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Hotels: Good start, dicey finish… - Views on News from Equitymaster
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  • Jan 3, 2005

    Hotels: Good start, dicey finish…

    At the start of the year, in our hotel sector review, we concluded by saying "the worst is probably over for the Indian tourism sector". While the sector was turning around at that time, in the last twelve months, the process has just accelerated with most of the hotel majors posting impressive numbers. And this is consequently reflected in the fact that a portfolio of Rs 10,000 each invested on December 26th 2003 in seven hotel companies would have yielded Rs 15,200 by now, a gain of 52% in one year!

    What was different in 2004 as compared to 2003?
    One of the key highlights last year was the fact that international tourist arrivals in FY04 stood at 2.9 m, the historical high. This was in total contrast to the trend one witnessed in the last three years. Tourist flows into the country was disrupted on account of various events like September 11, Gujarat riots, Kashmir border unrest, Afghan war and SARS outbreak. But things have continued to look better. As per the latest information available, tourist arrivals till November 2004 (starting April 2004) has already touched 3 m with one more quarter to go. We expect international tourist arrivals to grow at a CAGR of 8% in the next five years.

    The year 2004 also marked the launch of budget hotels in the country to tap the fast-growing domestic tourism industry. As per Indian Hotels, domestic tourism last year grew by 15% and it is expected that the growth rate in the next three years will be maintained. Indian Hotels set up its first budget hotel (IndiOne) in Bangalore and has plans to increase the count to 60 over the medium-term. We believe that this is a fundamental transition. The reliance on international tourist inflows for growth in the domestic market will reduce, albeit to an extent, in the short-term and meaningfully in the long-term. The ITC Group also has a presence in this segment (Fortune Hotels).

    The outperformer of the year: Hotel Leelaventure
    As is evident from the graph above, Hotel Leelaventure has outperformed all other hotel chains by a fair margin. This year has marked a turnaround for the luxury segment players. Though the company's operating margins were among the highest in the industry, high interest burden was affecting profitability at the net level. But a private placement in the calendar year 2004 will reduce this burden combined with significant cash flow generation from its existing properties. The company's Bangalore property dominates the RevPar table and is likely to be a key growth driver in the long-term.

    The underperformer of the year: EIH
    Despite an enviable property portfolio, the underperformance of EIH, both on operational and financial fronts, remains an area of concern. As the operating margin comparison graph shows, while all the other hotel chains have been able to improve margins significantly on the back of higher occupancy and increase in room rates, EIH's performance fail to reflect the same. This despite the agreement entered into with the Hilton Group for joint marketing and management is a surprise to us. Though the scope for margin improvement remains high, the risk profile of the stock is higher.

    What to expect?

    1. More international hotel chains are likely to enter the Indian market in the next three years (including the likes of Four Seasons). While room supply is expected to grow at an estimated 10% in the medium-term, the fact that tourist inflow is expected to grow at a CAGR of 8% in the long-term is a comforting factor to us. While we expect the Mumbai and Delhi region to remain competitive, other metros like Bangalore, Hyderabad, Chennai and select Northern sectors will grow faster than the industry (in terms of room rates).

    2. While smaller players with a concentrated property mix benefit from focus, we believe that players with a diversified market presence have a much better scope to restructure, unlock cash from redundant properties and invest in new properties to capitalise on the growth prospects. If things go as per plans, this year, some hotel chain may acquire properties abroad in key gateway cities.

    3. Despite promising prospects, investors have to remember that valuations of hotel chains, globally and in India, have been downgraded post September 11, as the risk from geo-political events has increased. The latest Tsunami is likely to further impact tourist inflows, though the magnitude is too early to ascertain. At current prices, the risk-reward equation of investing in hotel stocks is skewed towards risk and retail investors have to be careful as to which stock they wish to invest.



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