A year after 26/11 and despite the economy having recovered somewhat, hotels continue to suffer low occupancy and falling tariffs
The global recession has brought the high life business to a juddering halt. As corporations strain under a global slowdown, expensive travel was the first on the list of corporate benefits to get the axe. Overseas company trips have been cut short, substituted by conference calls and luxurious stays in 5-star hotels have been replaced by meetings over ordinary coffee.
Discounts and lower rates aren’t helping either. Even as late as September, foreign travel had not picked up. An unholy confluence of a global recession, swine flu fears and the Mumbai terror attacks of a year ago have conspired to keep the cash registers at hotels across the country from ringing merrily. The only bright spot is that economic activity seems to be picking up again. Will that help the hospitality industry recover some of its smiles and grace again?
Not yet. “The hotel industry -- and airlines -- are among the first to be hit by economic downturn and are among the slowest to recover since spending on travel is considered discretionary for most leisure travellers and some businesses as well,” says Nisha Harchekar, analyst at Way2Wealth Research. She points out that after the last sector cycle peaked in 1997, the industry recovered its verve only in the second half of 2003. The six years in between were plagued by several tourist unfriendly events such as nuclear tests in 1998; the threat of war between India and Pakistan in 1999; the 9/11 terror attack in 2001 and finally, the SARS scare in 2003. A global economic upswing in the second part of that year finally gave a boost to the hotels industry.
Fast forward to late 2008, and the terror attack on two of Mumbai’s top hotel groups, again dashed all hopes of a quicker recovery. A HVS report says the terror attack caused the biggest drop in revpar (revenues per available room) to 20 per cent in Mumbai for FY09. “This was due to the Mumbai terror attacks, which catapulted across the international firmament as the electronic media beamed live images of the Taj going up in flames, even earning the dubious distinction of being ‘India’s 9/11,” it said. The attack, the report said, raised concerns in the minds of international travellers about India’s worthiness as a safe travel destination.
Turbulent Times
The global downturn has led to a severe deterioration in financials of hotel companies
Click here for large image
Haunted by the past
One year on, the industry seems to be still weighed down by the impact of that horrifying attack. International business tourist traffic at the end of the first half of this fiscal is down 7 per cent from a year ago. The average occupancy rate stood at 57 per cent at the end of September, down 11 per cent from a year ago and far lower than the 70-75 per cent seen in 2006-07 (See graphic: Under pressure). The worst-hit were Hyderabad and Pune, where occupancy rates fell by 23 and 27 per cent respectively.
| | | | To battle falling occupancies, hotels adopted a strategy of reducing ARRs, which saw a decline of 21 per cent y-o-y | | | | |
|
To improve occupancy, many hotels decided to cut ARRs (average room rates), which slumped by 21 per cent this year as compared to a year earlier. “The first half of FY10 continued to see declining demand as companies cut back on travel,” says Kaushik Vardharajan, executive director, HVS Global Hospitality Services. “This period saw quite steep declines in average rates as companies renegotiated their corporate rates aggressively and hotels focused on retaining key corporate accounts and maintaining occupancy levels.”
Room rates in Bangalore, North Mumbai, Delhi and Pune sank the most (24-31 per cent). In the September-ending quarter, ARRs declined by 4 per cent on average from the earlier quarter. Only two leisure tourist spots -Goa and Agra -- reported lower ARR losses of 7 per cent and 4 per cent yoy respectively. In fact, Agra reported a 2 per cent increase in ARR on a qoq basis. Analysts attribute this to the fact that Agra has traditionally been very slow to attract new hotels, and, therefore, room supplies.
HVS has an interesting observation that goes some way in explaining why hotel groups have been slashing ARRs to attract more occupancies. It says that, in the past three years, hotels had been charging rates that were 50-75 per cent higher than average global rates. The report warns that “if such a trend continues, India is at a risk of out-pricing itself and the industry will then have only itself to blame.” Now with the good times long gone, analysts say hotel companies have few alternatives than to cut rates to attract travellers. But it also means reduced profits, which is evident in the September quarter figures. HVS’ Vardharajan says that the earlier differential of 50-75 per cent has now come down to 20-25 per cent. So don’t expect any expansion in ARRs for some more quarters yet.
