Graphic: Mint
Graphic: Mint

Higher room tariffs are yet to sweeten return on capital for hotel chains

A combination of factors, such as low room additions and improved demand over the last three years, has led to an increase in room tariffs

After languishing for a decade, luxury hotel chains are optimistic about improved room rates in 2019. A combination of factors, such as low room additions and improved demand over the last three years, has led to an increase in room tariffs.

According to Crisil Ltd, pan-India average room rates in fiscal year 2019 are likely to be about 7,400-7,600 in the luxury segment—about 6-8% higher than three years ago.

While this is not great considering the 28-30% drop over a decade until FY18, it signals the ability of these hotels to raise tariffs, after a long lull.

Limited room additions in the last five-six years in the premium segment helped bridge the demand-supply gap that was the biggest obstacle to raising room rates. The 4% CAGR (compound annual growth rate) in supply was outpaced by 6% demand growth.

The first six months of FY19 mirrored a 200 basis points increase in the occupancy rates at 67% on a pan-India basis. A basis point is 0.01%. Icra Ltd’s sample for the industry witnessed strong uptrend in revenues during Q2 FY19, with quarterly growth at a 28-quarter high. While the base impact (weak Q2 FY18 due to the goods and services tax roll-out, demonetization, liquor ban, etc.) has bumped up growth, the reopening of a few hotels, and growth in realizations, rising food and beverages income, and new openings have also supported revenue growth.

Brokerage firms expect the improving trend to continue. “The business sentiment is expected to improve with improving economic conditions, ease of doing business and steady increase in commercial absorption in top cities translating to more corporate travel," explains Rahul Prithiani, director at Crisil Research. So far in FY19, leisure destinations reported better operating profitability as the rupee depreciation may have favoured inbound tourism.

Improved occupancy and revenue has already set hotel stocks on fire. The Indian Hotels Co. Ltd and EIH Ltd have rallied 25-30% on the Street since September. Some such as Hotel Leelaventures Ltd are scouting for buyers to bail them out, after being caught in a debt quagmire.

However, from an investor standpoint, the return on capital employed is still not attractive and in low-single digits coming in below the cost of capital in most cases. It would be a long haul to rake in profits as other operating costs are rising too.

Given this scenario, unless cash flows are sufficient to trim debt, these stocks are prone to volatility. Their performance, therefore, is linked to a myriad of domestic and international factors such as foreign exchange movements, inflation and global macroeconomic scenario.