailand (12 mn).

In the first five months of this calendar year, FTA increased by a robust 14.5 per cent to 18.7 lakh, as compared to 16.32 lakh in the corresponding period last year.

World Travel and Tourism Council (WTTC) forecasts tourist arrivals to grow at a 10 per cent CAGR till 2012, one of the highest in the world, and considers India as one of the major and fastest growing tourist destinations in the world.

Domestic tourism is also rising due to easy availability of finance for holidays, reduced airfares and improving affordability. However, despite being a global business hub and a major focus for developed countries, the current availability of 1.5 lakh registered rooms is low compared to one million rooms of our neighbour, China.

According to a leading mutual fund, India's room capacity needs to double in the next five years in order to support 6 per cent plus GDP growth. This bodes well for hotel companies as ARRs and occupancy rates (ORs), which are already high, will continue to remain so for the next three years, especially for luxury hotels.

Though many hotel chains have announced expansion plans in the last year, additional rooms will only get added later as new hotel projects have a long gestation period.

ORs which increased by about 600 basis points to 75 per cent in FY06 are expected to rise further to over 80 per cent in next two years. Similarly, ARRs are expected to increase by 20 per cent.

Hotels in Bangalore and Hyderabad have benefitted the most due to increased IT/ITES/BPO activities. While Bangalore recorded the highest ARR of Rs 11,100, with an OR of 79 per cent in FY06, Hyderabad registered the highest OR of 82 per cent.

However, even other regions such as Delhi, Gurgaon, Chennai, Pune and Kolkata are also witnessing a similar trend of fast growth in ARRs and ORs amid overall economic development and nationwide shortage of rooms.

Going forward, the maximum jump in ARRs will happen in cities like Pune, Delhi and to some extent, Mumbai.

Since the hotel industry has high fixed costs, any improvement in ARRs and ORs leads directly to an improvement in the bottom line, though personnel costs are on the rise.

With skyrocketing real estate prices, many hoteliers like Indian Hotels and EIH are increasingly adopting the strategy of managing hotels also called a management contract, which involves less or no capital infusion and the company is paid a fee for its services. This improves the bottom line further.

However, there is a caveat for investing in hotel stocks. The industry is cyclical and sensitive to global and domestic factors like rising interest rates, economic downturn and foreign exchange risk.

However, a slight slowdown in demand would not impact profits adversely, say analysts. The overall outlook for hotel stocks looks promising. 
 

FINANCIALS
Rs crore	Net sales	% chg	Operating Profit	% chg	Net Profit	% chg	Trailing P/E (x)
Indian Hotels	1084.30	27.90	314.96	73.35	183.80	107.20	35.89
Hotel Leela	323.90	26.20	157.72	36.84	101.73	123.90	22.60
EIH	756.39	28.80	221.00	69.44	122.65	212.20	25.60
Taj GVK	188.74	63.50	85.37	91.63	46.25	107.40	27.44
Asian Hotels	328.49	27.30	125.82	43.79	56.70	122.20	23.51

Indian Hotels
The company, which owns the Taj Group of hotels, is the best pick among the major hotel stocks due to its market leadership, its expertise and also its entire range from budget hotels to service apartments to super luxury resorts, say analysts.

Further, it carries low debt on its books. On a consolidated basis, in addition to its 15 properties, Indian Hotels also holds strategic stakes in domestic and international group companies like Taj GVK (25 per cent) and Oriental Hotels (34 per cent) among others.

The group operates over 70 properties with more than 9,000 rooms. It plans to set up three new hotels in Africa and each one in Mumbai, Coimbatore, Chennai and Pune to add to its portfolio.

With these, the company's room inventory is expected to increase by more than 2,000 rooms by 2008.

The company reported a robust financial performance in FY06 (see Financials). Along with a higher room sales of 33 per cent, food and beverages (F&B) sales also saw a 21 per cent growth. This led to a revenue growth of 28 per cent. With stable costs, operating profit jumped 73.3 per cent and net profit more than doubled aided by a decline in interest costs.

Consequently, both operating and net margins have witnessed an expansion. Its consolidated results have been better than standalone, net sales increased by 40 per cent and net profit by 94 per cent.

According to analysts, the higher demand-supply gap mainly in the luxury category is expected to help Indian hotels to increase its ARRs and occupancies.

On a standalone basis, the stock trades at 24 times and 19 times FY07E and FY08E respectively.

