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Indian Hotels: Analyst meet excerpts
Jan 25, 2005

Performance Summary
Indian Hotels announced its third quarter results yesterday. In line with the trend in the last four quarters, there has been a substantial improvement in profitability on the back of increased tourist inflows, the consequent rise in occupancy rates and ARRs (average room rates).

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 1,889 2,491 31.9% 4,560 5,813 27.5%
Expenditure 1,567 1,822 16.2% 3,903 4,701 20.4%
Operating profit (EBDITA) 322 669 108.1% 657 1,112 69.2%
Operating profit margin (%) 17.0% 26.9%   14.4% 19.1%  
Other income 63 35 -44.6% 163 221 35.6%
Interest (net) 55 93 70.7% 181 263 45.5%
Depreciation 121 155 28.1% 350 408 16.6%
Profit before tax 209 456 118.4% 289 662 128.8%
Extraordinary income/(expense) 11 (0) - 36 166 363.9%
Tax 53 106 98.1% 87 191 120.3%
Profit after tax/(loss) 166 350 110.7% 238 637 167.1%
Net profit margin (%) 8.8% 14.0%   5.2% 11.0%  
No. of shares (m) 45.1 45.1   45.1 45.1  
Diluted earnings per share (Rs)* 14.7 31.0   10.6 28.2  
Price to earnings ratio (x)         18.1  
(* annualised)            

What is the company's business?
Indian Hotels Company Limited (IHCL) is India's largest hotel chain with an estimated room inventory share of 25% in top seven cities in the luxury segment (room inventory share is the share of Indian Hotels of the total rooms available). On a standalone basis, while the company derived 48% of its net sales from room revenues in FY04, the food & beverages division contributed 43% to net sales. IHCL also manages hotel properties, which added to 4% of net sales in FY04.

What has driven performance in 3QFY05?
Robust tourist inflow: International tourist inflow into the country has increased by almost 25% to 3.4 m for the period between April to December 2004. More importantly, dollar spends has grown at a faster rate of 30% during the year, which is of significance to hotel chains like Indian Hotels that derive close to 70% of their revenues in dollar terms. In an analyst meet yesterday, the company indicated that occupancy rates increased in all the major seven metros. But the rise in ARR was the highest in the city of Bangalore (more than 60%) owing to lack of adequate supply to meet demand. In the city of Chennai, the increase in ARR stood at 17% during the quarter.

When occupancy increases, hotel chains also benefit from higher food and beverages income (depending on the property and the restaurants). The last three year average F&B to room revenue ratio for Indian Hotels was 87% on a standalone basis. A combination of both these factors has enabled the company to post more than 31% growth in revenues in 3QFY05. Since the second half is typically the peak season for hotel chains, we expect similar performance from the company in 4QFY05 as well, if not better.

Operating leverage kicks in: Hotels is a high fixed cost business. When the industry is in a downturn, the ability to curtail expenses beyond a point is limited. But during upturns like now, the rise in expenses tends to be relatively lower than the revenue growth, which is what explains the increase in operating margin in 3QFY05. In the analyst meet, the company indicated that staff cost is higher during FY05 because of the full impact of international hiring last year and staff training expenses, which could decrease as a percentage of sales in the future. While license fee as a percentage of revenues have increased, it is partially because of new properties being added under the licensing agreement. As far as margin outlook is concerned, we believe that the other expenses to sales ratio will further decline and so will be the staff cost.

Cost break-upů
(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Raw materials 188 234 24.0% 484 575 18.7%
% sales 10.0% 9.4%   10.6% 9.9%  
Staff 499 571 14.6% 1,216 1,383 13.7%
% sales 26.4% 22.9%   26.7% 23.8%  
License fee 181 289 59.8% 392 610 55.8%
% sales 9.6% 11.6%   8.6% 10.5%  
Power & lighting 147 161 9.9% 479 500 4.4%
% sales 7.8% 6.5%   10.5% 8.6%  
Others 553 567 2.5% 1,333 1,634 22.6%
% sales 29.3% 22.7%   29.2% 28.1%  

Over the last few quarters: As is evident from the graph below that highlights the growth in occupancy rates, ARRs and the consequent impact on operating margins, there is a secular trend. Though the rate of increase from here on will be lower, as the company adds new properties (both in terms of management contracts as well as in terms of room expansion), revenue growth prospects continue to remain promising. As far as the impact of tsunami on the company, in the analyst meet, the management clarified that the impact is minimal except for one property in Mauritius. Since the property is covered, we do not believe it will have any significant impact on the consolidated profitability.

What to expect?
The stock currently trades at Rs 513, implying a price to earnings multiple of 20 times our FY06 standalone earnings estimates (price to book value multiple of 2.5 times FY06E). Post the robust 3QFY05 performance, we will have to upgrade our earnings estimate for FY05 and beyond. While consolidated financials are not available, as per the management, almost all subsidiaries, associates and joint ventures have posted improved performance and this is a positive. It is important for investors to understand that the stock has to valued on a consolidated basis because of its investments in various profitable subsidiaries and associates like Taj SATS (the catering venture with Singapore Airlines), Taj GVK, Taj Kerala, Oriental Hotels, Piem Hotels (the President chain) and many management contract-based properties.

On a consolidated basis, the stock trades at a price to earnings multiple of 14.6 times our FY06 estimates (price to book value of 1.6 times). While the scope for margin improvement and balance sheet restructuring is higher on a consolidated level, we have exercised caution in our estimates. Besides, upside from the use of FCCB issue proceeds, which the management is likely to use for property acquisitions in the domestic and international markets is not factored in for the lack of clarity. Given this backdrop, we remain optimistic about the prospects of the tourism sector in general and Indian Hotels in particular. However, there are some risks as well. Given the susceptibility of the sector to global events and the current high valuation levels, the returns may not be commensurate to the risk. Given the backdrop, despite the upside potential, the stock is for high risk investors.

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