Indian Hotels: Into a new trajectory - Views on News from Equitymaster

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Indian Hotels: Into a new trajectory

Jul 25, 2005

Performance Summary
Indian Hotels announced its first quarter results recently. While the topline growth of 27% YoY in 1QFY06 is encouraging, what is also commendable is the doubling of operating profit in the same period. Robust tourist inflows, historically high occupancy rates resulting in lucrative room rates were key growth drivers.

(Rs m) 1QFY05 1QFY06 Change
Net sales 1,594 2,023 26.9%
Expenditure 1,391 1,612 15.9%
Operating profit (EBDITA) 203 410 101.7%
Operating profit margin (%) 12.8% 20.3%  
Other income 95 56 -41.0%
Interest (net) 91 58 -36.5%
Depreciation 123 151 22.7%
Profit before tax 85 258 204.1%
Extraordinary income/(expense) - - -
Tax 21 89 326.9%
Profit after tax/(loss) 64 169 164.2%
Net profit margin (%) 4.0% 8.4%  
No. of shares (m) 45.1 52.3  
Diluted earnings per share (Rs) 5.7 12.9  
Price to earnings ratio (x)   52.3  

What is the company's business?
Indian Hotels Company Limited (IHCL) is India's largest hotel chain with an estimated room inventory share of 25% in top seven cities in the luxury segment (room inventory share is the share of Indian Hotels of the total rooms available). On a standalone basis, while the company derived 49% of its net sales from room revenues in FY05, the food & beverages division contributed 39% to net sales. IHCL also manages hotel properties, which added to 5% to net sales in FY05.

What has driven performance in 1QFY06?
Tourist inflows even higher: After a record year of tourist inflows (over 3 m in FY05), the inflow of international tourists into India is expected to grow by over 10% in FY06 and the first quarter performance of all hotel majors highlights the broader trend. Not only have occupancy rates improved, but room rates in all the key metros are also showing significant signs of strength. We believe that the company's growth rate in topline in 1QFY06 is sustainable (barring unforeseen circumstances). In fact, our topline growth estimate for Indian Hotels, on a standalone basis for FY06 is 27% YoY.

Fixed cost is fixed: As we had mentioned before, the sector has high fixed costs and therefore, during growth phases, the rise in operating profits will be at a much faster pace than the topline growth. The 1QFY06 improvement in margins has to be viewed in this context. Last year, the company incurred one-time expenses towards improved employee training and getting international experience as a result of which, employee cost to sales was high. This year, the company hopes to maintain total employee costs under control, which is evident in 1QFY06. We expect this benefit to sustain in the next two years. Control over other expenses and a marginal increase in power costs in relation to sales growth are also contributors to the doubling of operating profit in 1QFY06.

Operating leverage benefit…
(Rs m) 1QFY05 1QFY06 Change
Raw materials 165 194 17.4%
% sales 10.4% 9.6%  
Staff 414 476 14.9%
% sales 26.0% 23.5%  
License fee NA 214 -
% sales - 10.6%  
Power & lighting 166 171 2.5%
% sales 10.4% 8.4%  
Others 645 559 -13.4%
% sales 40.5% 27.6%  

Interest costs falls: The net interest costs have fallen considerably in 1QFY06 due to the fact that the FCCB proceeds have been used to retire some high-cost debts in the books. Despite a 40% fall in other income, profit before tax has risen by more than 200% in 1QFY06, which is encouraging. While this is the standalone performance, at the consolidated level, we believe that profitability is likely to be even higher.

Over the last few quarters: As is apparent from the graphs above, the operating margins of the company has been showing consistent improvement. However, when one compares the operating margins of the company with peers like Hotel Leelaventure, there is a huge gap. Just to put things in perspective, Hotel Leelaventure's margins in 1QFY06 stood at 49% due to its premium properties. While this also highlights the scope for improvement for IHCL, in our view, considering the property mix, Indian Hotel's standalone operating margins can touch 27% levels by FY07.

What to expect?
The stock currently trades at Rs 677 implying a price to earnings multiple of 19.2 times our estimated FY07 earnings, which we believe warrants an upgradation. We currently have a HOLD view on the stock from a two to three year perspective.

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