Growth expectations and better margins drive gains in hotel stocks

Industry earnings and growth/recovery rates have consistently surpassed market expectations over the past six quarters

The hospitality industry has seen plenty of interest since the catastrophic impact of the pandemic, which led to losses in FY21. The hotel industry market cap has more than tripled since 2019 on the combination of a strong earnings rebound and positive surprises, as well as three recent listings.

The industry has good tailwinds. The anticipation is, demand for rooms will outrun supply for a few years despite capacity expansions. Also, the enforced efficiency and cost-cutting measures instituted during the pandemic are paying off in terms of better margins. Three of the top four hotel stocks by market capitalisation hit their all-time highs on Monday given growth expectations (infrastructure, higher travel/ events) and margin improvement (premiumisation, cost efficiencies) going ahead. 

There’s been a recovery in domestic tourism post-Covid, and better infrastructure creation by the government has led to improved road and air connectivity. Macro growth has translated into a resurgence in corporate travel and more hospitality events. The government has also been vocal about its initiative to try and make India into a global tourist hub.

There’s a premiumisation trend with average room rates up 30 per cent in CY23, at Rs 7,500 vs sub Rs 5,700 pre-Covid (CY19). All cities appear to be above Dec 2019 in terms of average room rates, and many have seen even higher gains. Occupancy rates of CY23 match CY19.

The industry earnings and growth/ recovery rates have consistently beaten the street in the past six quarters. Earnings growth could remain strong for hotels in FY25 and FY26 though growth rates will ease down compared to FY22-FY24 as base effects come into play. Indian Hotels (IHCL) which hit its all-time highs on Monday could, for example, see 18 per cent operating profit growth till FY26 while Chalet Hotels could see even higher growth rates.

The operating profit margins in FY24 are expected to be over 25 per cent. This is well above the 14-15 per cent reported in FY22 and 19-20 per cent reported in FY19 pre-pandemic. While Q1FY25 will see some slowdown due to elections, IPL-related spends could compensate. In FY24, the industry saw room rate growth of 20 per cent for large chains such as IHCL, Marriott, and EIH and mid-high teens growth is expected going forward.

In FY23, revenue per available room or RevPAR (which is a combination of room rates and occupancies) grew year-on-year (Y-o-Y) by almost 88 per cent, and there was Y-o-Y growth again in FY24, pushing RevPAR well above the pre-pandemic period, where it averaged Rs 4,200-4,400 for branded rooms. In February 2024, industry RevPAR was Rs 6,497 which was 10 per cent above February 2023 with room rates being 8 per cent higher Y-o-Y while occupancies were up by 200 basis points Y-o-Y at 72-74 per cent. Pan-India, room rates are likely to rise from Rs 7,700 to Rs 7,900 in FY25.

Organised players are expanding their footprint in an asset-light manner. Supply growth is estimated to be 4-5 per cent annually over the next 4-5 years, adding over 50,000 rooms to the current inventory of 160,000 branded rooms. The industry has moved from asset-heavy investing to multiple asset-light options such as management contracts, franchising or revenue-sharing models.

These models help boost revenue and operating profit margins by reducing capex. Management contracts could account for 80 per cent of room addition over FY24-FY28. While IHCL has relatively high valuations as market leader, other listed groups are more moderately priced. Investors will also be interested in seeing the valuations received by ITC’s Welcomgroup as and when the hotel division is spun off.