Hotel - Sector Initiation - Centrum - 22032011

Please refer to important disclosures/disclaimers in Appendix A Centrum Equity Research is available on Bloomberg, Thomson Reuters and FactSet

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Rahul Gaggar [email protected] + 91 22 4215 9683

Hotel Sector22 Mar 2011

India

2 Hotel Sector

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Please refer to important disclosures/disclaimers in Appendix A Centrum Equity Research is available on Bloomberg, Thomson Reuters and FactSet

Rahul Gaggar [email protected] + 91 22 4215 9683

Happy hours back again We believe the downturn in the Indian hospitality industry is over. The strong pick-up in demand due to rising occupancies will boost revenues and profits, goingforward. The sector faced global recession, terrorism, and pandemics during FY08-10 and average room rates (ARRs) plunged by 25-50%. With robust economic growth and higher tourist arrivals, occupancy levels are set to rise. We reinitiate with a Buy on Indian Hotels Company (IHCL) and Hold on EIH and Hotel Leela.

Concerns overdone: During FY08-10, the hospitality sector was hit by global economic slowdown, the 26/11 terrorist attack in Mumbai, pandemics and negative travel advisories. High capital costs to set up greenfield projects, high leverage (due to heavy borrowings forexpansion) and long gestation periods led to low return ratios. Renovation and repositioning of properties aggravated the situation. IHCL, EIH and Hotel Leela’sreturn ratios (RoE and RoCE) plunged to a low 2%-5%.

Sector is profit making: Our analysis suggests the luxury hospitality business offer good returns, unlike what current return ratios suggest. Our analysis of a hypothetical standalone hotel property gives us an IRR of 16.4%. The property would start giving return ratios in excess of 16% after year 7, with healthy EBITDA margins in excess of 35% from year 3 onwards.

Occupancy levels, ARRs going up: Improving business activity has lifted occupancy levels to over 75% in major metros. Historically, rising occupancy levels are followed by improving ARRs, which augurs well for the sector.

Foreign tourist arrivals to sustain demand: Foreign tourist arrivals (FTAs) in India are expected to register 8.2% CAGR over 2010-2019 (Source: World Travel & Tourism Council). We estimate this would lead to an additional demand of ~26,000 rooms in the luxury segment, an occupancy rate of ~65%.

Oversupply a distant dream: The demand-supply mismatch still remains. Earlier, Mumbai, Delhi, Chennai, Kolkata, Bangalore and Hyderabad were to add ~84,000 premium rooms by 2011-12. But, they will only add55,000 rooms, 35% below expectation at the maximum.

Valuations: We reinitiate with a Buy rating on IHCL (TP: Rs135), and Hold on EIH (TP: Rs93) and Hotel Leela (TP Rs 39).

Key risks: Upside – Higher-than-expected FTAs. Downside – Any terrorist attack or economic slowdown will cause concern.

Key Data – Indian Hotel

Bloomberg Code IH IN

Reuters Code IHTL.BO

Current Shares O/S (mn) 759.5

Diluted Shares O/S(mn) 759.5

Mkt Cap (Rsbn/USDbn) 59.5/1.3

52 Wk H / L (Rs) 118/76

Daily Vol. (3M NSE Avg.) 1,166,469

Face Value (Rs) 1

EIH

Bloomberg Code EIH IN

Reuters Code EIHO.BO



Mkt Cap (Rsbn/USDmn) 46.2/1

52 Wk H / L (Rs) 181/74

Daily Vol. (3M NSE Avg.) 209,699

Face Value (Rs) 2

Hotel Leela

Bloomberg Code LELA IN

Reuters Code HTLE.BO




52 Wk H / L (Rs) 59/34


Face Value (Rs) 2

USD = Rs45.4

CMP TP Rating P/BV (x) EV/EBITDA (x) EV/ Adj. ROOM (x)