Among the big hotel groups, the performance was less than sparkling. For the first half of FY10, Indian Hotels’ occupancy rate dived 9 per cent to 56 per cent from a year ago. The company -- India’s largest hotel group -- is expected to finish this fiscal year with an occupancy rate of around 63 per cent, say analysts. The ARR for Indian Hotels was down 22 per cent in the same period to Rs 7,753 per day. Analysts forecast the ARR will improve to Rs 10,712 in the coming months - winter is peak business season for hotels. Rival East India Hotels (EIH) also reported an occupancy decline of 8 per cent in H1FY10. Occupancy stood at 52 per cent, the lowest among the bigger hospitality groups, although analysts expect it to rise to 60 per cent in the next few quarters. Its ARR decline of 20 per cent to Rs 8,800 was also similar to Indian Hotels’ performance. Hotel Leela experienced better occupancy -- 60 per cent -- but ARRs took a harder knock, tumbling nearly 30 per cent .(See graph: Steep fall)
Tourist Tap
There has been a slight uptick in the number of foreign tourist arrivals
Click here for large image
Tourist attraction
Still, it’s not the end of the world. Experts say that domestic travel is frequently overlooked when looking at tourist numbers, as foreign tourist numbers are the focus of attention. However, domestic tourists totalled 563 million compared with about 5 million international visitors in 2008. Experts say hotels could shift the customer emphasis on domestic tourists to gain for two reasons -- increased spending power of domestic travellers and the growing availability of budget hotels.
| | | | Due to muted earnings expectations, hotel stocks have been beaten down to levels
below, or near their asset values | | | | |
|
Of course, for tourist numbers to increase, you also need to give them a compelling reason to come here. One potential tourist -- local and domestic -- magnet could be the Commonwealth Games to be held in New Delhi next year. Industry body Assocham estimates the event will increase tourist foreign exchange earnings by 20 per cent to $17 billion over the next two years. Around two million foreign tourists and 3.5 million domestic tourists are expected to attend the Games itself. Industry sources say around 30,000 additional rooms will be required in Delhi and the NCR. But HVS remains circumspect on execution at the ground level. On the basis of physical verification, HVS estimates only about 5,700 rooms will be added in time for the Games. To be fair, the big hotel groups are not twiddling their thumbs on this. They are doing their best to add capacity: Indian Hotels is planning to add 400 rooms in Dwarka, New Delhi, while Hotel Leela is aiming to add 260 rooms in the NCR region before the Games. EIH also plans to add 202 rooms in Gurgaon in the second/third quarter of next year, expanding its 475-room presence in Delhi and NCR areas (16 per cent of existing rooms). Vardharajan points out that despite having all hotels rooms in and around Delhi sold out and despite ARRs climbing higher during the sports event, they may not have a significant financial impact on hotels for the rest of the year. “Hotel players in the NCR region could get additional revenues of 28-30 per cent during the period,” says Rashesh Shah of ICICI Securities.
Click here for large image
Tough times ahead
Meanwhile, expect hotel companies to slog it out in FY10.
“We expect the industry to undergo a tough phase in FY2010, although some sort of recovery in tourist traffic can be expected from 2HFY10,” says Viraj Nadkarni of Angel Broking. “We expect demand growth to normalise from FY2011E.” That’s a view mirrored by Harchekar of Way2Wealth who says that “recovery is a steady process as this industry takes time to recover”. We expect things to improve in H2FY11.” In a similar vein, Ashish Jagnani of Citi says he expects “occupancies and ARRs to remain under pressure over the next 1-2 years – we forecast average occupancies to decline to 62 per cent in FY10, before recovering to 65 per cent in FY11, and ARRs to decline 6 per cent in FY10 and 1 per cent in FY11”.
No surprise then that analysts expect earnings growth to remain muted for the rest of this current financial year. Aggregate revenues and earnings declined by 22 per cent and 96 per cent respectively for the three largest hotel chains -- IHC, EIH and Hotel Leela. Even the higher numbers expected in the December quarter and the next are unlikely to be sustained going ahead. The December and March-ending quarter’s are typically the strongest quarters for hotels.
