East India Hotels (the Oberoi Group) announced its second quarter ended September 2004 results last month. While sales growth at 19% in 2QFY05 is lower than the growth rate witnessed in 1QFY05, on a YoY basis, margins have improved noticeably. Owing to higher interest and depreciation charges, the company has slipped into losses in 2QFY05.
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What is the company's business?
East India Hotels (EIH) owns, manages and operates 35 hotels largely catering to the business segment. The hotels are operated under two well-known brands - 'The Oberoi' in the five star category and 'Trident' in the budget category. However, the company has historically trailed behind the market leader Indian Hotels, as far as occupancy and other operational parameters are concerned. Also historically there has been a high reliance on the Mumbai and Delhi properties from where the company derives nearly 90% of its revenues
What has driven performance in 2QFY05?
Industry on the recovery path: Though occupancy rates and numbers with respect to the growth in average room rates (ARR) of the company are not available, considering the 26% growth in international tourist inflows into the country and a 36% rise in dollar spends by tourists in the first four months of the fiscal, EIH has benefited. Besides, the company's marketing and management agreement with the Hilton Group for eight of its hotel properties should have helped matters. Having said that, as compared to Indian Hotels on a standalone basis, the company's performance is mediocre.
High fixed cost industry: The fixed cost to total cost ratio for hotel sector typically ranges between 65% to 70%, depending upon the mix of properties. With sales growth showing consistent upward trend in the last seven quarters (graph below) and fixed cost remaining the same, operating margin expansion is not a surprise. But the margin expansion for EIH is magnified because 2QFY04 was a very poor quarter for the company. Even on the margins front, EIH has underperformed its peers like Indian Hotels, Hotel Leelaventure and Taj GVK.
Net loss in 2QFY05: If one were to exclude the extraordinary adjustments with respect to employee separation expenses, as compared to the net profit of Rs 39 m in 2QFY04, EIH has posted a net loss of Rs 4 m in 2QFY05. The tie-up with the Hilton Group has failed to boost the company's performance for now and to that extent, the performance in far from encouraging.
What to expect?
The stock currently trades at Rs 274 implying a price to earnings multiple of 36.4 times our FY05 earnings estimate. While we expect profitability to improve in the second half (as it is the peak season), we will have to downgrade our projections for FY05 post the results. Despite impressive property list in India and in international markets, EIH's underperformance remains an area of concern. To that extent, investors have to exercise caution.
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