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Indian Hotels: Time to reap the harvest
Oct 28, 2005

Performance summary
Indian Hotels announced its 2QFY06 results today. While the company's topline, on a standalone basis, registered a growth of 21% YoY, net profit has risen by more than 3.5 times (excluding extraordinary income in the same quarter previous year). While the growth in net profit was led by margin expansion, higher other income and lower interest expenses have also helped matters.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 1,728 2,086 20.7% 3,322 4,109 23.7%
Expenditure 1,489 1,694 13.8% 2,880 3,307 14.8%
Operating profit (EBDITA) 239 392 64.1% 442 802 81.4%
Operating profit margin (%) 13.8% 18.8%   13.3% 19.5%  
Other income 92 175 90.9% 186 231 23.9%
Interest (net) 79 53 -32.4% 169 111 -34.6%
Depreciation 130 149 14.6% 253 300 18.5%
Profit before tax 122 365 200.1% 206 622 201.7%
Extraordinary income/(expense) 166 - - 166 - -
Tax 64 100 55.5% 85 189 121.9%
Profit after tax/(loss) 223 265 18.7% 287 434 51.1%
Net profit margin (%) 12.9% 12.7%   8.6% 10.6%  
No. of shares (m) 45.1 52.3   45.1 52.3  
Diluted earnings per share (Rs) 19.8 20.3   12.7 16.6  
Price to earnings ratio (x)         44.6  

What is 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% of net sales in FY05.

What has driven performance in 2QFY06?
Robust demand: After growing by more than 13% in FY05, we understand that the international tourist inflow continues to exhibit robustness, in light of heightened business activities in the country. Also, as per the management, domestic business travel segment is showing strong growth. What this means for Indian Hotels is high occupancy rate and remunerative room rates. The room revenues increased by 29% YoY in 1HFY06. The banquet income also grew by 21% in the same period.

Revenue snapshot…
(Rs m) 1H FY05 1H FY06 Change
Room Revenues 1,563 2,021 29.3%
F & B 1,400 1,649 17.9%
Other Income 155 244 56.8%
Management fees 195 204 4.7%

Rising Occupancy rate: Occupancy rates have risen YoY in all the regions other than Bangalore where it fell from 80.4% in 1HFY05 to 76.2% in 1HFY06. The ARRs have also risen with Bangalore leading the way. The increase is in the range of 15% to 25% in 1HFY06. We believe that the outlook for ARRs remains encouraging. We have factored in around 8% to 10% growth in Indian Hotel's standalone ARRs, assuming current business condition sustains.

Industry performance…
City Occupancy rates (%) ARRs (Rs)
  1HFY05 1HFY06 1HFY05 1HFY06 Change
North Mumbai 61.3 73.6 4,698 5,420 15.4%
South Mumbai 59.2 61.8 5,299 6,129 15.7%
Chennai 68.4 73.8 3,883 4,545 17.0%
Kolkatta 59 71.6 3,190 3,470 8.8%
Bangalore 80.4 76.2 7,412 10,079 36.0%

EBDITA expands, but...: Hotel sector is a high-fixed cost industry and whenever there is a sharp rise in revenues, bulk of it directly flows into operating profits. On a YoY basis, both in 2QFY06 and in 1HFY06, operating margins have expanded. However, the concern is that operating profit margin improvement is below par when one considers the fact that the company incurred one-time employee training related expenses in the corresponding quarter previous year. This was non-recurring in nature and to that extent, we expected higher margin improvement in FY06. In fact, staff costs as a percentage of sales have increased in 2QFY06, which according to the management is due to wage settlements and new property additions. We have a much higher operating margin estimate for the full year. Since the second half is typically the peak season, we do not foresee any need to revise our estimate downwards for now.

The cost side…
(Rs m) 2QFY05 2QFY06 Change 2QFY05 2QFY06 Change
Raw materials 176 201 14.1% 342 395 15.7%
% sales 10.2% 9.6%   10.3% 9.6%  
Staff 397 481 21.1% 811 957 17.9%
% sales 23.0% 23.1%   24.4% 23.3%  
License fee NA 221 - NA 435 -
% sales - 10.6%   - 10.6%  
Power & lighting 173 182 5.3% 339 352 4.0%
% sales 10.0% 8.7%   10.2% 8.6%  
Others 743 609 -18.0% 1,388 1,168 -15.9%
% sales 43.0% 29.2%   41.8% 28.4%  

Other income boost net profit: The company raised almost Rs 6.5 bn through FCCB issue a year and a half ago towards funding its international expansion plans. With large part of this corpus still un-utilised, the company has earned interest income, which reflects in the 90% rise in other income in 2QFY06. The extraordinary income in 2QFY05 reflects the gain on sale of stake in TCS, one of the Tata Group companies through the IPO route. Excluding this gain, net profit has increased by more than 3.5 times in 2QFY06, which is commendable.

What to expect?
The stock currently trades at Rs 741 implying a price to earnings multiple of 15 times our estimated FY08 consolidated earnings. The company has recently added 'The Pierre' in New York through the management contract route, which has an estimated 201 rooms. The management will invest around US$ 35 m over the next one year towards refurbishment to improve ARRs from the current level of US$ 454 per room. IHCL is planning expansion in the domestic market also in a big way. It includes construction of new hotels, renovation, expansion of existing property and adding hotels through management contracts. The funding for these expansions is likely to be from internal accruals. Taking account the industry prospects and the expansion plans of the management, we have a HOLD view on the stock.

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