• DECEMBER 10, 2004

Hotels: It's party time!

The last one and half years have been memorable for the Indian tourism sector. After the September 11 jerk and the consequent fallout in terms of lower international tourist arrivals into the country, there has been a marked turnaround in industry fortunes. We take a closer look at the broader industry trend and what lies ahead for hotel stocks.

As the chart below shows, while there is a secular uptrend in the international tourist arrivals into the country since the early 1990s, in the last four years, the inflow have been rather lacklustre. To put things in perspective, the ten year CAGR of international tourist inflows stand at 10.3%. In the last five years, however, the growth is just 1.2% CAGR. The slower growth could be attributed to various geo-political events like September 11 attacks on the US, Iraq war, SARS, Gujarat riots and tensions in Kashmir, to name a few. But if the latest tourist inflow data is any indication (trade, hotels and transport sector consistently outperforming GDP growth on a quarterly basis), the industry is in for good times going forward. Our interaction with hotel companies suggest that tourist inflows have risen by more than 26% (April to August 2004) and more importantly, dollar spends are also higher. As a result, we expect another record year for the tourist sector (tourist arrivals is estimated to cross 3.5 m in FY05).

The benefits of the sharp rise in tourist inflows is already visible in the performance of hotel stocks in 1HFY05. The graph below highlights the trend in occupancy rate, average room rates (ARR) and operating margin of Indian Hotels, one of the major hotel chains in the country. The same has been the case with other chains like EIH (Oberois), Hotel Leelaventure, Taj GVK and ITC Hotels. In fact, Hotel Leelaventure has witnessed a faster growth in ARRs owing to its premium property in Bangalore. Given the fact that the second half is typically a busy season for the hotel sector, we expect occupancy rates and ARRs to increase significantly, which will be reflected in operating margins. The average occupancy rate of Indian Hotels in the second half of FY04 was around 76%, which we expect to touch around 79% in 2HFY05.

Hotels is a capital intensive sector with fixed cost accounting for almost 60% to 70% of total cost, depending upon companies. So, whenever there is a sharp rise in revenues (led by higher occupancy and room rates), the expansion in margins at the operating level tends to be significantly higher. The graphs below shows the comparative costs mix of the key players in the hotel sector (on the left) and a broader comparison of margins and return ratios (on the right). While Hotel Leelaventure's operating margins will continue to remain superior as compared to its peers, we expect significant scope for improvement in return ratios for all players in FY05 and beyond. With the long-term growth in international tourist arrivals estimated at around 9% per annum, we believe that the average occupancy rate in the next three years is likely to be much higher than the trend in the last five years. This would mean better profit margins than the current levels.

Though valuation of hotel stocks at the current juncture seem to be on the higher side, as we have mentioned earlier, the second half is typically is the busy season and therefore, earnings in 1HFY05 does not reflect the true picture. Besides, we believe that the hotel sector is in a transition phase from a long-term perspective. Apart from promising international tourist inflow prospects, the fact that domestic tourism is growing at 15% per annum is also a positive. Having said that, it has to be borne in mind that the sector is highly susceptible to geo-political events and economic performance and to that extent, the risk profile of hotel stocks are very high.

Valuation snapshot...
FY04 Indian Hotels EIH Taj GVK Hotel Leelaventure
Price (Rs) 529 291 290 133
EPS (Rs)* 12.7 7.5 12.9 1.3
Price to earnings (x) 41.6 38.7 22.4 105.6
Price to book value (x) 2.7 1.6 3.5 1.3
EBDITA margin 12.3% 13.3% 29.5% 38.7%
Net margin 7.2% 6.3% 14.5% 4.0%
(*1HFY05 annualised, EIH EPS is FY05E our estimates)

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