The valuations stagger the hotel lounge

A notable feature of the last quarter was the sharp increase in average room rate (ARR). This resulted in higher revenue per available room. In a report on February 22, analysts at Motilal Oswal Financial Services said total revenue for hospitality companies under its coverage is up 56% year-on-year, 34% sequentially and 20% versus Q3FY20 (a pre-Covid quarter) increased. The Motilal Oswal report suggests that this is despite the occupancy level being lower than the pre-Covid level. Aggregate data includes hospitality business of Chalet Hotels Limited, ITC Limited, Oberoi Realty Limited, Brigade Enterprises Limited, Lemon Tree Hotels Limited and consolidated data of The Indian Hotels Company Limited and EIH Limited. Overall, the operating margin of the sector was supported by seasonal factors. Very.

So there are drivers for further demand. These include the government’s intention to leverage the G20 summit to promote inbound tourism, the wedding season and the men’s cricket ODI World Cup in October and November. “Demand is growing at 5.4% or more, while supply is at 3.4% for the first nine months of FY2023. “There is a clear demand-supply gap, which cannot be bridged overnight,” said Sunil Damania, chief investment officer, MarketsMojo.

To be sure, a high ARR can be a deterrent. A channel investigation by ICICI Securities Ltd shows that hotels continue to charge rates at least 10% higher than pre-Covid levels.

Margins are likely to remain healthy going forward due to higher room rates. However, there is a concern that high and steady inflation may put pressure on consumers’ purchasing power, thus reducing demand for discretionary spending. Jinesh Joshi, research analyst at Prabhudas Lilladher, cautioned, “This could dampen leisure travel somewhat, as people may find the rates unaffordable.” Still not back to pre-Covid levels, which affected corporate-focused Chalet Hotels’ earnings performance in the last quarter.

Meanwhile, in 2022, shares of leading listed hotel companies such as Indian Hotels, Lemon Tree, Chalet Hotels and EIH saw a sharp rally of 42-84%. Besides reviving demand, strong room-adding pipeline and increased adoption of asset-light models, which augur well for their balance sheet strength, also boosted optimism in some of these stocks.

However, so far in 2023, stock returns have been muted. Shares of Lemon Tree and EIH have seen a sharp decline in comparison to the Nifty 500 index. It appears that the positivity related to the reopening theme and the companies’ efforts to keep balance sheets lean have largely been priced in. Therefore, investors shouldn’t expect a repeat of last year.

Furthermore, there are concerns over the health of the global economy and a possible recession, which is a downside risk for the sector. In its Q3FY23 earnings call, the management of Indian Hotels said it expects international travel to return to pre-Covid levels in FY24. Clearly, if the recession risk pans out, international travel could be affected.

Against this backdrop, the valuation of hotel stocks is not cheap. On FY24 EV/Ebitda, Indian Hotels stock is trading at a multiple of 22.5, and peers Lemon Tree, EIH and Chalet are in the range of 17-24 times, shows Bloomberg data. Higher valuations may put a stop to the rally in these stocks.