Identifying a hotel stock: Do's and don'ts - Views on News from Equitymaster

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Identifying a hotel stock: Do's and don'ts

Jul 12, 2003

How to analyse a company? This is the first question a retail investor has in mind before taking investment decisions. In continuation to the article last week on ways and means to identify an FMCG stock (Read more), consider key factors to be borne in mind when it comes to identifying a Hotel stock.Profile
Unlike FMCG sector, automobile sector or even bank sector, hotel industry is more global in nature. As a result, geo-political events, say September 11 attack, play a vital role in influencing tourist arrivals into and outside India. The ability of a player in the sector to attract the bulk of tourists coming into India and travel within the Indian border depends on select factors. These include the strength of the property portfolio (whether near a heritage site, near airport, commercial capital and so on) and brand awareness. For example, Taj (Indian Hotels) and Oberoi (EIH) are generic names in India when it comes to premium hotel chains.

Normally, hotels are capital intensive in nature having long gestation periods, which not only has a bearing on the free cash flows of hotels but also affects the return on capital employed (ROCE) for a period of time.

Revenues for a hotel chain are a factor of occupancy rate (number of rooms occupied) and average room rates (popularly termed as ARRs). Revenues are also derived from food and beverages, management services and so on. Consider key factors that influence occupancy rate and ARRs.

Occupancy rates
Consider the chart below. The hotel sector benefits from both holiday and business travel. Holiday travel in India is generally seasonal in nature. Historically, over 60% of total tourist arrivals into the country is during the period between September-May. On the other hand, business travel is a factor of various factors. This includes government's effort to promote India as a tourist destination, long-term economic growth prospects and higher foreign participation arising by hike in FDI and FII holding limits in Indian companies and joint ventures.

For the last few years inbound (coming into the country) tourists have been around 2.5 m while out bound (going out of the country) tourists have been around 30 m. Out of the inbound, a large part of the travelers to the country are of the business class, while the rest are leisure segment. Connectivity between cities in the form of better road infrastructure, airports and seaports also play a vital role in increasing the share of India in the global tourist pie. India is a country of various cultures and has some of the world-class heritage sites, which when promoted in the global arena, can attract the global tourist.

On the domestic leisure travel front (i.e. people traveling within India for both commercial and leisure reasons), there is lot of seasonality involved. Besides, as income increases, aspiration level of the population also gains ground and consequently, spills over into better occupancy rates for hotel chains. While it may not be true for luxury hotels, players in the budget hotel sector and time-share segment benefit in a large way.

Average room rates (ARRs)
Without getting into complexities, there are three classes of rooms in a hotel i.e. business, leisure and luxury. It is important to understand that room rates are less elastic to a fall in price at the higher end of the segment (luxury) than at the lower end of the spectrum (business/leisure). Therefore, even in a downturn, players like Indian Hotels are relatively able to maintain higher operating margins than EIH. Established players in India have an edge over MNCs and the unorganized segment, due to properties near heritage sites.

Competition also plays a vital role in determining the sector's ARRs. Currently, the big hotels have average occupancies of 60%. This points to excess supply. That itself is sometimes a dampener on ARRs.

The global scene
International hotels are derive a big chunk of revenues from casinos and betting arenas. Margins in this segment are also higher. But for Indian hotel majors, setting up casinos and betting arenas is not allowed according to Indian laws. However, when domestic hotels are compared to international hotels then they are fairly competitive in terms of average room revenues.

How to put a value to a hotel chain? Net Asset Value (NAV) is the answer.

For arriving at a Net Asset Value
Setting up a 5 star hotel = Rs 30-35 m*
Add = Cash + investments
Deduct = Debt
Net Asset Value (NAV)Total
DivideNo. of Shares
NAV per share = Rs x
Compare with current market price
* depending upon the area of setup

Coming to the NAV of domestic hotels, on the basis of replacement cost method let us see the value of the hotels at current prices. By NAV we can arrive at the actual value of the properties of the hotels. Based on that, NAV per share can be calculated, which gives the actual value the shareholder should be paying for being a part of the company. However, for hotels, which have been in the industry for a period of time their NAV would be on the higher side, as the property bought would be at a much lower rate than the present times. Like for instance the NAV of Taj and Oberoi Hotels would be higher than that of ITC Hotels and other hotels.

Key things to look at before investing in a hotel stock

  1. What are the strategy and the capex plans of the company over the next 5-10 years? As mentioned earlier, hotels are capital intensive in nature having long gestation periods, which not only has a bearing on the free cash flows of hotels but also affects the return on capital employed (ROCE) for a period of time. So the bigger the capex plan, the more caution one should exercise. This criteria is favorable for established hotel chains.

  2. Economic cycles also determine earnings prospects (during a downturn, properties are cheaper and hotel chain generally tend to increase capacity). Moreover, in tough times like September 11, hotel stocks take a beating. It is at this time that the established players should be looked at, for when the concerns fade away, these will be the first ones to benefit from an economic upturn.

  3. A hotel chain should not be leveraged on any specific segment i.e. luxury or leisure. Though elasticity is lower at the premium end, when tourist flow is affected, this player could be the worst hit. Diversification reduces volatility in earnings, to an extent.

While growth prospects continue to remain heartening, the sector is typically a high-risk-high-return game due to the vulnerability to external factors. Buyers beware!

Click here to identify stocks from other sectors.

Related Links for Hotel Sector: Quarterly Results NEW | Sector Analysis Report | Sector Quote | Over The Years

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1 Responses to "Identifying a hotel stock: Do's and don'ts"

Deepak vyas

Oct 7, 2009

you have mentioned,
How to put a value to a hotel chain? Net Asset Value (NAV) is the answer.
While in the cost of setting up a 5 star hotel.
of earlier made properties cannot be compared if the properties (land) is on lease let say 50 years or 99years. The older the property, the less value it possess because it doent own the land. ??????

Please value the Indian hotels & Email to me.

Thanks
Deepak vyas
New Delhi

Like (1)
  
Equitymaster requests your view! Post a comment on "Identifying a hotel stock: Do's and don'ts". Click here!

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