Hotel sector poised for a rebound. Should you check in?

With high cost of land and limited avenues of financing, the room supply growth is expected to moderate to 7.9 per cent CAGR over the next three-four years.

After a lull of almost a decade, the hospitality industry in India is set to witness a meaningful uptick going ahead. Increasing middle-class population, rising disposable income, growth in foreign tourist arrivals (FTAs), and the government’s numerous initiatives to grow the domestic tourism are some of the factors, analysts say, augur well for the industry.

Fundamentals for the Indian hospitality industry are turning favorable, with demand growth (10-12 per cent) likely to outpace supply growth (5 per cent over FY18-23), reports suggest. Earlier, new inventory / room supply growth of 10.6 per cent against room demand growth of 10.2 per cent over FY08-18, was keeping the hotel room rates in check. However, with the pace of new room addition slowing down, signs that the market is finally absorbing the additional supply are now visible. As a result, occupancy levels have inched up from 58 per cent in FY13 to 67 per cent in FY18, according to a report by Motilal Oswal Financial Services (MOSL).

Rashesh Shah, analyst at ICICI Direct agrees. With high cost of land and limited avenues of financing, the room supply growth is expected to moderate to 7.9 per cent compounded annual growth rate (CAGR) over the next three-four years against 11 per cent CAGR reported over FY02-17.

"Hence, we believe the hotel industry would witness gradual and sustainable rise in room rates backed with strong occupancies over next three-four years. This would put the industry back into its growth cycle after one of the longest slowdowns seen in hotel performance lasting over six consecutive years from 2009 to 2015," Shah says.

That apart, improving occupancy levels are expected to drive healthy average room rate (ARR) growth and given the fact that hotels are a high operating leverage business, margins are expected to improve significantly, notes Himanshu Shah, research analyst - institutional equities at HDFC Securities.

Ruling out an all-out consolidation via merger and acquisition (M&A) route in the industry, another trend, Shah of HDFC Securities points out is the consolidation of inventory through management contracts by existing hoteliers. This means a lot of individual hotel chains are aligning with branded players to expand their operations.

So, should you check in?

Among stocks, analysts are bullish on Indian Hotels and EIH Ltd. For the second quarter of FY19, Indian Hotels’ consolidated loss narrowed to Rs 52.1 million as against Rs 576.7 million in the year ago period. Total income came in at Rs 9.8 billion, up 14 per cent year-on-year (y-o-y) against Rs 8.6 billion in the year-ago quarter.

Analysts at Motilal Oswal Financial Services expect a compounded annual growth (CAGR) in consolidated revenue/EBITDA of 9 per cent/25 per cent over FY18-20 for Indian Hotels and maintain a buy rating on the stock with a target price of Rs 160. Going ahead, the hotel, ICICI Direct says, plans to add 20 new hotels through management contracts, further boosting the topline. In addition, cost rationalisation and revenue per available room (RevPAR) growth is expected to drive margins in FY18-20E.

“Indian Hotel’s balance sheet is expected to strengthen further due to asset monetisation and higher free cash flow (FCF) generation (average FCF of Rs 4 billion over FY19-20 versus Rs 2.8 billion over FY13- 18). Return on capital employed (RoCE) is likely to improve from 4.6 per cent in FY18 to 7.5 per cent in FY20,” analysts at ICICI Direct said in a recent report.

East India Hotels (EIH) reported healthy revenue growth of 22.5 per cent YoY during the second quarter of FY19 backed by improved occupancy across its properties along with incremental revenues from refurbished Delhi property. In the next three years, EIH plans to open at least eight new hotels consisting of nearly 700 rooms.

Maintaining a buy rating on the stock with the target price of Rs 205, ICICI Direct says better working capital management and healthy operating cash flows suggest robust financials of the company. "Further, EIH also has a strategic partner, Reliance Industries, with an 18.5 per cent stake in the company. We believe this would help the company grow faster with a rebound in the macro environment," say analysts at ICICI Direct.