Indian Hotels Company Research Report By Nirmal Bang

Cost optimization – driver of profitability

We recently met the management of Indian Hotels Company Limited (IHCL). Management indicated that it is focusing on a four pronged strategy for earnings growth. The key drivers of the profit growth are expected to be: (1) RevPar growth (2) Cost optimization (3) Growth in Food and Beverages (F&B) (4) Increase in memberships of club ‘Chambers” and (5) Increase in management contracts. RevPar and F&B growth YTD has been relatively muted due to slower growth from MICE and corporate segments.

Management stated that growth for 2QFY20 till date has been muted relative to expectations due to:

(1) Flat RevPar in July 2019 and slow RevPar growth in August 2019

(2) Continued underperformance by Corporate and MICE segments

(3) Flat occupancies; marginal reduction in ARR

(4) International operations (UK) performing better due to sports events.

While the RevPar and F&B growth YTD FY20E has been muted, management is hopeful that 2HFY20 will grow at a stronger pace. Historically, second half of the year has contributed to 70% of the full year profits.

Post our discussion with management and with other industry experts, we have revised our estimates for IHCL. Post revision, EBITDA is expected to grow at a three year CAGR (FY19 – FY22E) of 10% to Rs11,118mn in FY22E.

We have retained our Buy rating on the stock with a revised target price (TP) of Rs168 (Rs206 earlier). We have rolled over from FY21E to midpoint FY22E and valued the company at 21x mid year FY22E EV/EBITDA.

The downward revision of TP is attributable to downward revision of RevPar estimates. Revenue to be impacted because of muted RevPar and F&B: Weakness in Corporate and MICE segments till date is expected to maintain pressure on RevPar in 2QFY20E.

Although the RevPar is expected to post a YoY growth in 2QFY20E, growth would be lower than earlier expectations. The company expects to maintain the occupancy level but ARR is expected to trend marginally lower. Because of the slow growth of Corporate and MICE segments, the F&B segment is also expected to post lower revenue.

However, revenue growth is expected to be supported by increase in management contracts and increase in membership of ‘Chambers’ EBITDA to be driven by cost optimization: EBITDA is expected to grow at a three year CAGR (FY19 – FY22E) of 10% to Rs11,118mn in FY22E; Revenue CAGR during the three year (FY19-22E) is expected to be 7%. This is driven by cost optimization measures undertaken by management.

Some of the measures undertaken include: (1) Utilities – A joint venture with Tata Power Company for solar energy and also working with Siemens to take measures for reducing energy consumption. (2) Manpower – While the company plans to maintain its manpower-to-room ratio at 1.9:1, it expects the costs to gradually reduce with the retirement of high-cost senior employees and also hiring of relatively low-cost employees (3) Cluster-based shared services like common accounting, finance etc, (4) Synergies to be created by merging of the sales force of Taj and Ginger hotels. (5) Standardisation of equipment to get the benefits of discount through bulk buying of items like glasses, chairs etc.

Capex of Rs4,500mn in FY20:

Management indicated that capex of Rs4.5bn for FY20E is expected to be driven by capex for Ginger, Santacruz, Taj Mansingh, SeleQtions Connaught, Holiday Village, maintenance activities and other hotels. Gross debt to marginally decline during FY20: Management has indicated that the gross debt is not expected to increase in FY20E. Most of the capex is expected to be supported by cash flows generated from non core asset sale.

Monetization of non-core assets on track:

Management strategy to monetize non-core assets is on track. Management informed that it has monetized non-core assets worth Rs750mn during the year and is hopeful of sales of Rs2.5bn for FY20E. Maintain Buy with revised TP of Rs168 (earlier Rs206): We have rolled over our valuation from FY21E to midpoint FY22E. Our revised TP of Rs168 (earlier Rs206) for IHCL is based on 21x mid year FY22E EV/EBITDA, which is supported by EBITDA CAGR of 10% over FY19-FY22E.

The muted growth YTD FY20 in RevPar has led to our reduction in RevPar growth from 8% annually (FY20-22E) to 5%-6% annually (FY20-22E). However, we maintain that the hotel sector is in a cyclical upswing with improvement in RevPar albeit lower than expected, and also increase in the number of rooms driving higher revenue.

Higher revenue, together with a relatively muted rise in costs and high operational leverage are expected to lead to strong growth in EBITDA. Our optimism is further supported by a healthy balance sheet and negative working capital.