Indian Hotels: Hold ::Business Line

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Investors with a two-year horizon can hold the stock of Indian Hotels Company Ltd (IHCL). Expansion into the mid-market and budget hotel segments and higher realisations in its international operations due to rising room rates, should support Indian Hotels’ revenue growth over the next two years. Any weakness in the rupee will also aid profitability.

At the current market price of Rs 63, the stock trades at a modest multiple of 1.5 times to its book value, while it has historically traded at 2-4 times over the past five years. International hotel chains Intercontinental Hotel Group, Starwood Hotels and Accor SA trade at 2 to 9 times.

With 13,887 rooms spread across 115 hotels in India and international locations such as Maldives, Malaysia, the US, the UK and West Asia, Indian Hotels is the country’s largest hotel operator.

EXPANDING ITS PORTFOLIO

The last two years have been difficult for the hotel industry, especially for luxury chains, with the supply of rooms far exceeding demand.

The average room rate for the sector declined 5 per cent to Rs 5,648 in the first half of the fiscal compared to the same period last year. Occupancy rate also slipped to 54 per cent, a 2 per cent year-on-year decline.

Difficult industry dynamics also put pressure on IHCL’s revenues per available room, which declined form Rs 9,582 in FY 2011 to Rs 9,469 in FY 2012. In the first half of this fiscal, IHCL added five hotels to its portfolio, which includes two in the luxury segment (management contract) and three in the budget segment (Ginger).

Indian Hotels could see some improvement in performance over a two-three year time frame owing to its diversification moves. For one, its portfolio was dominated by luxury hotels such as Taj, Vivanta, and Gateway until recently. Cutback in discretionary spending due to economic slowdown in the domestic and international markets impacted Indian Hotels’ profitability in this segment.

To de-risk its business, the company has been expanding in the budget hotel segment through its Ginger brand, which is owned by its subsidiary, Roots Corporation. This brand could benefit from any down-trading by business travellers.

By March 2015, Indian Hotels’ total inventory of Ginger hotels is expected to more than double to around 7,190 rooms. Two-third of this would be in metro and Tier-I cities. This expansion will be aided by the infusion of capital into this business by Singapore-based private equity fund Omega TC holdings in April 2011. It invested Rs 320 crore in Roots Corporation valuing the subsidiary at Rs 700 crore. IHCL now holds 72 per cent in Roots Corporation.

In order to reduce the capital costs associated with expansion, Indian Hotels has also been adopting the management contact model to scale up presence in the luxury hotel segment. The company earns a percentage of revenues on the properties managed, with a higher profit share if the performance of the hotel crosses a certain hurdle rate.

IMPROVEMENT ON CARDS

The company’s performance for the first half of this fiscal has been uninspiring. Even as the consolidated revenues grew 14.5 per cent year-on-year to Rs 1,666 crore, losses widened from Rs 70 crore to Rs 90 crore. Fall in revenue per occupied room combined with higher interest cost took a toll on the company’s profit.

However, the operating losses were due to the newly-opened hotels (Bangalore and Hyderabad) as these were in the upscale market and required considerable working capital. Profitability is expected to improve as these new hotels stabilise and yield better revenues. Besides, a large part of inventory growth is coming through management contracts, which should also improve margins in the years ahead.

Though Indian Hotels has consolidated gross debt of Rs 3806 crore at the end of March 2012 , its overall debt-to-equity was at a manageable 0.7 times. The company’s interest outgo at Rs 214 crore, accounted for over 34 per cent of its operating profit in FY12. A decline in interest rates, as expected in the coming year, can improve the profit picture.

INTERNATIONAL OPERATIONS

IHCL’s international operations, which account for 25 per cent of the consolidated revenues, may also aid the company’s performance. The average room realisation for the international business improved by 2-10 per cent across geographies in FY12 compared to the previous year.

RISKS

One of the major uncertainties for Indian Hotels is its decision to bid for the acquisition of Oriental Hotels Express (OEH). IHCL made an offer for OEH at $12.63 a share, valuing the company at $1.86 billion.

OEH is a premium property and is in the process of a turnaround. However, now that the deal has been rejected by OEH’s board, a deal in the future at a higher valuation may be negative for the stock, as it may add significant debt to the balance sheet.