As a result of the muted earnings expectations, some hotel stocks have been beaten down to levels that are near their asset replacement costs. Such valuations make them attractive to investors, say analysts. “During a downturn, it makes sense to look at the replacement cost because it is at such times that many companies can start to trade below their asset value,” says ICICI Sec’s Shah.” One hotel looking attractive on this metric is Indian Hotels. This hotel chain has a replacement cost that is 35 per cent higher than the prevailing enterprise value (EV). Similarly, on an EV basis, Taj GVK is trading at nearly the same level as its replacement cost. On the flip side, Hotel Leela which has an estimated replacement cost of only Rs 1,200 crore is trading at an EV that is three times that (See table: It’s hot).
A significant portion -- 62 per cent -- of the EV of Hotel Leela comprises debt which is another symptomatic feature of the hotel industry. According to industry sources, out of every Rs 100 crore estimated to be the value of a typical room, about Rs 15 crore goes towards interest expenses, 25 per cent goes to land costs and the balance 60 per cent into the building, fittings, etc. Many hotel companies took on huge loans for expansion projects during the boom time. As cash inflows dry up, they’re struggling to pay back the money. That’s why these high debt levels will continue for the next couple of years, say analysts. For IHC and Hotel Leela, debt will account for nearly 60 per cent of their net assets by FY11, while in the case of EIH, that figure is 42 per cent.
Steep Fall
ARR and RevPAR across 10 key cities
Best choice hotels
Most analysts are betting that out of all the hotel stocks, Indian Hotels has the best chance of emerging out of recession first. Hotel Leela is still wheezing under the strain of servicing debt amounting to Rs 2450 crore (in FY09) -interest costs were equivalent to 3.8 times of what the company earned at Ebit levels in the September quarter.
EIH, on the other hand, is dogged by the prospect of limited upside in light of the recent share purchase of an existing stake-holder. The Oberoi family, which holds a 43 per cent stake in EIH, is expected to sell 17 per cent to Analjit Singh. Singh is also expected to raise his holding further by way of the mandatory open offer for an additional 20 per cent stake. This is expected to leave Singh and the Oberoi’s 26 per cent each. At 4.3 times book value, EIH is already trading at a hefty premium to its long term trading mean of two times book value, but most analysts also believe the stock may have limited downside from here.
A major portion of the EIH’s shares were owned by the promoter group and other institutions. While the Oberoi’s control 43 per cent, institutions like ITC, LIC of India, National Insurance, General Insurance and Reliance Capital together own another 32 per cent, leaving about 13 per cent for the public. Most of the institutions are also long-term investors and are not inclined to offload any time soon. Analysts say if Oberoi succeeds in bringing Singh as a equal shareholder, consumer giant ITC (which also has a hotels division) will find it practically impossible to take over EIH. ITC currently has a 14.98 per cent stake in EIH.
With his 25 per cent stake, Singh would be joined by the promoter patriarch in defeating any bid ITC would try to make. With its takeover ambitions thwarted, ITC may have little option but to offload its EIH stake at some point in the future.
It’s Hot
Indian Hotels is the cheapest on a replacement cost basis
Click here for large image
Despite being a good asset play, analysts remain sceptical of IHCL’s ability to improve its financial performance in a hurry. In the September-ending quarter, revenues slipped by 16 per cent to Rs 307 crore from a year ago, although they were still up nearly 8 per cent from a quarter ago.
Ebitda at Rs 51.1 crore was down by 43 per cent from a year earlier the Ebitda margin declined by 658 bps to 17.9 per cent. Excluding a property sale in Coimbatore, net profit declined by a whopping 94 per cent to Rs 3.7 crore from a year ago.
The occupancy rate was 60 per cent compared with 64 per cent last year, while ARRs were down by 23 per cent. Despite expectations of an improved quarter ahead, analysts expect profits to remain under pressure due to a combination of higher losses from its US operations (estimated Ebitda loss of Rs 35 crore in FY10), debt of Rs 4,646 crore (FY09), a longer payback period on the Rs 680 crore acquisition of Hotel Sea Rock and the yet to be recognised losses on the $260 million investment on a 9.3 per cent stake in the Orient Express, now estimated to be worth $61 million. Nevertheless, analysts still believe that with IHCL’s leadership position and breadth across hotel categories, it will recover ahead of the hospitality pack. At the cmp, the stock quotes at 17 and 12.4 times FY11E and FY12E EV/Ebitda respectively.