Indian Hotels: Prime property

Lower debt, asset-light focus and a recovery in demand will help the company improve its financials

Expectations of a recovery, higher tourist arrivals and plans to de-leverage have helped the Indian Hotels (IHCL) stock gain nearly 80 per cent over the past six months. After touching its four-year high recently, the stock on Friday ended seven per cent lower at Rs 93.55 as it went ex-rights (record date is July 21). While there might not be significant immediate upside from current levels, a further re-rating is likely in the medium-term given demand revival. Its presence across the entire hotel value-chain makes it a preferred pick in the sector.

Demand seems to be recovering with foreign tourist arrivals up 10 per cent year-on-year in the June quarter (January-June 2014 growth was five per cent) as well as higher business travel over the past couple of months. Recent steps in the Budget such as visa-on-arrival facility in nine major airports are expected to boost demand from foreign travellers. News of asset sales by hospitality majors is also an indication that the cycle is turning for the better. Analysts believe the industry’s core operating metrics such as occupancy and average room rents (ARR), which had collapsed since FY2008 (from peak of 80 per cent occupancy, Rs 15,000 ARR) are likely to improve. From 63 per cent domestic occupancy in FY13 for IHCL, analysts expect it to be in the 67-70 per cent in FY15/FY16, while room rents should improve by Rs 1,000 from Rs 9,500. For IHCL’s international properties, too, a turnaround is expected in FY15.

Analysts at J P Morgan believe IHCL will be a prime beneficiary of this recovery given operating leverage in the business, peaking out of domestic room supply and reduction in financial leverage. While average target price of analysts polled by Bloomberg since June for the stock is Rs 101, J P Morgan analysts have a target price of Rs 120.

While demand revival is key, the other issue IHCL needs to tackle is its consolidated debt of Rs 4,252 crore with a net debt-equity ratio of 1.5 times. Towards this end, last week IHCL sold its Sydney, Australia property, The Blue Hotel for $30 million (Rs 180 crore), which it had put up for sale last year. IHCL is also in the process of raising Rs 1,000 crore from a rights issue of compulsorily convertible debentures, of which half the amount will be used to lower debt. Despite the equity dilution of 18.4 per cent post the warrant conversions in FY16, given the annual interest cost savings of Rs 43 crore, analysts believe there will be only marginal earnings dilution of 0.9 per cent. The move, according to ICICI Direct analysts, will strengthen IHCL’s balance sheet further and improve its return on equity over the long-term.

Given that its peak capex is behind it and the company is focusing on asset-light model, a large chunk of incremental capex will be on management contracts. This should keep debt levels under control while bringing in revenue and profit growth.