Oriental Hotels: Renovation effect! - Views on News from Equitymaster

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Oriental Hotels: Renovation effect!

Feb 9, 2007

Performance summary
Oriental Hotels announced a decent set of numbers for the third quarter and nine months ended December 2006. For the quarter, while the company's topline registered a growth of 12.4% YoY, net profits have risen by 4% YoY (if one excludes the extraordinary income received in 3QFY06). The operating margins, however, contracted by 3.1% due to higher costs.

Rs( m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 449 504 12.4% 1,131 1,300 15.0%
Expenditure 281 330 17.8% 778 892 14.8%
Operating profit (EBDITA) 168 174 3.3% 353 408 15.5%
Operating profit margin (%) 37.5% 34.4%   31.2% 31.4%  
Other income 9 7 -16.4% 23 27 20.5%
Interest 1 0 -45.0% 3 1 -48.8%
Depreciation 29 30 0.5% 89 86 -4.3%
Profit before tax 147 151 3.0% 284 348 22.7%
Tax 51 52 1.0% 98 120 21.9%
Extraordinary item 20          
Profit after tax/(loss) 115 99 -13.7% 185 228 23.1%
Net profit margin (%) 25.6% 19.7%   16.4% 17.6%  
No. of shares (m) 17.9 17.9   17.9 17.9  
Diluted earnings per share (Rs)*         18.7  
Price to earnings ratio (x)*         21.8  
* 12 month trailing earnings            

What is the company's business?
Oriental Hotels is a southern India focused hospitality player with a total inventory of 666 rooms. On a standalone basis, the company owns seven properties in and around Chennai. The company has a track record of having generated strong cash flows in the past and is currently debt-free. On a consolidated basis, the company has investments in Taj Asia, which owns properties in Sri Lanka and Maldives. It also owns a 30% voting right in Taj Karnataka Hotels & Resorts, which has a property in Chikmagalur.

What has driven performance in 3QFY07?
Renovation effect: Oriental Hotels reported a 12% YoY growth in the topline. The topline performance of the current quarter is lower than its peers as 66 rooms (representing 32% of the hotels inventory) of Taj Coromandel, Chennai, were under renovation for almost the entire duration of the current quarter. October to December being a peak season, the renovation did affect the performance of the company. However the renovated rooms were commissioned by the first week of January 2007 and for the fourth quarter (which again is a peak season) the topline performance is expected to be robust. Also the company’s two prime properties in Chennai are the price leaders in the city and account for nearly 44% of the total inventory in Chennai. With the Chennai hotel market expected to remain robust over the next three years due to boom in the service sector and favourable demand-supply dynamics currently prevailing in the city, Oriental Hotels is expected to earn higher ARRs going forward. We have factored in around 20% CAGR in average room rates (ARRs) for the Chennai properties and therefore, the overall topline growth will be amplified in the next three years.

Cost break-up
As a % of net sales 3QFY06 3QFY07 9mFY06 9mFY07
Total Cost of goods 11.6% 11.7% 12.6% 12.5%
Staff Cost 13.5% 15.7% 15.9% 16.1%
Power and fuel 6.8% 6.2% 7.7% 7.1%
Other Expenditure 30.6% 32.0% 32.6% 33.0%

Wage pressure: The company faced pressure on the operating margins which fell from 37.5% in 3QFY06 to 34.4% in this quarter. This fall could be attributed to higher labour cost, which as a percentage of sales, increased from 13.5% in 3QFY06 to 15.7% in 3QFY07 due to revision of salaries. Though power & fuel costs witnessed a fall, other expenditure (as percentage of sales) also witnessed a marginal rise in the quarter due to the renovation costs. However, with the renovated rooms being commissioned in January 2007, the operating margins are likely to be on track going forward.

Staid bottomline growth: The company reported a 13.7% YoY decline in bottomline for 3QFY07. However, this was on account of extraordinary income pertaining to the profit on sale of asset to the tune of Rs 20 m, which the company received in 3QFY06. Excluding this, the bottomline has grown by a subdued 4% YoY largely due to a contraction in operating margins. Going forward, since all the rooms would be in operation, any further rise in the revenues will flow to the bottomline as hospitality being a fixed asset intensive business, operating leverage will play its part in perking up the margins. Considering the company’s 9mFY07 performance, we shall maintain our FY07 bottomline estimates.

What to expect?
At the current market price of Rs 408, Oriental Hotel’s stock is trading at a price to earnings multiple of 21.8 times its trailing 12-month earnings and 13.9 times our estimated FY09 earnings. The robust foreign tourist arrivals into the country and the domestic factors like increased activities in the aviation sector resulting in cheaper air fares and faster growth in domestic travel will continue to benefit companies like Oriental Hotels. Since most of its properties are market leaders in their respective cities we expect the ARR’s to remain firm going forward. We had recommended a ‘HOLD’ on the stock in January 2006 with a target price of Rs 560. We maintain our view.

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