Analysts see recovery for hotel stocks in H2 amid economic slowdown

Expectations of muted performance in September quarter are factored in, but any miss with respect to H2FY20 estimates could hurt stock valuations further

After outperforming leading indices such as the S&P BSE Sensex until the start of 2019-20 (FY20), hotel stocks have been laggards in recent months, thanks to demand pressure amid economic slowdown. The stocks of EIH, Indian Hotels Company (IHCL), and Lemon Tree Hotels are down by up to 9 per cent in the past three months.

Business headwinds, mainly due to the ongoing economic slowdown, are likely to weigh on September 2018 quarter numbers of most of the hotels. With a likely muted growth in the first half (April-September) of FY20, their growth in the second half (H2) of FY20 (October-March) would be key to hotel stocks.

Hotel companies failing to meet growth expectations in H2 could see further decline in their valuation/stock prices, suggest analysts. Already FY20 revenue growth estimates for many hotel stocks are lower, compared to 2018-19 (FY19).

Amit Agarwal, analyst at Nirmal Bang, says “H2 is a seasonally strong period for hotels. Nearly 70-75 per cent of yearly profits of the hotel sector come in H2 and the December 2019 quarter would be an early indication of that. Even a small miss on growth expectations during H2 could hurt valuations.”

Currently, larger hotel players are trading at 15-21x their respective 2020-21 estimated enterprise value to earnings before interest, tax, depreciation, and amortisation.

“The expected muted performance during the September quarter seems to have factored in the stocks,” adds Agarwal.

Some fundamental factors though seem to be in support of the hotel industry, suggesting an improvement in revenue per available room (RevPAR) is possible. A likely improvement in demand scenario, coupled with the festive and holiday seasons, should help get more footfalls for hotels in H2, compared to the first six months of the current financial year. However, growth may still be lower, compared to H2FY19. On the supply side, room additions are expected to be lower, and hence the hope of an improvement in the average room rate (ARR). RevPAR is arrived at by multiplying a hotel’s ARR by its occupancy rate.

“The current supply situation in the industry remains stable, with ARR hikes expected to sustain,” Nihal Jham, analyst at Edelweiss Securities, said in a recent note on Lemon Tree. While demand is growing at 5-6 per cent, supply addition is less than 4 per cent, estimate analysts.

The down risk to ARR growth could stem from competitive intensity from local players with availability of online platforms such as OYO. Larger players such as EIH though are likely to focus on ARRs, thereby aiding the overall pricing scenario. According to Nirmal Bang’s report, EIH has been known to be the price-setter rather than a price-taker.

In the June 2019 quarter, many listed hotel players had to face slower or muted growth in occupancy due to the impact of the general election, slow consumer spending, and shutting down of Jet Airways. The major impact was seen on corporate travels and meetings, incentives, conferences, exhibitions (MICE) revenue. However, improvement in ARR for some players helped their top line.

The corporate segment, including MICE, approximately accounts for 50-60 per cent of the overall room revenue (room revenue is around 50 per cent of the overall revenue) for the hotel sector. This also shows the degree of downside risk to the hotel industry’s growth if slowdown fails to recoup.

The current geopolitical situation, following the attack on crude oil installations of the world’s largest oil producer, Saudi Arabia, isn’t good news either. Nor are the expectations of slower global growth. In India, too, economic growth hit a multi-year low recently. So, unless the government’s measures to revive the economy fructifies, the near-term outlook appears cloudy for the sector, for now.

Overall, investors are recommended to wait until some revival signs regarding the December 2019 quarter performance emerge. For now, IHCL is the top pick of analysts in the hotel space, mainly due to its focus on asset-light model and an improving cash flow position.