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Hotels: Need to spin a wide web!

May 12, 2006

The Indian hotel industry has been in the limelight during the past three years. It went through a bad phase during the period 1997 to 2002. Varied reasons led to the poor performance of the hotel companies during this period, with the major being the nuclear tests carried out by India in 1998 and the consequent sanctions against the country, the fears of an Indo-Pak war in 1999, terrorist attacks in the US in 2001, and the SARS scare in 2003. All these factors combined to result in a drop in tourist traffic into the country. As a result of this, the hotel companies witnessed drops in their occupancy and room rates. Let us take a look at how things have unfolded for the sector post 2002.In broader terms...
The fortunes of the Indian hotel industry revived only in the second half of FY03 with a pick-up in global economy and a rise in the confidence level among global travellers (both business and leisure). The year 2005 has been the best year till date for inbound travel, with foreign visitor arrivals touching a record 3.9 m, resulting in international tourism receipts of Rs 262 bn. This impressive performance in tourist arrivals is attributable to a strong sense of business and investment confidence in India led by growth of the Indian economy, a strong performance of the domestic corporate sector and opening up of the economy to a greater foreign participation. Also, the rising middle class income and cheaper airfares have further given the impetus to the industry, in terms of a growing domestic tourist base.

While the factors mentioned above have helped the Indian hotel industry in improving upon its performance during the past 2-3 years, let us take a look at some of the micro aspects of the industry and see how these have changed with changing times.

Premium Hotel segment, average 10 cities
Source: cris infac
Room inventory: The industry's room inventory has grown at a compounded rate of 8% during FY00 and FY05, with around 7,800 rooms being added during this period. However, foreign tourist inflow during the past three years has grown at such a faster rate that even the addition to room inventory has been inadequate to cater to the same. This demand-supply mismatch has helped hotels to rake in higher occupancy levels and earn superlative room rates. Now, with new rooms expected to come only by FY08 and demand for rooms remaining robust, we believe that good times for the industry are here to stay.

ARR and Occupancy: As indicated above, owing to demand outpacing supply of hotel rooms in the past 2 years, the occupancy levels and ARR (average room rate) across major hotels in India have been on an uptrend. For instance, Indian Hotels' ARRs have grown from around Rs 4,000 in FY02 to Rs 5,500 in FY05, a compounded growth of around 11%. The hotel major's occupancy rates have also shot up from 55% to 72% during this period. On the back of short supply (at least till FY08), we expect ARRs and occupancy rates to increase further in almost all the major business and leisure destinations in India in FY07.

Margins: Being a high fixed cost industry, profitability of the hotel companies generally take a severe beating during the downturn. As a matter of fact, during FY02, Indian Hotels' operating margins fell down to 17% from 26% in FY00. On the contrary, in an upturn, when companies record better occupancies and higher room rates, after covering the fixed cost, a large part of the revenue filters straight to the bottomline. This is what we have seen happening with hotel companies in the past 2-3 years (see Indian Hotel's operating margins chart). Further, with a robust demand outlook and lack of sufficient supply, on the back of improving ARRs and occupancy, we expect margins for the industry to remain robust in the next 2-3 years.

As seen from the above analysis, while there have been many positives that have emerged for hotel companies in the past 2-3 years, investors should note that this good performance has been due to absence of any major geo-political adversity. With increased globalisation and with economies getting more closely integrated, we expect reverberations of events in one country to rapidly pass on to others, thus impacting the entire world economy. And the tourism industry, being one of the most closely integrated industries in the world, the effect of any adversity can be large. This is one concern that investors need to keep in mind while investing in hotel stocks.

As far as Indian hotel companies are concerned, while they shall continue to ‘bask in the glory' of an improved climate and demand-supply mismatch, companies with a geographically diverse business are likely to be better insulated than other to take on rough times. Now, that is called ‘spinning a (world) wide web'!

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