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Oriental Hotels: Economy benefits! - Views on News from Equitymaster

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Oriental Hotels: Economy benefits!

May 31, 2007

Performance Summary
Oriental Hotels reported a decent set of numbers for the fourth quarter and twelve months ended March 2007. Driven by the tourist rush (both foreign and domestic tourists), revenues during the year recorded a strong 17% YoY growth. Efficiency at the operating level led to the expansion in margins. All these factors put together, along with lower depreciation charges, led to the bottomline growth of 39% YoY.

Rs( m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net sales 501 616 23.0% 1,632 1,916 17.4%
Expenditure 323 358 10.8% 1,101 1,250 13.5%
Operating profit (EBDITA) 178 258 44.9% 531 666 25.4%
Operating profit margin (%) 35.5% 41.9%   32.5% 34.8%  
Other income 11 11 -4.6% 34 38 10.2%
Interest 1 0 -55.0% 3 1 -57.7%
Depreciation 30 32 7.5% 119 117 -1.3%
Profit before tax 159 237 48.8% 444 585 31.9%
Tax 56 82 47.2% 172 207 20.3%
Profit after tax/(loss) 103 155 49.6% 272 378 39.3%
Net profit margin (%) 20.6% 25.1%   16.6% 19.8%  
No. of shares (m) 17.9 17.9   17.9 17.9  
Diluted earnings per share (Rs)*         21.2  
Price to earnings ratio (x)*         17.2  
* 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 FY07?
Strong topline growth: While it is a known fact that the foreign tourist arrivals into the country have crossed the 4.4 m mark, we also believe that domestic factors like increased activities in the aviation sector resulting in cheaper air fares and faster growth in domestic travel have also benefited companies like Oriental Hotels. Most of its properties are market leaders in their respective cities. With Chennai being a key gateway city, Oriental Hotels has reported a 17% YoY growth in the topline for FY07.

Having said that, the topline performance is lower than our expectations, as 66 rooms (representing 32% of the hotels inventory) of Taj Coromandel, Chennai, were under renovation for almost the entire duration of the third 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 was higher by 23% YoY. We expect the Chennai hotel market to remain robust in the next two years on account of increased services sector activity apart from higher inflow of FDI in the state (that creates demand for business travel). This would result in a strong performance by the company going forward.

Cost break-up
As a % of net sales 4QFY06 4QFY07 FY06 FY07
Total Cost of goods 11.3% 10.3% 12.2% 11.8%
Staff Cost 13.9% 12.3% 15.3% 14.9%
Power and fuel 6.1% 5.4% 7.3% 6.6%
Other Expenditure 33.0% 30.1% 32.7% 32.0%

Higher margins: The hotel sector is a high fixed cost industry and thus benefits from operating leverage (profits improve sharply once the business generates enough revenues so as to meet the fixed costs and any incremental business revenues flow straight down to the bottomline). For the full year, operating margins have expanded by 230 basis points (2.3%), largely led by a reduction in staff and power and fuel costs (as percentage of sales). The margins are in line with our estimates and we expect it to improve on account of operating leverage going forward.

Faster growth in the bottomline: The net profit growth at 39% YoY has significantly out performed the topline growth as well as the operating profit growth. Being a virtually zero debt company (debt equity ratio in FY06 was 0.1) one should not read much in the decline in the interest costs. The decline in the depreciation cost further helped the net margins, which improved by 320 basis points.

What to expect?
At the current price of Rs 365, the stock is trading at a price to earnings multiple of 17.2 its 12 months trailing earnings. The Indian tourism industry has out performed the global tourism industry in terms of growth in the volume of international tourists as well as in terms of revenues. While we acknowledge the risks from faster rise in ARRs that could result in hotels out-pricing themselves, in general, we believe that occupancy rates of the hotel sector in general are likely to remain strong. As far as Oriental Hotels is concerned, most of its properties are market leaders in their respective cities. On a standalone basis, properties in the Chennai market accounted for 44% of total inventory of the company and with the proposed 75-cottage expansion at the Leisure property, the percentage will touch 50%. We have factored in around 20% growth in average room rates (ARRs) for the Chennai properties and therefore, the overall topline growth will be amplified in the next two years.

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