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Indian Hotels: Headed north?

May 26, 2004

Indian Hotel's (IHCL) performance in 4QFY04 as well as in FY04 reflects the turnaround in industry fortunes since the lows in 4QFY03, which was mired by SARS and Iraq war. Though margins in FY04 are lower, what is important to understand is that the overall trend in terms of improvement in occupancy and ARR (average room rate) is here to stay.

Standalone numbers…
(Rs m)4QFY034QFY04ChangeFY03FY04Change
Net sales 1,720 2,113 22.8% 5,690 6,652 16.9%
Other income 40 107 167.8% 210 308 46.9%
Expenditure 1,450 1,762 21.5% 4,680 5,629 20.3%
Operating profit (EBDITA) 270 351 30.0% 1,010 1,024 1.4%
Operating profit margin (%)15.7%16.6% 17.8%15.4% 
Interest 70 89 26.7% 370 269 -27.2%
Depreciation 110 135 23.1% 470 486 3.3%
Profit before tax 130 234 80.0% 380 577 51.9%
Extraordinary items 180 243 35.0% 150 225 49.8%
Tax 50 109 117.8% 130 196 50.4%
Profit after tax/(loss) 260 368 41.6% 400 607 51.6%
Net profit margin (%)15.1%17.4% 7.0%9.1% 
No. of shares (m) 45.1 45.1   45.1 45.1  
Diluted earnings per share (Rs)* 23.0 32.6   8.9 13.4  
P/E ratio (x)     26.3  
(* annualised)      

The hotel industry benefits from higher occupancy combined with improvement in ARRs. During this period, the fixed cost (generally higher) tends to spread over a wider base, which then translates into a sharp improvement in operating margins. The 4QFY04 performance of Indian Hotels has to be viewed in this light. The increase in revenues in 4QFY04 is on account of record occupancy levels of 82% as compared to 70% in 4QFY03. This is even higher compared to 3QFY04 (72%). The co-relation between occupancy rates, ARRs and operating margins can be observed from the graph below.

Though the company's performance is commendable in 4QFY04, this is also on account of decline in ARRs and occupancy levels in the same quarter last year owing to Iraq war and the SARS crisis. Since the hotel industry started witnessing reversal in fortunes from 2QFY04, margins for FY04 as a whole, is lower on a YoY basis. Besides, higher staff cost has also impacted margins. The company has attributed the same to wage hikes and new property additions (for instance, Taj Lands End).

The last three years have been very challenging for the hotel sector in general with a declining trend in occupancies, ARRs and consequently, operating margins. Just to put things in perspective, IHCL's margin of 15% in FY04 is significantly lower as compared to around 25% to 41% between FY92-FY01. We expect the company's margins to improve significantly in the next 2 to 3 years despite increased competition, if the current industry trend continues. IHCL is targeting to control staff cost and other expenditure in FY05.

Cost break-up…
(Rs m)4QFY034QFY04ChangeFY03FY04Change
Raw materials 185 195 5.5% 616 680 10.4%
% sales10.8%9.2% 10.8%10.2% 
Staff 367 544 48.0% 1,310 1,671 27.6%
% sales21.4%25.7% 23.0%25.1% 
Power & lightning 150 156 4.2% 589 617 4.8%
% sales8.7%7.4% 10.3%9.3% 
Others 745 866 16.3% 2,167 2,660 22.8%
% sales43.3%41.0% 38.1%40.0% 

The standalone net profit for FY04 has risen by 52% on account of benefits arising from lower interest charges and profit on sale of properties. If one were to exclude the extraordinary items from both the periods, net profit has actually risen at a faster rate. While the standalone picture is encouraging, the consolidated numbers are even more impressive (table below). It is important to look at the consolidated picture due to the fact that IHCL owned rooms account for just 35% on a consolidated basis. Subsidiaries, associates and joint ventures account for 9%, 42% and 14% of consolidated rooms respectively. The margin improvement was led by better performance by St. James Court (London) and Taj SATS (the catering joint venture with Singapore Airlines).

The consolidated picture…
(Rs m)FY03FY04Change
Sales and other income 9,050 10,470 15.7%
Expenditure 7,110 8,210 15.5%
Operating profit (EBDITA) 1,940 2,260 16.5%
Operating profit margin (%)21.4%21.6% 
Interest (net) 780 680 -12.8%
Depreciation 830 870 4.8%
Profit before tax 330 710 115.2%
Extraordinary items 40 210 425.0%
Tax 180 280 55.6%
Less: Minority interest (90) (90)0.0%
Profit after tax 280 730 160.7%
Net profit margin (%)3.1%7.0% 
No. of shares (m) 45.1 45.1  
Diluted earnings per share (Rs)* 6.2 16.2  
P/E ratio (x)  21.9  
(* annualised)   

The stock currently trades at Rs 354 implying a P/E multiple of 21.9x consolidated FY04 earnings. Given the backdrop of better economic growth prospects, the impetus from the service sector and increasing tourist arrivals, IHCL, in its analyst meet, has indicated that ARRs could rise at a much higher rate in 2HFY05 with a little room for increasing occupancy level. We therefore, expect both the standalone and consolidated financials to improve significantly in the next two to three years.

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