Indian Hotels stock: Well-placed to ride the demand opportunity

Operational gains will be driven by domestic business; debt reduction should add to profits

After a poor operating performance on account of unfavourable industry dynamics, weak performance of overseas subsidiaries and higher costs, things are looking up for India’s largest hospitality player, Indian Hotels. The improving demand scenario has led to the domestic industry occupancy levels and average room rates for FY18 hitting their highest levels in at least five years. Analysts say Indian Hotels, which has 14,500 rooms across the country, will be a key beneficiary of a turnaround in the domestic industry. Rashesh Shah and Devang Bhatt of ICICI Securities expect the sector to witness robust growth in the coming years led by higher occupancy, limited capacity addition and rise in spending by domestic travellers. 

Favourable demand-supply

With room additions reducing by half over the last 10 years, demand has been outstripping supply, with FY18 demand growth pegged at 5 per cent even as supply is lagging at 3.2 per cent. Occupancy levels are expected to improve further due to higher spending by domestic travellers, a rise in foreign tourist arrivals and government measures to boost tourism. Foreign tourist arrivals have been moving up consistently with the March quarter number at 3.1 million as compared to 2 million a year ago. 

Gains reflect in March quarter

The improvement in demand scenario reflects, both in pricing power and for a company with a large inventory, significant operating leverage. For hotel companies, since a large portion of expenses are fixed, a major chunk of the incremental revenues typically follows through to the bottom line. The March quarter results provide an indication. While standalone revenues, which account for nearly 70 per cent of overall revenues, grew 11 year-on-year, operating profit grew 30 per cent over the same period. Operating profit margins improved by 470 basis points to 32.4 per cent in the quarter, while for the full year they were at 24.3 per cent, up 270 basis points. 

Other triggers

In addition to the improving demand environment, brokerages such as HSBC identified two stock triggers. The first is the improvement in margins in international operations. While margins of Indian Hotels’ international subsidiary have been at single digits (5.5-8.5 per cent), profitability in domestic business has been on an uptrend, ending fiscal 2017-18 at over 24 per cent. Consolidated margins at 17.6 per cent are expected to improve substantially as the company pares its less profitable international exposure and domestic margins improve. The company, post the March quarter results, has outlined a strategy of improving operating profit margins by 800 basis points over the next four years, equally split between revenue growth (management fee, new inventory, revenue per room) and cost-control measures. And, analysts are confident of good margin gains, going ahead. They say peak margins for India business were at over 30 per cent; FY18 margins were at 24 per cent. So, there is still some distance to go.

An asset-light strategy should also keep interest costs and depreciation lower, thereby boosting the bottom line. Likewise, plans to turnaround the Ginger, its economy brand, should add to profits. Any divestment or turnaround in international subsidiaries and further debt reduction through sale and leaseback and monetisation of non-core assets (ITDC shares, residential apartments, land bank, etc) should help reduce debt, which at the end of FY18 stood at Rs 24.27 billion. The company, which raised Rs 15 billion by way of a rights issue last year, has brought down debt from Rs 338.3 million at the end of FY17.

Additionally, any change in goods and services tax (GST) could provide a further kick. The GST for rooms with rates above Rs 7,500 is currently at 28 per cent as compared to the 19 per cent prevalent earlier. Any change in the rates could come as a boost for the sector and Indian Hotels as a majority of its key hotels charge more than Rs 10,000 a day tariff.

Valuation

While the Indian Hotels’ stock trades at 25 times its FY19 enterprise value to operating profit estimates and some of the improvement in domestic business is factored in the price, further reduction in debt, gains in margins as well lower taxes should act as key tailwinds. The key risks include a slower than anticipated increase in demand or an aggressive pricing by competition. Also, Taj Mansingh, a property managed by Indian Hotels is being auctioned by the New Delhi Municipal Council. If the company loses out to secure the management rights, it will have some impact. But, it accounts for less than 5 per cent of revenue and will impact sentiment more than financials.