(Rs) (Rs) FY11E FY12E FY13E FY11E FY12E FY13E FY11E FY12E FY13E

Indian Hotels 78 135 Buy 2.3 1.9 1.7 16.8 12.3 9.9 10.8 9.2 8.7 EIH 81 93 Hold 1.7 1.7 1.6 21.2 19.2 16.9 18.0 17.9 17.7 Hotel Leela 37 39 Hold 1.6 1.5 1.4 29.7 18.0 14.9 39.0 30.3 24.9

Source: Company, Centrum Research Estimates

22 March 2011

Sector Initiation

INDIA

Hotels

4 Hotels

Table of Contents

Executive Summary 5

Investment Argument – Low return ratios give misleading picture of sector 6

Analysis of a 5-star hotel working model 7

Worst is over; occupancy levels, ARRs improving 9

Robust economic growth to propel recovery 12

Demand-supply mismatch to continue 16

Valuation 18

Key Risks 20

Annexure 21

Companies

Indian Hotels 23

EIH 41

Hotel Leela 57

5 Hotels

Executive Summary The Indian hospitality sector faced acute pressures of global recession, terrorism and pandemics, during FY08-10, severely denting the sector’s profitability. Since the end of Q2FY11, ARRs and occupancy levels improved. We believe the worst is over and though the sector may not touch the high growth in room rates of 2004-08 (10%-15% growth annually), it is at the cusp of a new growth phase. We estimate the hospitality sector to record 9.9% revenue CAGR FY10-13E to Rs236bn from ~Rs177bn. The luxury hospitality space is expected to grow 13.7% CAGR to Rs140bn from ~Rs95bn. We reinitiate coverage with a Buy on IHCL (target price: Rs135), and Hold on EIH (TP: Rs93) and Hotel Leela (TP: Rs39).

Low return ratios give misleading picture

The hotel sector is characterized by high value addition that does not necessarily lead to high return ratios. It has to incur heavy costs for periodic renovation and repositioning of properties. With land costs in metros escalating, setting up greenfield projects costs a lot of money. The gestation period too is long. This led to the incorrect belief that hotel companies have very low return ratios. An analysis on the working of a hypothetical standalone hotel property suggests that a 5-star luxury hotel would earn return ratios of over 20%, 10 years after it starts functioning. EBITDA margins would be over 40% from the fourth year onwards. Moreover, the standalone property will make at least a competitve16.4% IRR.

Worst is over

We believe the worst is over for the luxury hospitality industry. Though subdued performance continued in H1FY11, ARRs and occupancy levels began to improve from Q3FY11. Rising occupancy levels have been historically followed by improving ARRs. We however believe the rise in ARR would be slow and region-specific as room supply would match demand over the next 12-18 months.

Foreign tourist arrivals grow

Foreign Tourist Arrivals (FTAs), the mainstay for luxury hotels, registered 11.5% CAGR over FY02-09 to 5.1mn. During the period from October 2010 to January 2011, FTAs grew 9% YoY and are expected to register 8.2% CAGR in 2010-2019 (Source: World Travel & Tourism Council). We have assumed 8% annual growth in FTAs, leading to a demand for ~26,000 luxury rooms by Dec 2012.

The Indian tourist a major customer

Indians travelling domestically grew 13.6% CAGR over 2002-2008 to 527mn in Dec 2008 from 245mn in Dec 2002. With increased disposable income the potential for domestic tourism is immense. To put it in perspective, an 8% growth in the number of domestic tourists with 10% opting for luxury accommodation would translate into added demand for 40,000 rooms by March 2014.

Business travel – key demand generator

Improved economic growth also helps the hospitality sector. Growing business opportunities, cheaper airfares and better connectivity will keep the demand for rooms high. Many foreign trade and business delegations have visited India in the last 6-7 months. These are positive developments and the benefits will trickle down to the hospitality industry and increase the demand for hotel rooms.

Valuations

Given the huge expansion projects undertaken by hotel players and the impact on profitability and balance sheet, we believe that EV/EBITDA would be the best metric to capture the effects of changing capital structure along with operating efficiencies. The new facilities will take time to stabilize and hence will impact earnings and thus do not give the true earnings potential of the property.

