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Indian Hotels Stock Analysis | Long Term Outlook and Future Prospects

HomeIndian Hotels Stock Analysis | Long Term Outlook and Future Prospects

Stock of the Month (August 2013) – Indian Hotels

29 August, 2013

Price: Rs. 45.10

 This Stock Analysis report presents a long term outlook and the future prospects of Indian Hotels.
 
INVESTMENT RATIONALE

Expansion Plans

On October 18, 2012, Indian Hotels Company Limited (“Company”), which holds 6.9 % stake in the NYSE listed, Orient Express Hotels (“OEH”) made a US $ 1.86 billion offer to acquire all of the outstanding shares of OEH for $12.63 per share in an all cash deal representing a 40% premium to OEH’s previous closing price of $9.02 per share, and a substantial premium to the 52-week closing high of OEH shares which was $10.90 per share[1].

If Indian Hotels is successful in its bid to acquire OEH, it would transform the Company into a global hospitality chain and help the Company in expanding its portfolio into the leisure and tourism segments.

About Orient Express

OEH is engaged in the business of owning and / or operating luxury hotels, restaurants, tourist trains and cruises. Orient-Express brand operates 32 hotels (with two additional hotels opening in next twelve months), one restaurant and three safari camps which are spread over six continents. Additionally, OEH operates six trains and two cruises on three continents.

OEH has an inventory of 3,324 rooms (2,957 rooms in 100 % owned hotels and 367 rooms in JV properties). Some of the famous OEH properties include the Copacabana Palace in Rio de Janeiero, Brazil, Hotel Cipriani in Italy, Charleston Place Hotel in South Carolina USA, El Encanto in Santa Barbara, California USA,  Grand Hotel Europe, Grand Hotel Timeo in Sicily, Italy, and the famous ‘21’ Club restaurant in New York.

Currently, OEH shares are trading close to their historical lows. On 18 October 2012, before the announcement of the deal, OEH shares closed at a price of $9.02 per share on the NYSE which gave OEH a market capitalisation of $0.92 billion. Due to a slowdown in the hospitality sector, particularly in Europe and the USA, the share price of OEH shares is significantly below its intrinsic value.

Caveat: To finance the deal, Indian Hotels is likely to rely heavily on additional debt which would further leverage the Company, as equity dilution in such market environment may not be a viable option.

Indian Hotel Stock AnalysisWe believe that valuations in the hospitality sector in India are currently cheap and it is a good time to make such an acquisition.

In our view, Indian Hotel with the backing of a strong corporate group and a history of turning around struggling businesses will be able to capitalise on this purchase in the long term

Besides its bid for OEH, the Company has been expanding aggressively in both domestic and international markets.

The Company has enhanced its capacity by adding 8 new hotels (comprising ~ 859 rooms) in FY 2013. In FY 2014, Indian Hotel has already added 1 new hotel and is working towards adding another 11 hotels (comprising ~ 1,498 rooms)

As these properties become operational, additional revenue stream from new rooms will have a positive impact on Indian Hotel’s total revenue from operations. Additionally, the Company will be able to improve margins by cutting interest costs and other expenditure which are currently being incurred on developing these properties. 

Indian Hotel Stock Analysis

In November 2012, Indian Hotel opened its 18th overseas hotel, The Taj Palace Marrakech in Morocco. The Company is planning to expand its global footprint by entering the lucrative Chinese market where it is planning to open six hotels with its first property i.e. Taj Palace, Temple of Heaven, slated to open in Beijing next year.

Grossly undervalued share

In recent years, prolonged slowdown in global economy caused reduction in both leisure and business travel. At the same time, high inflation in India escalated raw material prices which added to the margin pressure for the Company.

The Company’s current market capitalisation is ~ Rs. 4,443 Cr. The total net debt on the books is ~ Rs. 3,100 Cr which gives the Company an enterprise value of ~ Rs. 7,543 Cr which we believe is drastically lower than the current market value of Indian Hotel’s owned properties.

Promoters hiking stake

On 22 June 2012, the promoters of the Company (i.e. Tata Sons) exercised the option to convert 48 million warrants into equivalent number of Indian Hotel shares at Rs. 103.64 per share for a total deal value of 497.47 Cr (of which 25% amounting to Rs.124.37 Cr had been received on allotment of warrants).

An increase in promoter stake is a strong reaffirmation by the insiders, who are the first recipient of any information and knowledge, that there is greater potential value in the business than what the market is paying for it. At the time of conversion, Indian Hotel stock was trading at Rs. 55.40 which indicates a market premium of 41.90 % paid by the promoters. This reinforces the conviction of the promoters that the market has undervalued the business and the price of the Company’s equity shares. 

Hospitality: Industry with enormous growth potential

Tourism accounts for 6% of India’s GDP. The current rate of growth in domestic tourism sector is ~ 9 % (calculated on a ten year CAGR). 

Indian Hotel Stock AnalysisIndia’s total share in world tourist arrivals remains a modest 0.6%. Whether measured by the yardstick of its vast tourism resources, or its emerging economic importance, India’s low share of tourism arrivals is certainly below potential. The Ministry of Tourism is planning to undertake widespread and aggressive promotional activities to increase India’s share in attracting foreign tourists by further intensifying the current marketing campaigns ‘Incredible India’ and ‘Athithi devo bhava’.

