Hospitality sector -Room for hope:: Business Line

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The hospitality sector has had it bad for a while. But the worst may be over soon. Check in for the details

The hospitality industry in India has had it rather inhospitable for quite some time now — from 2009 to be precise, when the go-go days in the Indian hotel industry gave way to a painful down-cycle. Since then, hotel occupancy levels in the country have dipped, average room rates (ARR) have fallen and the revenue per available room (RevPAR) has slipped badly.

Big squeeze

Blame this on the pincer the sector has been caught in. On the one hand, there is an oversupply of rooms with the massive expansion of the boom years coming to fruition.

On the other hand, demand growth has been less than expected due to weak economic conditions. Data from hospitality consultancy HVS shows that between 2009 and 2014, the number of branded rooms in the country grew at an annual average of above 17 per cent to cross the 1,00,000 mark.

Demand picked up after a disastrous 2009 when the global economic crisis and the Mumbai terror attacks took a heavy toll. But the growth has lagged supply, which already had a head-start. This meant a decline in room occupancy levels to about 57 per cent in 2014, a far cry from the nearly 70 per cent levels between 2005 and 2008.

In a highly competitive and fragmented market with numerous players, worried hoteliers have been resorting to discounting rates to draw in the tourists and businesspersons. This resulted in ARR (total room revenue divided by rooms occupied) declining nearly 6 per cent annually between 2009 and 2014.

Consequently, the RevPAR (total room revenue divided by room inventory), a key performance indicator in the segment, dropped nearly 7 per cent on an annual basis over this period.

The pain in the sector is reflected in the financials of several listed hotel companies. The Tata Group-controlled Indian Hotels, the country’s largest hotel chain, has seen its losses widen over the past few years.

The troubles have been worse for players which borrowed heavily to fund expansion, the luxury hotel chain Hotel Leelaventure being a case in point. Another biggie, EIH, which runs the Oberoi and Trident chains, has managed to stay in the black, but its operating profit has been under pressure for the past few years. Similar is the case in the hotel business of ITC.

Smaller names such as Royal Orchid Hotels have been in the red for the past few years. So is Kamat Hotels which has high debt on its books. In short, the financials of the hotel industry don’t paint a pretty picture.

Riding on expectation

Yet, many of the stocks in the sector have been on a roll over the past year. Indian Hotels and EIH have doubled or more while many other stocks, including Hotel Leelaventure, have gained between 30 and 50 per cent.

What’s behind this run-up? One, companies which stand to gain with a pick-up in the economy have been the market favourites in the run-up to last year’s election and thereafter. Hotels fit the bill neatly. Economic growth, if and when it picks up, should give a boost to leisure and business traveller numbers, both domestic and international.

Next, the new Government has made the right noises about the role of tourism in the country’s economy and, importantly, followed it up by picking the low-hanging fruit.

For instance, the electronic travel authorisation and visa-on-arrival facility for citizens of 43 countries (of the 180 planned) started from last November seems to be showing results. There was a near five-fold jump in tourist arrivals in December compared with the year-ago period.

If the Government is able to walk its talk, tourism and the hotel industry, could be big beneficiaries. There is also expectation of relief in the upcoming Budget on the sector’s long-pending demands.

These include rationalisation of high taxes on the sector and reducing the investment limits (currently ₹200 crore for hotel projects and ₹300 crore for convention centres) to qualify as infrastructure companies eligible for easier borrowing terms.

Turning tide

Then, there is a sense among industry experts that the worst may be over for the sector soon, and that it may be close to an up-cycle.

While new room additions over the next year or so (primarily from the backlog of earlier years) will increase oversupply, the situation is expected to stabilise thereafter with demand for rooms growing faster than supply. HVS estimates that while room inventory will grow less than 9 per cent annually between 2015 and 2020, demand will grow about 14 per cent. This should translate into improvement in all the key metrics in the sector — occupancy levels, ARR and RevPAR.

PR Srinivas, Director – Hospitality, India, at real estate consultancy Cushman & Wakefield, agrees and says that while there could be more pain in the near term, especially in the high-end category, the situation should improve and rates harden in the medium to long-term across market segments. What should also benefit is an increasing focus on new high-potential pockets within the large cities and Tier 2 cities.

The prospects are likely to be better in the budget and mid-market categories than in the upscale and luxury segments of the hotel market. In the past, most of the supply was in the higher-end with not much capacity addition in budget and mid-market segments. The focus now seems to be at the lower end of the pyramid.

Nearly two-third of the proposed supply over the next five years is in the budget and mid-market segments, shows data from HVS. This seems to draw on the fact that the domestic market — nearly a billion travellers annually and manifold bigger than the 7 million plus annual foreign tourist arrivals last year — offers huge untapped potential at the right price points.

Cushman & Wakefield’s Srinivas says the domestic market has been underestimated so far and taken for granted with the hospitality industry’s focus being at the top-end of the market. The creation of branded, standardised accommodation for the domestic market, he feels, could see many domestic travellers shift from the unorganised to the organised hotel market.

Brands such as Ginger (of Indian Hotels), Fortune (of ITC) and Ibis (of Accor) seem well-positioned to ride this trend. That said, with foreign tourist arrival numbers expected to gain momentum and up-trading among affluent domestic travellers, upscale and luxury hotels too should see growth. In effect, brand stratification is likely to grow.

Operate, don’t own

Another trend poised to gather more speed is ‘management contracts.’ Under this model, the big boys in the business, instead of building a hotel ground-up, re-brand and manage the property of smaller players for a fee and profit share.

This asset-light strategy is the way most mature hotel markets have evolved, says Cushman & Wakefield’s Srinivas. It benefits the owner by bringing in a reputed brand, expertise and distribution reach, and also the operator by allowing expansion without the usual heavy spend and long time-lines.

Big foreign chains Carlson Rezidor Hotel Group, Starwood Hotels & Resorts, Marriott International, Hyatt Hotels & Resorts and Accor have expanded in India mainly through the management contract route. They now count among the top 10 hotel brands in the country in terms of rooms. Home-grown Indian Hotels and ITC, the two largest hotel companies in the country, are also playing the ‘operator’ game in addition to building on their own.

Other India-based chains such as EIH, Hotel Leelaventure and Lemon Tree Hotels too adopt the management contract route or plan to do so.

The MICE (meetings, incentives, conferences, events) segment should also benefit with economic growth. While the room business brings in the best margins, the MICE segment helps hotels supplement revenue, especially in off-seasons. It is estimated that about 10 per cent of the sector’s revenue comes from this segment.

Stock choice

For investors looking for stock pickings in the hotel sector, it makes sense to stick with companies having scale, manageable debt and deep pockets. Indian Hotels and EIH fit the bill and the stocks hold upside potential despite their run-up.

Things have been bad but are likely to get better at Indian Hotels. It has been in the red the last few years due to the weak domestic market scenario, big write-offs in its international business and debt burden. But improving outlook for the sector and focused steps to moderate debt (including using proceeds from last year’s rights issue) bode well. The company’s presence in the budget and mid-market categories should also hold it in good stead.

EIH may not have a big presence in the budget and mid-market segments. But it has managed to stay profitable even in tough times. The company has low debt and the backing of deep-pocketed partners such as Reliance Industries. This should aid expansion.

It may be best to keep off the stock of Hotel Leelaventure. While it has marquee properties, the company is neck-deep in debt and efforts to reduce the burden have not yielded results. This has resulted in steep losses, and the situation may not improve soon.

The hotel business of conglomerate ITC is a minor contributor to the company’s profit (1.2 per cent last year). So, buying the stock to bet on the hotel business does not make sense.