6 Hotels

Investment Argument

Low return ratios give misleading picture of sector

During FY08-10, the hotel sector’s revenues and profitability declined, affecting working capital, worsening margins and lowing return ratios. Concerns were expressed over the financial health of hotel players. Most borrowed heavily for their ambitious expansion plans during the boom time (2004-08). High capital cost and long gestation periods led to low return ratios. We believe analyzing the revenue model of a standalone property of a hotel player’s core operations is a more appropriate method of valuing the sector than just looking at the return ratios of the whole company in the current environment.

High room rates and occupancy levels due to severe demand-supply mismatch lead to huge investments in the hotel sector in the latter half of the 2003-08 bull cycle. The global recession that started in mid-2008, the terrorist attacks in Mumbai on Nov 26, 2008 and swine flu, hugely impacted the Indian hospitality sector. Revenues and profitability plunged and most players reported abysmal return ratios. Huge borrowings for the expansion plans weighed on balance sheets. The high operating leverage of the industry made matters worse.

Exhibit 1: Return ratios plunged and D/E ratios deteriorated in FY09-10

RoE (%) RoCE (%) D/E (x)

FY07 FY08 FY09 FY10 FY07 FY08 FY09 FY10 FY07 FY08 FY09 FY10

IHCL* 18.3 19.7 11.3 5.3 14.1 14.1 8.3 5.0 0.5 0.6 0.6 1.0

EIH 17.1 19.0 12.8 4.7 7.6 9.0 3.0 0.3 0.9 0.8 0.9 1.1

Hotel Leela 13.0 16.5 10.2 2.3 4.6 4.9 1.9 0.8 1.1 2.2 1.3 1.4

* Note: IHCL standalone ratios

Source: Company, Centrum Research

We believe concerns on hospitality players’ financial health, especially low return ratios, are overdone. High fixed costs (employee, fuel, power and light, linen costs, etc) coupled with the downturn in the sector was the main reason for lower returns. Also, the industry incurs sustained capital expenditure for periodic renovation and repositioning of properties. Further, the huge borrowings for expansion and the long gestation period will keep return ratios suppressed in the immediate future because of high interest and depreciation expenses.

We believe investors should give more emphasis to the profit & loss statement of a standalone hotel property to evaluate the sector correctly.

7 Hotels

Analysis of a 5-star hotel working model

To illustrate our point, we have considered a hypothetical standalone hotel property for our analysis. We have constructed a profit & loss statement and a simple balance sheet to get a fair picture of the working of a hotel property.

We have considered a 400-room, 5-star luxury hotel at an estimated cost of Rs15mn per room (inclusive of land). The financing is 60:40 debt-equity at an interest rate of 12% per annum. Our debt repayment schedule begins in year 4 once the hotel becomes profitable and the debt is completely paid off by year 13. For the first 3 years, the interest outgo is the same given the property is loss-making. Year 4 onwards, when the property becomes profitable, the interest outgo and principal repayment work on the reducing mortgage concept. Thus, with each year the interest outgo reduces while the principal repaid becomes higher.

We have assumed 7.5% CAGR in ARRs, factoring in inflation and the historical growth in room rates of hospitality majors from 2002-10. Occupancy estimates have been gradually increased from 55% in year 1 to 75% in year 5 and maintained at that level. Food & Beverage (F&B) as a percentage of room revenues ranges from 40% to 65% depending on the location of the hotel. For a hotel in a major city where many MICE (Meetings, Incentives, Conferencing, and Exhibitions) events take place, the contribution is higher. Also, F&B commands higher margins and boost overall margins.

For our exercise, we have assumed F&B revenue at a steady 41% of room revenue. “Other Revenues” typically consist of laundry, Internet, taxis, phone calls, etc, and average between 8% and 15% of room revenue for different hotels. We have assumed Other Revenue at ~11% of ARRs. Room revenues are its primary drivers and hence a drop in occupancy levels would lead to a fall in “Others revenue” as well.

