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Indian Hotels: High flyer! - Views on News from Equitymaster

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Indian Hotels: High flyer!
Jul 27, 2006

Performance summary
It has been a dream run for Indian Hotels if the company's performance in the first quarter of the fiscal year is any indication. Led by higher room rates (occupancy improvement in the first quarter is limited as it is the lean season), the operating profit has risen by a healthy 60% YoY. Improved cassh flows from operations and FCCB conversion (foreign currency convertible bonds) have enabled Indian Hotels to report a 127% YoY jump in net profit in 1QFY07. The conversion of bonds into equity shares has resulted in lower interest charges during the quarter along with debt repayment. The company has proposed a stock split (from Rs 10 per share to Re 1 per share).

Rs m 1QFY06 1QFY07 Change
Net sales 2,023 2,573 27.2%
Expenditure 1,612 1,914 18.7%
Operating profit (EBDITA) 411 659 60.3%
Operating profit margin (%) 20.3% 25.6%  
Other income 56 127 126.9%
Interest (net) 58 40 -30.8%
Depreciation 151 170 12.9%
Profit before tax 259 576 122.6%
Tax 89 191 115.1%
Profit after tax/(loss) 170 385 126.5%
Net profit margin (%) 8.4% 15.0%  
No. of shares (m) 52.2 58.4  
Diluted earnings per share (Rs)*   35.2  
Price to earnings ratio (x)   33.7  
(*trailing twelve month earnings)

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 consolidated basis, including properties under the management control, the total inventory in FY06 stood at little over 9,100 rooms. On a standalone basis, while the company derived over 50% of its net sales from room revenues in FY06, the food & beverages division contributed 39% to net sales and the rest was accounted for by management contracts.

What has driven performance in 1QFY07?
Topline driven by ARRs: The overall occupancy rate in 1QFY07 stood at 66% as against 65% in the same period last year. Typically, the overall occupancy rate in the first quarter of the fiscal year hovers around 60% to 65% (64% in 1QFY06), as this is the lean season for the sector as a whole. However, in the analyst meet, the company did mention the fact that properties in Goa have witnessed record occupancies (summer season) because of aggressive promotions by hotel majors. In fact, in 1QFY07, occupancy rates in Goa stood at 69% as compared to 60% last year. Market leaders like Indian Hotels and Leela have run 'apex rates' in this quarter to boost occupancy. Though cities like Bangalore, Delhi and Chennai witnessed a decline in occupancy rates on a YoY basis, this is not worrying because the second half is the critical period for the secto. While we believe that this initiative has met with some success, much of the topline growth was on account of better room rates. Average room rates (ARRs) were higher by 32% YoY during the quarter. In our view, with Indian Hotels (on a consolidated basis) expected to add around 2,000 rooms over the next two to three years accompanied by robust demand, prospects look promising.

The cost side…
(% of net sales) 1QFY06 1QFY07
Raw material 9.6% 8.9%
Staff Cost 23.5% 22.9%
License fees 10.6% 10.5%
Fuel, power & light 8.4% 7.1%
Others 27.6% 25.0%
Of the operating income, room revenues grew by more than 34% during the quarter while F&B income (food and beverages) increased by 19% YoY. The company has been aggressively pursuing its 'asset-light' strategy (management contracts), which is paying of rich dividends. Management fee grew by 33% YoY in this quarter. Overall, it has been an encouraging start and we expect the momentum to sustain for the next two years.

Margins - getting better: Though Indian Hotels' operating margins are lower as compared to the likes of Hotel Leelaventure, Taj GVK and Oriental Hotels (concentrated portfolio of properties), there has been a significant improvement. The graphs below highlight the trend in operating margins since 1QFY03 and the trend in the first quarter of the previous four fiscal years. Except for license fees and food & beverage expenses, all other expenses have declined as a percentage of sales, which was the typical characteristic of the hotel sector. In favorable times, the growth in operating profit tends to much higher than topline growth.

Forex gains and FCCB effect on net profits: In 1QFY07, interest costs have declined significantly owing to the conversion of FCCB into equity shares (last year, the company paid interest on these bonds, which is not the case in this quarter). Also, the fact that the company is cash rich is also reflected in higher other income during the quarter. The increase in depreciation is attributed to the ongoing capital expenditure to increase inventories in key cities in India.

What to expect?
The stock is trading at Rs 1,184 at a price to earnings multiple of 33.7 times trailing twelve month earnings. Indian Hotels, on a standalone basis, intends to spend Rs 5 bn towards room expansion/modernisation over the next two to three years. Key properties are expected in Hyderabad, Bangalore, Mumbai and Coimbatore at the standalone. At the consolidated level, all the subsidiaries and associates (including Taj GVK, Oriental Hotels, Piem Hotels) are expanding rooms, which will propel topline growth. With some of its key overseas operations (especially London) turning around, we expect the consolidated profitability to outpace standalone net profit growth over the next two to three years. While valuations are an issue, from a long-term standpoint, we are positive on the company.

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