IHCL: A Promising Investment in Indian Hospitality

After slipping into losses in fiscal years ’21 and ’22, Indian Hotels Corporation (IHCL) managed a stellar turnaround in its financials in fiscal year 23. The stock, which delivered 77 percent compound annual growth rate in the past three years at nearly three times the Sensex rate, is near an all-time high. But given that tourism in India seems to be at an inflection point, with IHCL among the best places to tap, we think there’s more gas left in the tank for IHCL’s inventory.

Investors with a medium-risk appetite and a three-year-plus horizon could buy IHCL stock, trading at a forward earnings multiple of 36 times the FY25 estimate. This assessment seems plausible, given that projected CAGR revenue growth is around 12 percent in the next two years. Up from the 9 percent run rate in the past three years, 30 percent EBITDA margin forecast over volatile trends in past fiscals, and vastly improved.

Our positive business view of IHCL is based on significant room and property additions expected over the next few years and continued improvements in operating margin resulting from lean asset growth, even with developments such as the government’s intention to leverage the G20 Summit to boost inbound tourism, the Men’s ODI Cricket World Cup in October 2023 And the post-Covid recovery of international tourist feet promise to make the next few years good for high-end hospitality players.

Improving financial conditions

With the Covid pandemic a thing of the past, and travel taking a large share of the affluent Indian’s wallet, the 21,000-room ITC appears to be in a good place to capitalize on discretionary consumption trends. It has properties across budget, premium and premium segments of the Indian hospitality market.

Apart from the popular Taj brand, Vivanta offers upscale, premium properties under SeleQtions and the budget range under Ginger, positioned across price points for domestic and international travellers. Occupancy rates and room rates are expected to continue even as the company plans to add approximately 9,900 rooms (75 hotels) in a staggered fashion by March 2027 as demand for room supply increases. Seventy percent of the rooms added will be based on the management contract model. This should support current EBITDA margins (32-33 percent) over the medium term, aided by the light asset management contract track.

IHCL is the oldest operating company of the Tata Group. IHCL’s current portfolio includes 263 world-class properties, including Taj (11,726 rooms / 100 hotels), Vivanta (3,800 rooms), SeleQtions (1,346 rooms) and Ginger (4,814 rooms / 85 hotels). Apart from this, it has a flying kitchen company (Taj Sats) and new/affiliated businesses like Qmin – a gourmet delivery platform, amã Stays & Trails (experimental homes) and The Chambers (exclusive business clubs). On a consolidated basis, room revenue accounts for 48 percent of sales, followed by food and beverage revenue at 36 percent, management fees at 7 percent and the rest making up 9 percent. About 87 percent of IHCL’s portfolio and revenue comes from India, making it a proxy for discretionary domestic consumption. This is a seasonal business, as Q1 and Q2 are usually slower than Q3 and Q4.

Post-Covid, IHCL’s revenue growth and profitability have risen sharply, in line with smaller competitors such as EIH. While annual revenues have surpassed pre-Covid levels, operating margins are 9-10 percentage points above pre-Covid levels. Three factors have contributed to this – higher room rates on room shortfalls (15-20 per cent above pre-Covid levels), healthy occupancy for FY23 (71.7 per cent – Domestic Independent) and operating leverage arising from the two. This contributed to IHCL reporting its best-ever performance all year in fiscal ’23 (see table).

IHCL has also used the past few years to right past acquisition mistakes and shrink its balance sheet. Outstanding loans at the end of the year more than halved to Rs.818 crore in FY23, from Rs.2,326 crore in FY2019. A significant increase in free cash flow (over Rs.1,000 crore in FY23) helped pay off its loans. The interest coverage ratio rose to a very healthy 8.2x in fiscal ’23 (from 4.8x in fiscal 2019).

The company has a 3D strategy in place to chart its expansion plans over the next 3-4 years. It aims to have over 300 hotels, an EBITDA margin of 33 percent, and a 35 percent contribution to EBITDA from new businesses and management fees by FY26. In addition, there is a plan to offload stakes across hotels and banks. Selected real estate.

sector tailwinds

We are bullish on the prospects for IHCL shares on account of three factors.

Tailwind on the sidelines: Courtesy of Covid, not many hotels have been built in the last 3 years. This imbalance in supply and demand has helped increase occupancy rates as well as room rates in the hotel sector. Room demand is expected to grow at a compound annual growth rate of 10 percent during FY23-26 versus room supply compound annual growth rate of less than 5 percent during the same period. This should be supportive of room rates which are holding up even if they haven’t increased at the pace of the last two years.

The growing proportion of local individual consumers and small and medium businesses using premium hotel reservations, as opposed to large corporations with higher bargaining power, is also helping to maintain IHCL rates. The standalone domestic average room rate was €13,736 in FY23 vs. Rs10,734 in FY20. Hotels being a company with high operating leverage experienced EBITDA margins (FY20: 24%) to FY23: 33%) from IHCL a significant improvement with higher occupancy rates and tariffs. Margin gains should be held even as IHCL adds more than 2,000 rooms annually over the next 3-4 years (see table).

The path of light assets: Whilst this is traditionally a capital intensive business with a long life, IHCL is increasingly using a management contract model whereby it receives a fee to acquire and operate an existing premium property. Aiming to achieve a 50:50 mix between owned/leased and managed hotels, doubling management fees (Rs. 400 crore) within six years.

travel promotion: Indian hotel properties are expected to see continued strong demand in FY24, with big events like the G20 and the men’s ICC ODI Cricket World Cup. While regular events such as weddings support high-end players such as IHCL, domestic international travel is also a major demand driver for these players. The World Health Organization recently declared that Covid is no longer a Public Health Emergency of International Concern, and this should increasingly boost confidence among travellers. Foreign tourist arrivals are expected to reach pre-Covid levels by October 2023, from 60 percent of that level now.

According to data from the Ministry of Tourism, the number of foreign tourist arrivals in the first nine months of fiscal year 2023 was about 54 thousand — 70 percent of fiscal year 2020 levels. Foreign guests can boost both occupancy and room rates, especially for luxury IHCL properties such as the Royal Palace Hotels ($38,000/night in FY23).

assessment, risk

In fiscal ’25 estimated EPS of $10 per share, IHCL shares trade at 36 times earnings. This is not cheap. But the price of the premium awarded to IHCL is unlikely to go down, given that this is the biggest proxy for the long-term rosy prospects of global travel and tourism. IHCL’s $6.2 billion puts it among the most promising hotel stocks globally, and similar-sized peers like Whitbread and Wyndham face weaker forecasts in the next two years. Larger players like Accor and Hyatt operate at less than 10 percent PAT margin, half of IHCL levels.

The risks for our call are black swan events such as Covid, weakening global macros that will affect both corporate travel and price flexibility in the leisure sector, and any renewed actions by the Tata Group to revive its overseas acquisition spree.