The property will have 2.4 employees per room which is on the higher side compared to the industry norm of ~1.5 to 2 employees per room. The F&B business operates at gross margins of 75%-80% and hence plays an important role in increasing the margins of the hotel

Fuel & power cost is the second biggest fixed cost for a hotel and constitutes 8% -15% of hotel revenues. Other costs include linen, accessory replacements, advertising, commissions, etc. A typical hotel property should ideally break even at the EBITDA level in year1 itself with 22%-27% margin. On a steady state basis, a hotel property would make 45%-50% EBITDA margins peaking at 51%-52%. The primary driver of EBITDA margins for a luxury hotel is the ARR as most of the costs are fixed, and hence any increase in ARR will lead to margin expansion. Our EBITDA margins are 40%+ year 4 onwards which as per our analysis is standard. Our analysis suggests a standalone hotel will be able to generate at the very minimum IRR of 16.4% over a 20-year period. The return on equity will also jump up to over 20% year 10 onwards.

A hotel property has to be consistently maintained in good condition to drive revenues and this entails a recurring expenditure. We have in our model included a complete refurbishment of the hotel property in year 7 and year 14. The cost incurred by the hotel to refurbish would be ~Rs 2.5mn per room. A hotel never undergoes complete renovation at one go, but breaks it up into parts. The main reason for this is that it does not completely shut down during renovations. Typically for a multi-storied hotel, some floors would be taken up at a time for renovation.

The above hypothesis clearly shows that the current view of low returns gives a misleading picture on the sector. The long gestation period makes the perception worse.

8 Hotels

Exhibit 2: 5-star hotel working model Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 Yr 19 Yr 20 Comments

Room Nos. 400 400 400 400 400 400 400 400 400 400 400 400 400 400 400 400 400 400 400 400 ARR Rs 9,500 10,213 10,978 11,802 12,687 13,638 14,661 15,761 16,943 18,214 19,580 21,048 22,627 24,324 26,148 28,109 30,218 32,484 34,920 37,539 7.5% CAGR in Average Room Rate

Occ % 0.55 0.60 0.65 0.70 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75

Days 365 365 365 365 365 365 365 365 365 365 365 365 365 365 365 365 365 365 365 365

Room Revenue Rs mn 763 895 1,042 1,206 1,389 1,493 1,605 1,726 1,855 1,994 2,144 2,305 2,478 2,663 2,863 3,078 3,309 3,557 3,824 4,111

F&B Rs mn 381 403 469 507 583 627 674 725 779 838 900 968 1,041 1,119 1,203 1,293 1,390 1,494 1,606 1,726 F&B Revenue is ~41% of Room Revenue

Others Rs mn 61 89 104 145 167 179 193 207 223 239 257 277 297 320 344 369 397 427 459 493 Other Revenue is ~11% of room revenue

Revenue Rs mn 1,205 1,387 1,615 1,857 2,139 2,300 2,472 2,658 2,857 3,071 3,302 3,549 3,816 4,102 4,409 4,740 5,096 5,478 5,889 6,330

Employee exp Rs mn 294 318 343 371 401 433 467 505 545 589 636 686 741 801 865 934 1,009 1,089 1,176 1,271 8% CAGR in Employee Costs

% of Sales 24.4 22.9 21.3 20.0 18.7 18.8 18.9 19.0 19.1 19.2 19.3 19.3 19.4 19.5 19.6 19.7 19.8 19.9 20.0 20.1

F&B exp Rs mn 114 121 131 137 146 151 155 167 179 193 207 223 239 257 277 297 320 344 369 397 F&B costs are ~24% of F&B revenue

Other exp Rs mn 500 533 567 604 643 685 730 773 820 869 921 976 1,035 1,097 1,157 1,221 1,288 1,359 1,434 1,513 6% CAGR in Other Expenses

% of Sales 41.5 38.4 35.1 32.5 30.1 29.8 29.5 29.1 28.7 28.3 27.9 27.5 27.1 26.7 26.2 25.8 25.3 24.8 24.3 23.9

Total operating exp Rs mn 909 971 1,042 1,112 1,190 1,268 1,352 1,445 1,544 1,650 1,764 1,885 2,016 2,155 2,299 2,452 2,616 2,792 2,980 3,180

