The outlook on hotel stocks has improved steadily over the last couple of quarters. The December quarter’s weak revenue traction was a blip and the outcome of the sudden note ban. However, the sector is now flashing several positive signals, the most recent being a stable political and economic milieu that has been reinforced by the Uttar Pradesh election results.
Meanwhile, demand growth is steadily outpacing supply. With the economic downturn a few years ago, most expansion plans were also put on hold. With strong measures to improve infrastructure and connectivity, the domestic revenue passenger kilometre has grown at 20% in the past 12 months. Add to this, foreign tourist arrivals into India during calendar year 2016 were a robust 10.8% compared to 4.5% in the year before. Better still, this surpasses the growth in the rest of the Asia-Pacific region.
Improved travel and tourism has led to a 4 percentage point jump in occupancy rates to 62% from April to December from a year ago. An investor presentation by Indian Hotels Co. Ltd (IHCL) also shows that during these nine months, industry room rates inched up slightly after remaining stagnant for several quarters. Revenue per available room too rose by 6%. That is perhaps why the shares of luxury hotel chains run by EIH Ltd and IHCL retraced quickly in the last two months after falling sharply through November and December on fears of the adverse impact of the note ban.
Notably, in spite of a slight contraction in revenue, operating margins recovered in the December quarter. A report by Icra Ltd says that cost controls helped continue the trend seen in the September quarter. The average operating margin for 12 hotel chains under its ambit rose by 200 basis points to 25.9%—the highest in six years. A basis point is 0.01%.
That said, revenue and margins for the full year ended March 2017 are unlikely to show any dramatic growth. If the macroeconomic parameters continue to favour the hospitality sector, one may see revenue traction in fiscal years 2018 and 2019. However, costs, especially employee expenses, are likely to rise, which could cap further expansion in operating margins for premium hotel chains. Besides, most of the hotel chains are saddled with huge interest outflows, which continue to weigh down on net profits.
Indeed, some are in the process of deleveraging their balance sheets and limiting expansion too. A combination of this and revenue traction is the key to aid earnings growth and support valuations, that are fair at current price levels.