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Hotels: 4QFY06 and beyond

Apr 24, 2006

With the March quarter results around the corner, in this article, we highlight factors that investors should watch out for in the case of hotel companies and how are they likely to pan out going forward. While hotel stocks are in the limelight for the right reasons i.e. India gaining significant global attention, there are questions raised about the valuations.Tourist's are coming and spending: India is on a roll. In the first two months of the calendar year 2006, the country witnessed a 12.6% YoY jump in foreign tourist arrivals (0.9 m or 20.5% of foreign tourist arrivals in FY06). We expect international tourist arrivals to grow at a CAGR of 8%. With the ‘India Story' gaining significant attention among the global media and business community, outperformance cannot be ruled out!

Foreign exchange earnings from tourist spending were pegged at around Rs 54 bn in the first two months of 2006, registering a growth of 14.7% over the same period in 2005. This means that the average foreign tourist spent Rs 60,000. This, we believe, is higher than the previous year, largely on account of higher room rates (during this period air travel has become cheaper and exchange rate has remained more or less the same). Given the robust inflow of traffic, there is a mismatch between demand and supply of rooms in India (though the degree of mismatch varies city-to-city). This is helping hotel companies to hike prices and therefore, is reflected in higher average room rates (ARRs). According to estimates, India needs about 80,000 rooms in all categories over the next two to three years at an estimated cost of about US $8 bn to US $9 bn (of which, 20% is required in the premium segment). Though new capacities are expected to be operational in the next three to five years, demand will continue to outpace supply in the short to medium term.

Stronger margins: We anticipate margins to be stronger for most of the hotel companies. This is due higher ARRs and occupancy rates. With demand outpacing supply in the short to medium term, and ARRs are expected to increase by 13% to 14% annually over the next two years. Higher room revenues will directly flow to the bottom line.

As far as individual companies are concerned, we expect Taj GVK and Hotel Leela to maintain superior margins as compared to the industry. Indian Hotel's operating margin, which trails the industry average, will witness expansion, considering the fact that the one-time employee-related expenses that the company incurred last fiscal year are done with. To that extent, the expansion will be more apparent in this quarter (like in 3QFY06). Looking beyond IHCL, EIH should post robust growth in the bottomline in light of the margin expansion and lower interest charges.

What to expect?
Over the next two to three years, assuming that the geo-political situation remains favorable, we expect the net profit to outpace topline growth for hotel companies. Since majority of the new projects are likely to commence operation by the second half of the calendar year 2007, till then, growth will be value-led (higher room rates). We also believe that operating margins of hotel companies will be substantially higher than what we witnessed in the mid-1990s.

While we have a positive view on the sector, the current valuations of hotel stocks are a matter of concern. We value hotel stocks on the NAV basis. This is because, by this method, we can arrive at the actual value of the hotel properties (in terms of cost per room). Based on this, NAV per share can be calculated, which reflects the actual value of the stock and a fair value for the shareholder at which to acquire the shares of the company. However, currently with real estate prices sky-rocketing, the current NAV is very high with cost per room valued at around Rs 20 m to Rs 30 m. This will look attractive as long as real estate prices remain high. But with a downturn, the scenario would reverse. Hence, we would advise utmost caution at the current juncture.


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