EBITDA Rs mn 296 415 573 746 950 1,032 1,121 1,213 1,313 1,421 1,538 1,664 1,800 1,947 2,111 2,288 2,479 2,686 2,909 3,150

EBITDA Margin 24.6 30.0 35.5 40.2 44.4 44.9 45.3 45.6 46.0 46.3 46.6 46.9 47.2 47.5 47.9 48.3 48.7 49.0 49.4 49.8 EBITDA margins typically peak at 45-50% for most 5-stars

Dep Rs mn 240 240 240 240 240 240 280 280 280 280 280 280 280 320 320 320 320 320 320 320 Year 7 and Year 14 will see refurbishment of the property

EBIT Rs mn 56 175 333 506 710 792 841 933 1,033 1,141 1,258 1,384 1,520 1,627 1,791 1,968 2,159 2,366 2,589 2,830

Interest Rs mn 432 432 432 432 407 380 349 314 276 232 184 129 68 - - - - - - - The company will only interest costs for the first 3years

PBT Rs mn (376) (257) (99) 74 302 412 492 619 758 909 1,074 1,255 1,452 1,627 1,791 1,968 2,159 2,366 2,589 2,830 Full tax rate of 33.2% applicable

PAT Rs mn (251) (171) (66) 49 202 275 328 413 506 607 717 838 969 1,086 1,196 1,314 1,442 1,580 1,729 1,890

IRR 16.4%

Capital Employed 6,000 5,749 5,578 5,512 5,356 5,328 5,346 5,386 5,476 5,621 5,823 6,087 6,417 6,818 7,904 9,100 10,414 11,856 13,436 15,165 17,055

Debt 3,600 3,600 3,600 3,600 3,395 3,165 2,908 2,620 2,297 1,935 1,530 1,077 569 0 0 0 0 0 0 0 0 Debt Repayment will begin Year 4 onwards

Equity 2,400 2,149 1,978 1,912 1,961 2,163 2,438 2,766 3,180 3,686 4,293 5,010 5,848 6,818 7,904 9,100 10,414 11,856 13,436 15,165 17,055

Repayment (Rs mn) 205 230 257 288 323 362 405 454 508 569 - - - - - - -

RoCE (%) 0.6 2.1 4.0 6.2 8.9 9.9 10.5 11.5 12.4 13.3 14.1 14.8 15.3 14.8 14.1 13.5 12.9 12.5 12.1 11.7

RoE (%) -11.0 -8.3 -3.4 2.5 9.8 12.0 12.6 13.9 14.7 15.2 15.4 15.4 15.3 14.8 14.1 13.5 12.9 12.5 12.1 11.7 Incremental increase in Networth and no dividend payout keep returns low

Dividend 0.00 0.00 0.0 15 61 138 164 289 304 364 430 503 776 1,086 1,196 1,314 1,442 1,580 1,729 1,890 Year 14 onwards 100% dividend - post repayment of entire debt

Adjusted Equity 2,400 2,149 1,978 1,912 1,946 2,088 2,225 2,389 2,513 2,716 2,959 3,246 3,581 3,775 3,775 3,775 3,775 3,775 3,775 3,775 3,775

RoE (%) -11.0 -8.3 -3.4 2.6 10.0 12.8 14.2 16.9 19.4 21.4 23.1 24.5 26.4 28.8 31.7 34.8 38.2 41.9 45.8 50.1 RoE significantly jumps up as networth is not growing because of dividend payout

Source: Centrum Research Estimates

9 Hotels

Worst is over; occupancy levels, ARRs improving

We believe the worst is over for the hospitality industry. ARRs in the six major metros of Mumbai, Delhi, Chennai, Kolkata, Bangalore and Hyderabad had plunged by 25-40% in FY08-10. Strong occupancy levels of over 60% in H1FY11 (which is an off-season period) indicate recovery of the sector. We believe the sector is attractive in the medium term, driven by fundamental growth drivers, including the uptrend in domestic tourism and increasing FTAs. Moreover, the growth of niche tourism (medical, adventure and rural tourism) augurs well for the industry. Several international hotel chains have announced their plans to enter the Indian market and expansion plans by domestic hotel players reinforce the strong underlying fundamentals of the Indian hospitality sector.

