East India Hotels (EIH) Ltd

Industry

The travel and hospitality industry continues to be the sector, which has largely profited from the fast growing economy of India. This has largely been due to the 4.4 m tourist arrivals in FY07 (13% growth) over the previous period. The compounded growth in tourist inflow over the last ten years (FY97-FY07) has been 4.3%, while in the last five years; growth stands at 11.6% per annum. The hotel industry went through a rough patch between FY00 to FY04 owing to factors like the Asian financial crisis, Afghan war, Middle East unrest, September 11 attacks, SARS and domestic riots.

India occupies the forty-sixth position among the sixty tourist destinations in the world. The flourishing economy helped boost the demand for the industry. Globalisation and liberalisation gave it a new impetus. Also, to encourage the tourism sector, the government is planning to propose a conditional 10-year tax holiday for all tourism projects in the country. Companies will enjoy full tax exemption up to 50% of profits, but will qualify for tax benefits for the remaining amount only if they re-invest it in tourism projects. The Centre and States are also working out a PPP (Public-Private-Partnership) model to increase hotel capacity. Efforts to diversify tourist attractions by offering new products such as adventure tourism, wellness tourism, medical tourism and golf tourism are expected to have a positive effect on both foreign tourist arrivals and domestic tourism.

As per the 2006 findings, the total number of approved rooms by the Government of India stands at around 99,000 (estimated). These rooms are further classified into various segments out of which, Five star and Five star deluxe hotels account for around 27% of the total capacity, three star hotels (22%), four star (8%), two star (9%), one star and Heritage hotels (2% each) and the rest is divided between unclassified and unapproved hotels.

The five star hotel segments has grown the fastest during the last five years at a CAGR of 12%. Further this segment can be divided into 3 sub-segments namely Luxury, Business and Leisure. The growth in this segment indicates the genre of travelers coming into the country. Over the last few years the country has witnessed a large influx of business travelers in the country owing to relaxation of the government’s stand on Foreign Direct Investments (FDI) for most of the sectors in the country.

With the foreign traffic in the country touching 4.4 m mark, the hotel industry reached new heights this year. With disposable incomes having gone up, the leisure destinations have benefited and with the heightened industrial activities, business destinations have witnessed a healthy surge in the tourist traffic. Though both leisure and business travel was in upswing this year, it was the foreign business travel which grew the fastest.

Due to the favourable demand supply gap prevailing in the country, the average room rates (ARRs) and occupancy rates witnessed an increase for the third year in a row. The all-India occupancy mark touched the 70.8% mark for the first time and many cities were completely sold out on a number of weekday nights, resulting in hotels hiking their rates sharply.

India is no longer a city of metros with the growth having spread to newer regions. On the back of the service sector spreading its reach to smaller towns, clusters of manufacturing hubs emerging across the country and large SEZs being established across states, the demand for hotels in these regions have increased. Over the last 2 years, IT cities like Pune and Hyderabad, satellite towns of Faridabad, Gurgaon, Noida and Ghaziabad and tourist destinations like Jaipur and Goa are witnessing faster growth in room rates and occupancy than the metros.

Around 25,000 total rooms across different segment categories are present in Mumbai, Jaipur, NCR, Bangalore and Pune among other cities. Around 50,000 new rooms are expected to come up in these cities by the end of 2009. Each city will have different factors that will drive revenue growth for hotels. For instance, the Commonwealth games in Delhi, IT boom in Hyderabad and Pune would drive the demand for rooms going forward. Of the new rooms, while 53% will be added in the luxury and first class segment, 47% will come up in the mid market segment of which 16% will be budget hotels. Hotel majors have lined up expansion plans across segments to capitalise on the rising tourist inflow.

Company Background

M.S. Oberoi established East Indian Hotels (EIH) in 1949 and is the flagship company of Oberoi group. It owns the second largest chain of hotels in India. The company is in luxury hotels, restaurant, management contracts and travel and tours business.

The company’s various business activities are illustrated below: 

Financials

EIH posted a net profit of Rs 427.50 million for the quarter ended September 30, 2007 as compared to Rs 273.90 million for the quarter ended September 30, 2006. Total Income has increased from Rs 2042.60 million for the quarter ended September 30, 2006 to Rs 2351.20 million for the quarter ended September 30, 2007.

