Lemon Tree Hotels is best placed to ride the industry upcycle. Buy for TP of Rs 140 (40% upside): PL

Rating: BUY| CMP: Rs109 | TP: Rs140

Best placed to ride the industry upcycle

We initiate coverage on Lemon Tree Hotels Ltd (LTHL) with a ‘BUY’ rating and TP of Rs140. We believe LTHL is well poised to capitalize from impending uptick in the Indian hospitality industry given 1) leadership position in midscale/economy segment with ~19% market share 2) aggressive plans to rapidly expand via asset light management contract route that is expected to improve BS strength and uplift margin profile and 3) operationalization of Aurika hotel in Mumbai with 669 rooms. Aurika is expected to be a crown jewel for LTHL as it is strategically located in dense micro-market of Mumbai (near airport) and we expect the hotel to generate revenues of Rs2,764mn in FY26E (2nd full year of operations with an EBITDA margin of 60%). Backed by opening of Aurika, Mumbai in Oct-23 and addition of 4,808 managed rooms by FY26E, we expect revenue/PAT CAGR of 19%/36% over FY23-FY26E. We value LTHL on SOTP basis. The standalone business is valued at 21x FY26E EBITDA while Fleur, an asset owning subsidiary with 59% stake, is valued at 22x FY26E EBITDA to arrive at a per share value of Rs140. Initiate ‘BUY’.

LTHL’s market share set to rise in the mid-market hotel segment: LTHL’s isolated choice of focusing on mid-market segment at a time when the branded hotel sector was an inverted pyramid (luxury/upscale room count was higher than mid-scale/economy count) enabled rapid expansion with swift market share gains. We believe LTHL’s share is expected to rise further as there are roughly ~2mn rooms in the unbranded category that are suitable for branding in the midscale/economy segment where LTHL has well established brands like Lemon Tree Hotels, Lemon Tree Premier, Red Fox and Keys.

Transformed into an asset light business: Expansion via management contract route not only makes the business asset light (capex is incurred by the property owner) but also uplifts margin profile as flow-through is high. Over last 5 years, the count of managed room inventory has increased from 1,841 rooms (34% of inventory) in FY19 to 3,190 rooms (38% of inventory) in FY23. We expect the ratio of managed rooms inventory to reach 57% in FY26E as barring Aurika, Mumbai (669 rooms; owned hotel) entire inventory expansion plan is via management contract route resulting in 44% CAGR in management fee income over FY23- FY26E to Rs1,079mn in FY26E.

Aurika, Mumbai to emerge as a crown jewel for LTHL: LTHL is coming up with a new hotel in Mumbai near the airport under brand Aurika that is expected to be operational in Oct-23. We believe Aurika, Mumbai is likely to be a key growth driver and crown jewel for LTHL as 1) it is strategically located in dense micro-market of Mumbai (near airport) and hence would require lower time to stabilize once operations begin (we expect occupancy of 75% and ARR of Rs11,179 in FY26E) and 2) will uplift ARR and margin profile as ~13% of owned FY23 inventory will operate at an ARR which is ~2x of company-wide ARR with an EBITDA margin of 60% odd (in 2nd full year of operations).

Outlook and Valuation: We expect LTHL to report revenue/PAT CAGR of 19%/36% over FY23-26E amid operationalization of Aurika, Mumbai in Oct-23 and addition of 4,808 managed rooms over the same period. We value LTHL on SOTP basis and arrive at per share value of Rs140. Initiate ‘BUY’.