Appetite for hotel stocks improves

Surprisingly, in less than a month after the March quarter results were announced, stocks of leading hotel chains in the country have bounced back after years of doing nothing much. Shares of Indian Hotels Co. Ltd (IHCL), represented by the Taj brand, lead the pack and are up 25%. Another stock, TajGVK Hotels and Resorts Ltd, is up 18%, while others like EIH Ltd are inching up too.

The reason for the sudden appetite for hotel stocks is the better-than-expected recovery in the domestic hospitality business. March quarter revenue grew by around 10%, with operating margin expansion beating analysts’ estimates.

Moreover, the clouds of overcapacity in the luxury hotel segment are gradually receding. Prospects for better room tariffs and occupancy rates (ORs) are thus improving. An analysts’ presentation by IHCL says that while supply of rooms increased by 3.9% during fiscal year 2016 over the previous year, demand grew by 10.5%.

Interestingly, demand growth is being fuelled by higher domestic ORs across cities. If this continues, room rates could gradually move up, leading to growth in average revenue per room.

And that’s not all. Foreign tourist arrivals (FTA) into the country grew by 10% in the first three months of calendar year 2016. This is commendable, given the damp global economic sentiment and after the single-digit growth seen annually since 2009.

All these factors promise a rise in revenue in the medium term, very important for luxury hotel chains that have been languishing with excess capacity. Further, the fact that most hotels have deferred or cancelled any expansion plans is good news, as it will help improve balance sheet health of these firms.

Some are trying to trim existing debt too. According to ICICI Securities Ltd, IHCL’s debt should come down in the coming years, given its strategy to follow an asset-light business model, where it will undertake more contracts. Its plan to divest low-margin yielding assets, like the one in Boston, will improve cash flows and profitability in the long run. This may be the reason why IHCL’s stock outperformed its peers in the last one month.

Likewise, TajGVK’s stock is rallying after it posted a strong recovery in operating margin in the March quarter on the back of better operating leverage and lower raw material cost.

That said, some luxury hotel chains like Hotel Leela Venture Ltd are in dire straits with operating loss, debt burgeoning to 18 times the equity and obvious inability to service interest charges on borrowings. Of course, a discerning Street has consistently punished this stock, which after steadily falling is now hardly on the investor’s radar.

The writer does not own shares in the above-mentioned companies.