Highlights - No meaningful recovery before FY22 - Leveraged plays such as Lemontree and Mahindra Holidays in a tight spot - EIH and Chalet Hotels better off - Avoid the sector till clarity on a near normal life
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It has never been this hard for the hospitality industry. With the COVID-19 scare keeping travellers and tourists at bay, the impact is almost immediate on hotel companies.
Occupancies and tariffs, which came off substantially in March, reveal the extent of the damage. The pain is expected to linger in the first half of FY21. Signs of normalcy, in our view, can come only in FY22.
With a sizeable hit to revenues, many hotel companies in India will see a big drop in profitability and could report losses in coming months. They usually have significant fixed costs such as employee expenses and power and lighting bills. With revenues gradually drying up, fixed expenses are likely to eat into profits and margins.
Companies with high debt on their balance sheets have a bigger worry as they have the added burden of servicing their interest cost. The lower occupancy is also expected to keep revenues under stress in FY21.
How well prepared are hospitality players to cope with this crisis? We did a stress analysis for major hotel companies to ascertain their ability to service fixed costs in these trying conditions. Our base case scenario is a 25 percent fall in revenue.
Lemontree Hotels – The foggy view
Lemontree, a growing mid-market hotel chain, recently acquired the Keys brand, pushing up its debt-equity ratio to 1.33 times, higher than its peers. The company has a low 1.1x interest cover.
Our stress analysis indicates that the company has very little cushion in FY21. A 25 percent decline in revenue could rapidly take down the interest cover to around 0.3 times in FY21. With elevated fixed costs, the company might face a substantial erosion in profits and margins in coming quarters and even run up losses.
Indian Hotels Company (IHCL) -- On the same boat
Over the past three years, IHCL, which runs the Taj chain of properties, has worked on cleaning up its balance sheet by paying off debt expeditiously. Currently, it has a debt equity ratio of 0.48x with an interest cover of 2.2x.
IHCL has substantial employee costs, which are much higher than peers at almost 45 percent of sales. Under our stress conditions, with a 25 percent drop in revenue in FY21, the company’s margins may see a sharp fall. A high fixed cost, covering employees, other fixed and interest costs, can push down the interest cover to as low as 0.5x.
We believe that the company is not fully insulated against the demand crunch and might feel the pinch in coming quarters. What could salvage the situation a bit is its shift to the management contract model, likely leading to a lower impact on revenues.
EIH – At a vantage point
EIH, the owner of the Oberoi and Trident hotels, has a nearly debt free balance sheet with a debt equity ratio of 0.1x and an interest cover of 3.6 times. While the company has low debt, employee costs range around 29 percent of sales, near the sector average. The current lockdown will impact the company’s topline owing to lower occupancies and tariff in FY21, but with limited fixed cost, the company is better positioned than peers to face the slowdown. Our stress analysis for FY21 suggests that with a 25 percent fall in revenue, the company stares at substantially lower margins but on a relative basis, the impact would be lower than its competitors.
Chalet Hotels - better positioned
Chalet Hotels has a debt equity ratio of 1.03x with an interest cover of 1.9x. While the interest cover is on the lower side, other fixed costs like employee expenses are lower than peers at around 15 percent. Under our stress analysis for FY21, the company is better placed to tackle the fall in revenue. Despite the revenue headwinds, the company I able to maintain an interest cover of around 1.6x. The operating margins also see limited impact relative to peers.
Mahindra Holidays and Resorts (MHRL) – Tough times ahead
With a high debt equity ratio of 2.6x and a low interest cover of nearly 1.9x, MHRL has high employee cost. Given the high fixed expense liabilities, a depressed revenue will have a strong adverse impact on the company’s margins, apart from shrinking interest cover to below 1x. This indicates that the company has little cushion to face the headwinds in FY21. The company may even see losses in this financial year.
Outlook
Before the coronavirus outbreak, hotel companies had been in the grip of the economic slowdown. The virus-triggered lockdown has only rubbed it in, posing strong downside risks to earnings. We expect a substantial impact on the earnings of these major hotel chains in FY21, especially in the first half. Our assessment is there would be a gradual recovery in the second half, but sector fundamentals would start normalising only in FY22.
Our stress analysis also suggests that Lemontree and Mahindra Holidays and Resorts have a tall order ahead of them due to high debt and low debt servicing cover. Even the reputed brand Indian Hotels Company is not fully immune to the ferocity of the virus attack as a slump in revenue amid high fixed costs would erode its profits in coming days. EIH and Chalet Hotels appear to be ahead of the curve in dealing with the emerging situation. While the stocks of most hotel companies have seen a steep correction the wounds will also take months to heal.
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