• OCTOBER 21, 2004

Indian Hotels: It is an uptrend

Performance summary
Indian Hotels, the owners of the Taj chain of hotels, has posted a sharp rise in operating profits for the second quarter ended September 2004. The revenue growth was primarily led by higher occupancy and average room rates (ARRs). The tourism sector has been on an upturn over the last four quarters and as a market leader, Indian Hotels has benefited from the same.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 1,376 1,728 25.6% 2,672 3,322 24.3%
Expenditure 1,190 1,489 25.2% 2,337 2,880 23.3%
Operating profit (EBDITA) 186 239 28.6% 335 442 31.9%
Operating profit margin (%) 13.5% 13.8%   12.6% 13.3%  
Other income 58 92 59.5% 100 186 86.1%
Interest (net) 60 79 30.9% 126 169 34.5%
Depreciation 115 130 13.0% 229 253 10.5%
Profit before tax 68 122 79.5% 81 206 156.0%
Extraordinary income/(expense) (13) 166 - 25 166 -
Tax 20 79 290.6% 33 85 156.0%
Profit after tax/(loss) 35 208 498.9% 72 287 296.5%
Net profit margin (%) 2.5% 12.1%   2.7% 8.6%  
No. of shares (m) 45.1 45.1   45.1 45.1  
Diluted earnings per share (Rs)* 3.1 18.5   3.2 12.7  
Price to earnings ratio (x)         35.6  
(* annualised)            

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 48% of its net sales from room revenues in FY04, the food & beverages division contributed 43% to net sales. IHCL also manages hotel properties, which added to 4% of net sales in FY04.

What has driven performance in 2QFY05?
Robust tourist inflow:After touching the record level of 2.9 m in FY04, the international tourist arrivals till August 2004 was higher by 26% YoY (April - August). As per our interaction with the company, there has been a sharp rise in dollar spends as well during this period. Consequently, both ARRs and occupancy levels have risen in 2QFY05 (graph below), similar to the trend witnessed in the last four quarters. The rise in sales has to be viewed therefore, in this context. Also adding to the topline growth are the commencement of Wellington Mews and the first of the budget hotels in Bangalore (IndiOne). We expect occupancy rates to increase for FY05 and beyond while the increase in ARRs is likely to slowdown.

One-time expenses subdue margins:
On a standalone basis, while the company derived 48% of its net sales from room revenues in FY04, the food & beverages division contributed 43% to net sales. IHCL also manages hotel properties, which added to 4% of net sales in FY04. As is evident from the table below, while the company has been successful in reducing most of the costs, other expenditure as a percentage of sales has increased dramatically. The other expenses here include provision towards some of its foreign currency assets (Rs 59 m or 3.4% of 2QFY05 sales) and Rs 52 m (3% of sales) as consultation fees for employee training. The latter of the expenses is, in our view, one-time in nature. If one were to exclude this item, the rise in operating margins is much higher. Since the hotel industry operates on high fixed cost, whenever there is a sharp rise in the topline, the bottomline increases at a faster rate. The medium-term outlook for margins remains promising.

Cost break-up…
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Raw materials 151 176 16.7% 296 342 15.4%
% sales 11.0% 10.2%   21.5% 19.8%  
Staff 336 397 18.3% 718 811 13.1%
% sales 24.4% 23.0%   52.2% 46.9%  
Power & lighting 160 173 7.9% 332 339 2.0%
% sales 11.6% 10.0%   24.2% 19.6%  
Others 536 743 38.6% 991 1,388 40.1%
% sales 39.0% 43.0%   72.0% 80.3%  

Over the last few quarters:
As is evident from the graph, the hotel industry is coming out of a trough. Since the industry is seasonal in nature, it is not prudent to compare performance on a quarterly basis. Margins, ARRs and occupancy rates have improved in 2QFY05 as compared to 2QFY04 and we expect the trend to continue, albeit at a slower rate.

What to expect?
The stock currently trades at Rs 453 implying a price to earnings multiple of 35.6 times annualised 1HFY05 earnings. While we have been aggressive on the margin expansion side for FY05 as a whole than the actual performance, we would maintain our stance owing to continued strength in tourist inflow. Besides, the second half is also the busy season for hotel chains like IHCL and consequently, occupancy rates are likely to be much higher.

Having said that, the stock has outperformed the Sensex in the past and valuations have corrected upwards. Though it is not a cheap stock anymore, the upside will be driven by net profit growth. While the standalone numbers are in line with our estimates, the consolidated picture is likely to be even better. Despite these positives, investors have to bear in mind that the sector is highly vulnerable to geo-political events and to that extent, the risk profile is on the higher side.

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