Look beyond Indian Hotels' rights issue and check in for a long stay

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Ruchi AgrawalMoneycontrol Research

At its AGM (annual general meeting), Indian Hotels Company (IHCL) approved plans for an equity rights issue to raise Rs 1,500 crore. Markets weren’t happy with the move. While the stock has corrected on this news, we see longer-term tailwinds for the sector in general and the company in particular that beckon investors’ attention.

One more rights issue?

The proposed rights issue would be the third from IHCL in the last 10 years, the first two being in 2008 and 2014 for equity & non-convertible debentures, and fully-convertible debentures, respectively. The proceeds are expected to be used for refurbishments of properties, debt repayments and new property development.

The company has announced plans for Rs 3,000 crore capex in the coming five years of which Rs 300 crore will be invested in the year 2017-18 for renovating 14 percent of its existing portfolio. A portion of funds raised will be used to repay a part of the debt. As per sources, a significant portion of the proceeds is also planned for the development of its SeaRock Mumbai property.

The announcement came as a dampener when the markets were expecting significant restructuring and debt repayments without resorting to additional capital raising and the resultant equity dilution. The stock has corrected 10 percent since the announcement.

Should you avoid IHCL or capitalise on the weakness?

While prima facie the market was disappointed, we have to view the reaction in context of the stock’s huge underperformance. The stock has dipped 15 percent in the last 12 months, as against a 14 percent gain for the Nifty. On the positive side, the company has started restructuring initiatives (likely to get a boost under the Group’s new top management) and the macro environment seems to favour the industry.

At the current price of Rs 112, the stock is trading at an EV/EBITDA of 23 and EV/Sales of 3.5, which is comparable with the industry average.

Numbers improving a bit: On a consolidated basis, the margins have started improving and net loss has reduced. In Q1 FY18, consolidated revenue was Rs 907.3 crore and EBITDA Rs 90.6 crore, both down 4 percent YoY (a seasonally weak quarter). On a standalone basis the numbers were strong (largely domestic operations, or nearly 73 percent of the business). Revenue grew 6 percent and excluding impact of one-off payments, the same grew by 10 percent. EBITDA margin expanded by 1.4% percent to 15.2 percent . Finance costs witnessed significant reduction YoY due to debt repayments.

Balance Sheet Clean Up: Over the past few years, over leveraging and heavy finance costs have been a major drag for the company. Like most other Tata group companies, IHCL is undergoing major balance sheet restructuring. Non-profitable portions of the international operations have been divested, written down or moved to management contracts.

The debt repayment process has started with Rs 1,065 crore being repaid in 2016-17. Further divestments have been indicated by the company to remove unprofitable properties from the portfolio and pay off debt. This would lower the finance cost and help generate profit. The company now aims to move towards an asset-light model in the international markets with management contracts and focus more on the legacy domestic operations.

Demand and Supply dynamics: IHCL operates with four major brands and is positioned towards the high cyclicality bracket with more than 80 percent exposure in the upscale segment. After a demand slump and excess supply, Indian hotel industry is now witnessing an encouraging reversal in that trend. The period 2016-17 saw a supply growth of only 3.1 percent, where demand increased by 6.2 percent. Globally, the hotel RevPARs (revenues per available room) are highly cyclical and follow a typical 7-9 years phase. Hotel occupancies are recovering and IHCL is well positioned to monetise from higher room rates.

Shift from unbranded to brand: Around 25 percent of the Indian hotel industry falls under the branded category unlike 40 percent in major developed economies. Owing to higher disposable incomes, deeper penetration of technology, awareness and reach, there has been a flight of customers from the unbranded segment to the branded segment globally. Most major hotel chains (Marriott, IHG to name a few) have been aiming to capture this branded economy segment. For IHCL, 84 percent of the room pipeline is planned for domestic markets, and 20 percent in the economy segment.

Regulatory impact: Most of the regulatory headwinds, including demonetisation and the alcohol ban are largely behind the company. Food and beverage sales seem to be picking up now. The recent Supreme Court order to remove city highways from the alcohol ban rule will further provide stimulus to F&B revenues, which were earlier impacted in a few properties.

While the GST tax slab for premium brands (where IHCL has its major exposure) at 28 percent could impact demand, the net impact could be lower on account of the input tax credit that companies can claim.

There are a few positive tailwinds like the introduction of e-visas by the Indian government that should augur well for tourist arrivals in the country.

Overall, tourism, being an important employment generator, would continue to receive support from the government. That should have a positive rub-off on the hotel industry.

With a favourable macro and the management’s effort to clean up the balance sheet, the future might throw up opportunities. Benefits of the cleanup have already started flowing into the performance. While globally the RevPAR and occupancy cycle has matured and this could flow into Indian markets with a lag, we expect efficient players to survive. The weakness in IHCL could be an opportunity for long-term investors.

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