Make room for Indian Hotels in your portfolio

Favourable sector dynamics and deleveraging moves signal further upside from current levels

The Indian Hotels stock gained about five per cent over the past two trading sessions, while the broader markets have been volatile. In fact, it has been on an uptrend since mid-March to Rs 130, its highest levels since mid-January 2008. The gains in the past two sessions can be attributed to the upgrade by brokerages, including Morgan Stanley, which has doubled its target price to Rs 160.

Slowing supply growth, coupled with rising prices should be supportive of higher growth both in the occupancy levels (estimated to increase by 600 basis points) as well as pricing levels, which are expected to see an eight per cent annual jump by financial year 2017-18 (FY18), says Morgan Stanley. Steps such as selling Taj Boston, investing in strengthening digital assets to encourage direct booking, reducing distribution costs and growing more through the management contract model (asset light) should help drive down leverage. The research house expects debt-to-equity ratio to come down from an estimated 1.4 times in FY16 to about one by FY19.

The company had recently announced that it intends to sell Taj Boston and expects to get at least $125 million (Rs 842 crore). It is a loss-making property and proceeds from the sale can be used to reduce debt. Analysts at JPMorgan say investors might start factoring other such sales on US assets such as  Pierre and Taj Campton Place as well as its investment in Belmond (earlier Orient Express Hotels). This could lead to accelerated deleveraging of the business.

The other positive is improvement in operational metrics for the sector, which should benefit the company, given Indian Hotels’ size and presence across segments. While supply was up 3.9 per cent in FY16, demand growth for the sector came in at 10.5 per cent, leading to improved revenue per available room (RevPAR) growth. Indian Hotels’ standalone revenue growth in FY16 was the highest over the past five years on the back of better RevPAR performance.

Analysts say favourable industry economics (lower supply, steady demand) should lead to improved show in the current financial year. Muted margin trends for the company, too, seem to have bottomed out on the back of improved operating leverage and cost control. This should inch up, driven by higher revenue growth and relatively lower cost increase.

In this backdrop, analysts are giving higher valuation multiples of 15-17 times the enterprise value to operating profit, which could move up to a peak valuation of 20 times if growth and improvement in financials is more than current estimates.