30-100% returns in 1 yr: Hotel stocks are soaring & there's more steam left

With premium hotels best-placed to reap the benefits, stocks such as Indian Hotels and EIH should see a revenue uptick

Led by Indian Hotels and EIH, hotel stocks have been hitting their 52-week highs on expectations of strong December quarter results as well as a favourable demand-supply situation. Stocks in the sector, which have been laggards in recent years, generated returns between 30 and 100 per cent over the past one year.

The immediate trigger would be the December quarter results. Foreign tourist arrivals have grown 14.5 per cent in the December quarter after five consecutive quarters of single-digit growth. With better growth in foreign tourist arrivals and improved domestic demand, analysts at ICICI Securities expect occupancy levels to improve during the quarter on a year-on-year (y-o-y) basis.

The sector is expected to see a cyclical recovery with demand expected to grow faster than supply. While the overall sector is expected to grow at six per cent over the next couple of years, the premium category will outperform with growth of about nine per cent. Binaifer F Jehani, director, CRISIL Research, expects demand growth to increase on the back of increasing foreign tourist arrivals, higher demand from domestic tourists, increasing corporate travel, business (exhibition/conferences) activities and social events, in line with an improving economy.

Supply, on the other hand, is expected to be muted at five per cent. The sector which hit a peak in FY08 suffered from oversupply in FY10-13 when supply of rooms averaged 17 per cent during this period, which was followed by a more muted seven per cent during FY13-17. This is expected to fall further to five per cent now, which, coupled with demand drivers looking up, should help improve occupancies and average room rents. 

Pavethra Ponniah, vice-president and sector head-Corporate Ratings, ICRA, expects revenue per available room (RevPar) to grow at 4-4.5 per cent in FY18. This, according to her, will accelerate to five-seven per cent during FY19 and FY20, driven by traction in average room rates. RevPars are a product of room rates and occupancies. Analysts expect the increasing revenue per available room trend driven by higher occupancies to boost the operating profit margins of hotel companies over the next couple of years. 

While valuations, given the surge in prices over the past year, are not exactly cheap both on the enterprise value to operating profit (17 to 19 times one-year forward estimates) or price to earnings ratios (upwards of 50 times one-year forward estimates), there is still some juice left if replacement cost value is taken into consideration, says an analyst. Replacement cost per room for a premium property in the bigger metros is pegged at Rs 40 million and the slew of private equity deals in the space have happened at the replacement cost value.

Given higher demand projections for premium category, Indian Hotels and EIH are the two major players which are expected to benefit from the uptick. Most brokerages are bullish about the prospects of Indian Hotels. Reduction in debt after restructuring of its operations and margins expansion on the back of sale of loss-making units and cost control measures are positives. This should be aided by new additions to its portfolio through higher-margin management contracts. Though the company reported pricing growth of eight per cent in FY17, tax increase under the goods and services tax impacted pricing in the first half of FY18. Given occupancies in some key markets at 70 per cent analysts expect pricing growth to come back. At the current price the stock, which has gained over 50 per cent over the past year, is trading at 17 times its FY19 enterprise value to operating profit. Investors can consider the stock on dips. 

EIH remains a top pick of analysts at ICICI Securities with the immediate trigger being stable December quarter numbers. The company is expected to report a four per cent growth in revenues as compared to a drop last year. Strong demand and occupancies will help improve average revenue rates too. Analysts expect the company to improve its margins by 40 basis points y-o-y, given volume/scale benefit. At the current price, the stock, which has doubled over the past one year, is trading at 19 times its one-year forward enterprise value to operating profit. Investors can wait for valuations to cool off a bit before buying the stock.