Valuation

Given the robust growth in the tourist inflows to India, strong ARRs and firm occupancies, along with significant expansion plans, EIH is expected to maintain its margins and return ratios in the medium-term followed by a strong growth in FY10. The current business seems fairly valued. Upsides could be expected once its BKC project nears completion. At the current price the stock trades at 26.45x FY08E EPS of Rs5.37 and 25.58x FY09E EPS of Rs 5.55.

Concerns

• Any delays in upcoming properties would impact revenue estimates, thereby affecting profitability negatively.
• Tourist inflows into India have been growing at a robust rate of 18% from 2003 to 2006. In 2006, tourist arrivals touched record levels of 4.4 million. For the nine months in 2007, tourist arrivals have shown a healthy growth of 14% over corresponding period in 2006. Although tourist inflows is expected to grow, any slowdown would bring a deceleration to the Indian hospitality dream run.
• Other South Asian countries have also been focusing on tourism, and are attracting visitors from India and other parts of the world. Many corporate groups have been booking group packages. These destinations pose competition for leisure hotels. But EIH does not face such competition, as its revenue drivers are properties located in areas where it focuses on the business travelers.
• Travel and tourism industry is highly sensitive to risks arising from terrorist activities. In case a destination country being prone to terrorist strikes, the originator countries may pass a word of caution or on the extreme not allow their citizens to visit such countries, thereby impacting the hospitality business adversely for such period.
• The demand-supply mismatch of quality rooms has increased in favour of the hospitality sector, so has the imbalance in availability of trained staff. The employee cost has increased to as much as 21%-24% in the hospitality sector. This is the single largest component of expenditure and a further crunch in workforce could drive costs even higher thus hitting the margins and bottom line.

Outlook

According to the 2002 estimates of the World Tourism Organisation (WTO), international tourist inflow in India by 2020 would be 10 m, which means the tourist influx has to grow at a CAGR of 6.5% for the next 12 years. This makes the country one of the fastest growing tourist destinations in the world second only to China. As of FY07, the increase in the tourist arrivals is well inline with the WTO estimates.

India accounts for 0.5% of world tourism, and the tourist inflow is expected to grow at the rate of 4% till 2010. Strong GDP growth, improving infrastructure, confidence on the country's economic prospects, open sky policy and the 'Incredible India' campaign has improved the outlook for India. This positive outlook would increase the tourist arrival in the country and the hotel industry is expected to be the major beneficiary. Even domestic tourism is gaining momentum. Rising disposable incomes, cheaper airfares and better connectivity would continue to increase the demand for rooms. The favourable demand supply gap is likely to continue till FY09 when major expansions would come in. With no new supply coming in the near future, average room rates are expected to surge higher. ARRs have grown at a compounded rate of 18% over the last three years.

Many international hotel chains either have or are on the look out for setting up shop in the country. Companies like the Hilton and Hyatt group have already tied up with local giants East India Hotels and Asian Hotels. Others like Four Seasons, are on the lookout for a partner or would be setting up their own hotels, government permitting. This clearly shows that India is on the international tourism radar.Although prospects are promising, as mentioned earlier, any change in the global geo-political situations can and have adversely affected the performance of this sector. Also, the heightened demand for land, especially from real estate players has led to a steep escalation in the prices. Also, shortage of manpower is going to be a huge challenge going forward. Hotel players with a diversified portfolio across different segments are likely to be the key beneficiaries. This should be one of the determining factors while investing in this sector.

Addition of rooms in the hospitality sector is a capital-intensive activity, which causes a constraint on the free cash flows of companies and thereby impacts return ratios negatively in the short run. EIH is expected to run through this cycle in its expansion period. In FY08 and FY09, a dip in return on net worth to 16.7% and 15.4% as against 17.9% in FY07 is expected. However, the return will rebound in FY10 to 17.7% once the new hotels get commissioned. With EIH’s ARRs firm at more than Rs 10,000 on standalone basis, increased room base and business outlook to be robust. It is foreseen that the return on capital employed to head northwards post FY09 to 14.4% in FY10 from 13.4% in FY07 post sliding to 12.2% in FY08 and 11.5% in FY09.