Hotel sector: Little room for growth

The hospitality industry witnessed a mixed year in 2008. In this article, we shall examine the factors that contributed to the growth and some of the challenges that this sector faces.

The sector began the year 2008 on a strong note. Rising tourist inflow, higher occupancy and room rates continued to benefit the hotel players. In the first four months of the year, the tourist arrivals were higher by 11.7% YoY. Existing hotel companies, new foreign players and real estate players continued with their expansion plans. Prospects were looking good, until the sector faced a double blow.

Double trouble
The worst financial crisis in many decades, high oil prices and a slew of militant attacks hit the hotel industry. Often described as a "fragile" industry, the demand for travel is highly susceptible to events like economic slowdown, wars, disease outbreaks and terrorism. When the Indian tourism and hotel industry had just started gaining recognition worldwide, it was laid low by a double whammy. The first being the global credit crisis and the second, the recent terror attacks on the iconic hospitality landmarks; the 'Taj Mahal Palace and Tower Hotel' and the 'Oberoi Trident'. Nearly 40% of the annual revenues are expected to be lost on account of the recent crisis.

Lower growth
During 1HFY09, lower corporate spending, fluctuating dollar and opening of credit crisis did impact occupancy rates in some cities like Bangalore, Pune, Hyderabad and Chennai. The room rates however, remained high. While the actual number of tourist arrivals has increased, the YoY growth is on the lower side. While during 2007, a 16% YoY growth was seen in tourist arrivals during the first 8 months, the same stood at 10% YoY this year, indicating slowdown. According to the Ministry of Tourism, October 2008 saw an increase of just 1.8% in the number of foreign tourist arrivals compared to the same time in 2007.With the latest terror strike (26/11) during the onset of the peak season, things got murkier. This prompted the Indian government to ask hotels to slash their prices in the hope of keeping demand stable. Though the room rates have officially increased, hotels are selling corporate travel packages at huge discounts to maintain occupancy levels. Tour operators believe that the real discounts and tariff cuts are as high as 30% to 50%. With hotel rates touching unreasonably high levels last year, a correction was nevertheless due.

Going forward
2008 was definitely a year to forget for the hotel industry and the government is taking plenty of initiatives to revive it. 2009 is to be observed as the 'Visit India Year'. The concept is that those who visit India in 2009 would thereafter experience India's rural tourism, eco tourism, adventure tourism, wellness tourism in specially worked out packages in 2010 and 2011. Further, the rate cuts would also make India a cheap tourist destination to visit.

Further, cost pressures, liquidity crisis and regulations concerning the real estate sector have made funding for hotel projects difficult. This coupled with unrealistically high land prices and government red tapism could result in hotel projects taking longer to fructify. Real estate players (DLF, Unitech, Parsvnath) are being hit adversely by the market slowdown. The phenomenon is expected to have an effect on hospitality development in India. This may lead to a stop or delay in the completion of projects as well as a revision of the project expenditure. As per KPMG, only 60% of hotel projects announced in key metros are operational as per schedule. Developers have also diverted their plans in favour of commercial or residential buildings due to liquidity crunch and higher land prices leading to a longer breakeven period. Considering all these factors, industry estimates that just over half of the planned 0.1 m new rooms will finally be built. Hence, considering the demand supply mismatch, the new room additions will not create overhang. Thus, we believe that the existing players would benefit from the continued demand-supply mismatch once the economy revives.

While leisure travel would continue to be low, business travel, domestic travel, medical tourism and mid market segment would be the target areas. As per estimates, domestic tourism has risen from 366 m in 2004 to 462 m in 2006, emerging as a major driver for the industry. Just to give an idea about how big this opportunity is, we can say that the domestic tourists' number is more than the entire population of the US.

This slump in the industry will also provide opportunities to existing hotel companies with high cash in their kitty to acquire distress assets at cheaper valuations. While the summer would be cold for the hotel industry, with India's fundamental prospects being attractive over the long term, the momentum would get better.