Hotel sector witnessed robust growth during FY03-08 …

The hotel industry in India registered unprecedented 18% CAGR during FY03-08 due to the booming domestic and global economy, increase in business and leisure travel and robust growth in inbound tourism. The increase in business travel can be attributed to rising trade flows and the entry of more international players to the country.

Exhibit 3: Average ARRs and occupancy levels across 6 major metros

5,0005,5006,0006,5007,0007,5008,0008,5009,0009,500

10,00010,50011,00011,500

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Average ARR Average occupancy

Bottoming Out

Source: Crisil, Centrum Research

Gets hit by double whammy in FY09

The global recession in mid 2008, high oil prices and the terrorist attacks in Mumbai adversely impacted the hotel industry in FY09. Demand for travel is highly susceptible to economic slowdown, wars, disease outbreaks and terrorism. When the Indian tourism and hotel industry had just started gaining recognition worldwide, it was hit by the global financial crisis and terror attacks on the iconic Taj Mahal Palace & Tower and the Oberoi Trident.

The economic slowdown, which began in H2FY09, hit the hospitality sector badly with ARRs and occupancy levels plunging. The luxury segment bore the brunt as in times of crisis companies/people cut costs and scale down from luxury to affordable segment. The terrorist attacks in Mumbai on 26 Nov 2008 further aggravated the situation. Occupancy levels in early 2009 in Mumbai dropped to 40%.

10 Hotels

FTAs on an upswing …

Foreign tourist arrivals (FTAs) are expected to register 8.2% CAGR over 2010-2019 (Source: World Travel & Tourism Council). Our financial model estimates that this would translate into demand of ~26,000 rooms in the luxury segment. The model incorporates the number of FTAs, their average length of stay and the number of people per room. According to the Travel and Tourism Competitiveness Report 2009 by the World Economic Forum, India is ranked 11th in the Asia-Pacific region and 62nd overall, moving up three places on the list of the world's most attractive destinations. It is ranked the 14th best tourist destination for its natural resources and 24th for its cultural resources, with many World Heritage sites, both natural and cultural, rich fauna, and strong creative industries in the country. India also bagged 37th rank for its air transport network.

… and rising consistently

FTAs are still the mainstay for luxury hotels and registered 11.5% CAGR over FY02-09 to 5.1mn. The global economic slowdown and Mumbai terror attacks disrupted this trend and FTAs declined in 2009 for the first time since 2000. However, the improving world economic scenario since March 2009 has resulted in FTAs improving again. In Q3FY10, FTAs were higher than the corresponding period in Q3FY09 and Q3FY08. And the period from October 2010 to January 2011 had an average of 9% YoY growth.

Exhibit 4: FTAs have been rising since Sept 2009

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650

750

Jan

Feb

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r

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g

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v

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('000s)

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Source: Ministry of Tourism, Centrum Research

Promotions by the Tourism Ministry (like the Incredible India campaign) have aided the growth of the sector. The World Travel & Tourism Council has forecast 8.2% CAGR in FTAs over 2010-2019. We have assumed 8% annual growth in FTAs (~6.2mn) which translates into demand for ~26,000 luxury rooms by Dec 2012. The Tourism Ministry has also started visa on arrival schemes for some countries on a trial basis. We believe such measures will aid the hospitality sector.

The government is also pushing cruise tourism. In June 2008 it approved the Cruise Shipping Policy to develop India’s cruise tourism sector. This will help attract foreign tourists to India who till now travelled to other South East Asian nations. The policy is also aimed at popularizing the cruise tourism among domestic tourists as well.

In its bid to boost tourism infrastructure the government in 2009 allowed hotels rated 2 star or above a 100% deduction in capital expenditure (excluding land, goodwill and financial instrument), provided the hotel property commences operation on or after 1st April 2010. The RBI has also re-classified hotels under the infrastructure sector thus allowing them to raise ECB’s to the tune of $100mn per year under the “Automatic Route”. The only criterion is that the proceeds of the issue can be utilized only for capital expenditure and not for acquisition of land.

