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IHCL: Waiting for the upturn

Apr 13, 2002

Indian Hotels Company Ltd. (IHCL) is the dominant hospitality chain in the country with leading positions across various segments. This is not surprising considering the vintage of the Taj Group, which dates back to 1902. Over these years, the group has established a formidable chain across India. Currently, the total numbers of hotels under management is sixty, including properties abroad. With the advent of liberalization Indian Hotels experienced a phase of rapid growth. Over a five-year period between FY92 and FY97, the company's sales and profits grew at a compounded rate of 23% and 47% respectively. With a freer regime to conduct business, a cross section of industries ramped up capacities to meet demand from a wave of consumerism. Attracted by the large middle class numbers were also foreign companies, which entered into collaboration with Indian counterparts. This led to increased business travel, especially inbound, which facilitated the aforementioned growth.

The structural change in economic policy is also likely to have put India on the global tourist map. With people talking about the country, many are likely to have wanted to visit the exotic land. Over the concerned period, international visitors arriving in India increased from an estimated 1.5 m per year to 2.5 m. Domestic tourists in the country doubled during this period to an estimated 160 m. These factors are likely to have led to the boom years in the early and mid nineties.

Having said that, international visitors to the country have stagnated at 2.5 m over the last five years. This customer category constitutes a lion's share of premium hotel revenues. While business and leisure travel contributed to the growth in the early nineties, growth in both segments has tapered off over the recent past. This could be attributed to failure to push forward the liberalization process. The Government has been stumbling over implementing second-generation reforms. Also, political instability, internal law & order and external affairs did not lead to a conducive environment for attracting the foreign tourist.

Therefore, authorities and industry associations have work cut out for them. India always has been the land of potential. Even in the tourism industry, we fall short of the progress made by our regional peers. In the current budget, the Government has tried to mend its ways with renewed focus towards the sector. Tourism has infrastructure status in the budget. Besides, reforms have been proposed in ancillary sectors as well. Government has proposed reforms in real estate laws, privatisation of airports and ports and development of world-class roadways. These developments could facilitate increased flow of leisure and business travel over the medium term.

But as has been seen before in the industry, high growth also raises the specter of competition. The boom years of the nineties did not go unnoticed by the foreign hospitality chains. Consequently, over the following five years, FY97 - FY02, the Indian market has seen the entry of Le Meridien, Hilton, Marriott, Regent, Hyatt and Claridges. As if these were not enough, many of the Indian brands are on an expansion to cash in on the latent demand. ITC has rejuvenated its presence in the sector by undertaking expansion through the flagship company rather than the subsidiary, ITC Hotels. The effect of increased competition can be seen on Indian Hotels. Between FY92-FY96, operating margins of the company increased from 26% to 41% while over the next four years margins retraced their way to 26%.

This has been the result of petering industry growth combined with higher competition. Besides new players eating into the pie, competition also ups the ante on talented manpower. Services are primarily a people-oriented business. Therefore, manpower costs are likely to constitute the largest share of operating expenses. This expense head, which ranged between 13% - 16% of sales, shot up to 20% over the last two years. As more foreign competition enters Indian shores, as in other service sectors, manpower costs are likely to increase. Another expense head, although constituting a small percentage of sales, which could rise, is advertising & publicity.

Having said that, the challenges before Indian Hotels are apparent, managing competition, manpower and promoting the travel industry. It seems, that a business travel wave is likely to lift all the boats, but a boom in tourism could favour Indian Hotels. The group manages 50 properties across the country, which gives it leverage to gain from heightened spends on leisure travel. Tourism is the largest industry in the world, it is among the top foreign exchange earners for the country and as disposable incomes rise, travel is amongst the top on the 'to do' list. Consequently, Indian Hotels is well positioned to exploit any gains arising from travel into or within the country.

FY02 was amongst the worst years for the hospitality industry. These events, however, are extraordinary and likely to be one-time occurrences. Consequently, we expect Indian Hotels to register improvement in operating financials for FY03. Reflecting the challenges faced by the company, valuations have tumbled from highs of 30x in FY95 to the current 6x 9 months FY02 annualised earnings (including extra-ordinary items). Adjusting for extra-ordinary items, the markets seem to have adjusted valuations to reflect the improvement in business conditions. Consequently, patience is likely to be the key for stock gains.

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