India’s luxury hotel industry has been on a roll for the past three years.
Market leader Indian Hotels Ltd’s turnover has grown at a compounded annual growth rate (CAGR) of 35.8% in the past three years. Its consolidated sales now stand at Rs2,511 crore. During the same period, EIH Ltd’s consolidated sales have risen at a CAGR of 29.9% to Rs1,004 crore. ITC Ltd’s hotels business has risen at the fastest rate of 57% to Rs986 crore, albeit from a lower base.
More importantly, cumulative pre-tax earnings of the three companies have doubled every year for the past three years. Apart from better economies of scale coming from higher occupancy rates, hotel companies have also benefited from an increase in room rates. Pre-tax margins of the three companies (on a cumulative basis) have risen from under 8% in financial year 2003-04 to 26.6% in the last financial year. It’s no wonder hotel stocks have been outperformers in the rally that began in 2003. Between January 2003 and December 2006, Indian Hotels’ share price rose 714%, more than 2.5 times the return of the Nifty (262.7%). The EIH stock rose by 312% during the same period. The good run may not be about to end, but there are signs that growth may slow down a bit because of a much higher base.
Last year, for instance, EIH and ITC reported a revenue growth of 23.4% and 25.8%, respectively, lower than their average in the previous two years. Indian Hotels managed to maintain sales growth at around 36%, but like its peers, profit growth fell sharply. It reported a growth of 65.9% in pre-tax profit, after growing profits by 111.3% and 156.7% in the previous two financial years. ITC’s profit growth fell to 35.9%, while EIH’s pre-tax profit rose 53.2%. Both firms had seen earnings grow at a CAGR of more than 100% in the previous two years.
This could be one of the reasons hotel stocks have underperformed the market lately (see chart). Besides, there were some worries about increasing supply in some markets. Last year, higher supply caused occupancy rates to fall in key markets such as Delhi, Bangalore, Chennai and Hyderabad. But room rates have continued to rise despite the increase in supply. Revenue per available room, a key measure for the hotel industry which takes into account both occupancy and room rates, rose in each of these markets. For Indian Hotels, revenue per available room across all markets rose 33% last year. In the March quarter, revenue per available room rose by 31%, indicating a slight deceleration.
Analysts aren’t worried about the supply situation, citing that the completion of a number of hotel projects has been pushed by one-two years because of delays by developers. As a result, demand is expected to outstrip supply for some more time to come. But given the high base, the markets are being careful with their bets. Indian Hotels now trades at 23.6 times trailing earnings, lower than the valuation 24.7 times earnings it enjoyed the same time last year. EIH’s price-earnings valuation has fallen by about 8%.
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