According to the world Travel and Tourism council, India will be a tourism hot-spot from 2009 to 2018, having the highest 10-year growth potential. In the years to come, we believe that India has the potential to emerge as a major tourist destination which will have a direct positive impact on India’s hospitality industry where there is a current shortage in the availability of rooms.  

The total foreign tourist arrivals in India in 2010 were 5.58 million. The foreign exchange earnings from tourism during 2010 were US$ 14.19 billion. For the calendar year 2012, Foreign Tourist Arrivals reached an all time high of 6.65 million.

The total foreign tourist arrivals in India in 2010 were 5.58 million. The foreign exchange earnings from tourism during 2010 were US$ 14.19 billion. For the calendar year 2012, Foreign Tourist Arrivals reached an all time high of 6.65 million.

According to the Working Group Report for the 12th Five Year Plan (2012-2017) of the Ministry of Tourism (“Working Group Report”), the number of foreign tourist arrivals in 2016 is estimated to be 11.24 million. The foreign exchange earnings from tourism will increase from Rs. 64,889 Cr (US$ 14.19 Billion) in 2010 to Rs. 1,34,383 Cr (US$ 30.3 Billion) in 2016. Additional fee from Tourism during 2010-16 is estimated to be Rs. 69,494 Cr (US$ 15.7 Billion).

Domestic tourism also plays an important role in overall tourism development in the country. The number of domestic tourist visits increased from 462 million in 2006 to 740 million in 2010. Number of domestic tourist visits in 2016 is estimated to be 1,451.46 million. In 2009 when the country witnessed a negative growth of 2.2 % in foreign tourist arrivals, domestic tourist visits registered a growth of 18.8 %. Domestic tourism is likely to grow further on the back of a rapidly rising middle class with increasing disposable incomes.

The average room rates and total revenue figures for hospitality businesses are likely to spike up sharply given the current shortage of rooms and expected increase in both business and leisure travellers over the next few years. The Working Group Report estimated the requirement of additional rooms in 2016 as below:

Indian Hotel Stock Analysis

Hospitality sector is poised at a pivotal point to reap the benefits of India’s growth potential. As economies and markets begin to stabilise we expect hospitality sector to outperform the overall market over the next 3-5 years.

INVESTMENT CONCERNS  

Demand Slowdown: Tough economic environment to continue in the short term

The global macroeconomic environment remains bleak. Until the European sovereign debt crisis is resolved in a meaningful way and the United States economy revives, volatility in the global markets is likely to continue. 

For past many months India has been suffering from a high rate of inflation with the general level of prices for commodities and raw materials rising at an alarming rate. This has put incredible pressure on margins of hotels. For FY 13, Indian Hotel’s raw material expenses went up by 5.23 % while expense on fuel, power and light went up by 17.55 % (y-o-y). In comparison the Companies gross sales increased by only 8.71 %.

High inflation has also kept R.B.I. from cutting key interest rates which directly affect the travel industry. In addition, fuel price inflation has resulted in air travel getting dearer by up to 30-40 % due to which domestic travellers in particular have cut back on their travel spends.  While we believe that we are nearing the end of a bad economic cycle any meaningful improvement in the economy will primarily depend upon progress on the following fronts:

         i.            European sovereign debt crisis;

        ii.            The state of high inflation in India; and

       iii.            The structural challenges which the US employment market is facing.

Increasing competition

India, after China is considered the most lucrative hotel market in the world. There is fierce competition to tap into the growth potential in the Indian hospitality space. Many foreign hotel chains like Marriott, Hyatt Hotels Corp, InterContinental Hotels Group (IHG), Hilton Worldwide, Accor SA, Four Seasons Hotels and Resorts and Starwood Hotels and Resorts Worldwide, have joined hands with several developers and investors to open scores of properties across the country. This has resulted in a negative demand supply mismatch leading to a reduction in the Average Room Rates (“ARRs”) in key cities with the exception of Goa.

Indian Hotel Stock Analysis

Given the rising affluence of India’s middle class and the growth trajectory of Indian economy, we remain positive on the long term future prospects of the Indian hospitality sector. At the same time, we expect ARRs and occupancy levels to remain low in the near term as foreign chains continue to develop properties resulting in increased supply of rooms in various cities. 

Profitability of international subsidiaries remains a concern

Over the last few years global economic conditions have remained in a state of turmoil. The Indian and global hotel industry has been badly affected by the downturn precipitated by the global financial crisis. Despite concerted efforts to contain the impact of sovereign debt crisis in Europe, there seems to be no clarity on how things may develop in future. Growth in the United States is still subdued despite many populist measures and attempts made at stimulating the economy.

The Company’s overseas properties are situated in countries which are facing the brunt of slowing economic growth. In particular, profitability of International Hotels Management Services Inc which runs the New York, Boston and San Francisco hotels remains a concern as the company reported a net aggregate loss of US $ 3.62 Cr for FY 2013 and Rs. 168.16 Cr for FY 2012. Unless economic growth in key markets such as the United States shows signs of improvement, Indian Hotel’s international operations are likely to remain under pressure which will have a negative impact on the overall financial condition of the Company.


About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.