Thematic report on the Hotels Sector (Indian Hotels & Lemon Tree) by HDFC Sec

On a strong wicket

India’s hotel industry has witnessed a robust turnaround in demand after the pandemic, led by the rising discretionary spending on tours and travels, revenge tourism, improving economic environment fuelling corporate travels and revival of mega wedding season and other cultural events. Furthermore, with demand outpacing supply, which the latter is unlikely to catch over the next 2-3 years, we expect both average room rates (ARRs) and occupancies to remain strong, leading to higher RevPar for the industry. The current trend is very similar to the last upcycle the sector witnessed from 2004 to 2008, which commanded improved margins and multiples for listed entities. With international travel yet to pick up and corporate events gradually gaining pace, we believe that domestic hotel players having strong hotel pipelines and healthy balance sheets are in a very sweet spot to seize the opportunity that the upcycle in the sector would throw up.

We initiate coverage on Indian Hotel with an ADD rating and a TP of INR345 (22x FY25 EV/EBITDA) and Lemon Tree Hotel (LTH) with a BUY rating and a TP of INR108 (17xFY25 EV/EBITDA), considering a discount to the average twoyear forward multiple of the past five years. Both companies have a strong pipeline of room additions based on an asset-light model. This, along with sustainable cost reduction initiatives undertaken during the pandemic is likely to drive their toplines and spur margins without leveraging their balance sheets. Rather, the improving RoCE and strong cash flow would help both IHCL and LTH bring down their net D/E significantly by FY25E-FY26E to -0.3% and 0.9% respectively.

Strong pipeline to complement the robust demand

India’s tourism sector’s contribution to the GDP is expected to grow to USD250bn by FY30 vs USD178bn in FY21, according to the ministry of tourism. This is backed by the fact that rising urbanisation in several tier-2 and tier-3 cities will drive the demand for hotels in different segments. Factoring this in, the industry is expected to witness a robust room addition (42,000 rooms) by FY27, which will increase total supply by 28% to almost two lakh rooms (source: Hotelivate). Of this, IHCL is targeting to add ~8,700 rooms (+42% from FY22 inventory level), while LTH is aiming to add 2,600 rooms by FY26 (+31% over the FY22 inventory level). Accordingly, both companies are better placed with a strong pipeline to benefit from the upcycle in the sector.

Cost reduction and debt repayment bode well for margin enhancement

Hoteliers undertook various sustainable cost-reducing initiatives during the pandemic like multitasking workforce, reducing staff/room ratio, lowering overhead expenses, etc., which are yielding a high margin now, aided by improved demand and ARR. IHCL and LTH have been witnessing ~1.5x improvement in margins in H1FY23, compared to FY19-FY20 level. Further, shifting focus to assetlight management contracts and repayment of debt through fundraising has helped make their balance sheets lean in FY22. With the rights issue and QIP, IHCL’s net D/E has reduced from 1.0x in FY21 to 0.1x in FY22 and it is expected to become net cash positive in FY23. Lemon Tree’s net D/E is likely to decline from 2.0x in FY22 to 1.7x in FY23, before falling to 0.9x in FY25E. Hence, we expect that the RoCE for both IHCL/LTH will enhance from 7.2%/3.9% in FY20 (pre-COVID) to 12.4%/11.1% in FY25. The RoE is expected to escalate to 14.2%/23.8% in FY25E, from 7.7%/1.1% in FY20.