According to research by Religare Securities, on a replacement value basis, which is another way of valuing hotel stocks, the stock price is at a premium of 14 per cent to its replacement value of Rs 1,000 per share. This is quite reasonable taking into consideration its market leadership, size and expertise.

Hotel Leela
The company is well placed in key business and tourist locations like Mumbai, Bangalore and Goa. Over the next three years, the company is expected to more than double its capacity to over 2,000 rooms across eight locations with a capex of Rs 1,000 crore for which funds are in place. The company is spreading its reach to Udaipur, Chennai, Delhi, Hyderabad and Pune.

Amol Rao, analyst at PINC, is bullish on the company. Says he, "The company is expected to witness a jump in its profits and margins due to the addition of around 100-150 rooms in Bangalore and the Casino project at Goa in FY07. Further the company also enjoys one of the highest operating margins of about 50 per cent among the major hotels."

In FY06, the company reported a revenue growth of 26 per cent and operating profit growth of 36.8 per cent. Net profit has more than doubled.

A leading foreign broking firm expects the company's profits to grow at a CAGR of 159 per cent. The stock trades at 18 times and 15 times its FY07 and FY08 estimated earnings, which is at a discount to Indian Hotels (73 per cent) and EIH (50 per cent). While this looks attractive, the stock price is at a premium of 48 per cent on the replacement value method, according to Religare's estimates.

Taj GVK
Taj GVK, another mid sized hotelier with four properties (three in Hyderabad and one in Chandigarh) also looks attractive. The stock trades at 8 times its estimated FY07 earnings.

While it has strong pricing power in Hyderabad (reflected by an increase of 50 per cent in ARRs), the potential of its Chandigarh property looks strong due to its proximity to manufacturing hubs like Punjab and Haryana.

Further its 215 room Chennai property will start contributing in FY08. It has planned an expansion plan of Rs 400 crore over the next three years to increase its presence in south India, which will almost double its room inventory to 1,209 rooms. Further its foray into service apartments will lead to margin expansion.

In FY06, income rose 64 per cent to Rs 190 crore. Operating profit jumped 92 per cent to Rs 85 crore and net profits more than doubled to Rs 46 crore. The company also holds low levels of debt. The stock is at a premium of 23 per cent over its replacement value.

EIH
EIH, part of the Oberoi group, is the third largest chain in the luxury category after the Taj Group and ITC Welcomgroup, with 2,900 rooms spread across 20 locations operating hotels under the names Oberoi and Trident. The company has a presence in leading metropolitan cities like Delhi and Mumbai, which are profitable locations.

It also has an international presence in countries like Egypt, Indonesia and Malaysia. The company has entered into a strategic alliance with Hilton International, which has a global brand equity and marketing expertise, to co-brand hotels in India under the Trident Hilton Brand.

The company is in the process of operating a hotel in Bandra Kurla Complex with a capital outlay of Rs 650 crore, half of which is already spent. The company has changed its strategy from owning and managing its property to only management, which augurs well for future expansion of margins.

In FY06, net sales increased 28 per cent, operating profit jumped 69 per cent to Rs 221 crore and net profit grew more than 200 per cent. The stock trades at a P/E of 29 times for FY07E. It trades at a discount of 9 per cent to its replacement value.

However an analyst, who did not wish to be quoted, is not so enthusiastic about EIH as its financials are strained with high debt and lower margins as compared to its peers.

Asian Hotels
Asian Hotels is the only stock among the major hotel stocks, which is trading at a significant discount of 34 per cent to its replacement value.

This mid-sized company operates deluxe category of hotels with 1,140 rooms under the brand name Hyatt Regency in cities like Delhi, Mumbai and Kolkata resulting in high occupancies.

It has a tie-up with Hyatt International Asia Pacific for services and assistance in advertising and marketing.

However its low valuation is also due to its dependence on Delhi and Mumbai, which together account for 85 per cent of revenues-which can be risky. This is especially so as the company has no plans of expansion like other players.

However the company is best preferred due to its proximity to business locations such as the property near the airport in North Mumbai, a hub for the ITES/BPO industry and Kolkata, which is witnessing entry of players in IT and telecom.

Bariya expects the the company's operating profit to grow with improvement in its ARR and constant fixed costs due to low depreciation charges on its old properties. The company has strong cash flows. The stock trades at a P/E of 16 times and 14 times for FY07E and FY08E respectively.