11 Hotels

Exhibit 5: FTA and premium category room supply

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

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Total Premium Category Rooms Supply (RHS) Tourist Inflow (LHS)

Source: MOT, Crisil, Centrum Research Estimates

Exhibit 6: FTA and average occupancy levels

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FTA Average occupancy

Source: MOT, Crisil, Centrum Research Estimates

12 Hotels

Robust economic growth to propel recovery

India’s robust GDP growth (~8.6% in FY11E) has improved the outlook for the hospitality sector. Rising disposable incomes, cheaper airfares and better connectivity would continue to increase the demand for rooms. Efforts to diversify tourist attractions by offering new products including wellness tourism, medical tourism and golf tourism are expected to have a positive effect on both FTAs and domestic tourism.

Economic growth improves outlook for hospitality industry

Our economist has forecast India’s GDP to grow by 8.6% in FY11 and 7.5% in FY12. We believe the improved economic scenario would have a positive impact on the hospitality sector. According to the Ministry of Finance, the size of India’s travel and tourism industry was estimated at Rs179bn in FY09. Incorporating the expected GDP growth rates, it is expected to grow to Rs219bn in FY12. The luxury sub-segment within the five-star hotel segment accounts for 56% of the total hospitality industry. Hence, we estimate the Indian hospitality industry would grow to ~Rs124bn by FY12.

Exhibit 7: Hotel industry revenue and GDP growth

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60

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(Rsbn)

(7)(2)

3813

182328

3338

(%)

Hotel Industry (LHS) GDP growth (RHS) Hotel Industry growth (RHS)

Source: Ministry of Finance, Ministry of Tourism, Centrum Research Estimates

Flat ARRs in FY11E, marginal growth in FY12E

We believe ARRs would witness marginal 3% growth in FY11 to Rs8,113 vs Rs7,888 in FY10 and estimate a 5% increase on an all-India ARRs only in FY12E to Rs8,554. The main reasons for our conservative ARR assumptions are the uncertainty regarding global economic outlook and supply pressure, albeit limited. We believe occupancy levels would be strong in FY11 and FY12, with the major players expecting over 70% and on a Pan-India level ~65%.

Exhibit 8: ARR growth lags GDP growth

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GDP Growth (%) (LHS) ARR Growth Rate(%) (RHS)

Source: Ministry of Finance, Crisil, Centrum Research Estimates

13 Hotels

Worst times did not see lowest occupancies

Incidentally, even during FY08-10, occupancy levels across the major cities (except south Mumbai) hovered around 60%. The improvement both in the domestic and global economy since March 2009 has boosted occupancy levels (occupancy levels rose to values closer to pre-slowdown levels in most cities and even higher in some cities). A rise in occupancy levels is generally followed by rise in ARRs, which is already seen albeit at a very slow pace.

Exhibit 9: Occupancy levels (%) H1FY10 H1FY11

South Mumbai 52 49

North Mumbai 59 62

Delhi 59 66

Bangalore 50 60

Chennai 52 61

Hyderabad 51 56

Kolkata 59 66

Goa 59 58

Source: IHCL, Centrum Research

Exhibit 10: Average occupancy levels (Sept 2008 – Aug 2010) City Occupancy (%)

Bangalore 60.0

Delhi 67.9

South Mumbai 59.3

North Mumbai 62.7

Pune 51.1

Hyderabad 56.1

Chennai 61.0

Kolkata 65.6

Agra 61.2

Ahmedabad 61.6

Goa 62.2

Jaipur 55.9


Healthy occupancy levels over next 3-5 years foreseen

Our supply-demand analysis indicates demand for premium category rooms would outstrip supply. Many hotel and real estate companies had announced major expansion plans during the boom phase (FY04-08). Many real estate developers have either delayed/cancelled their hotel projects due to the liquidity crunch and some international hotel chains deferred their expansion plans. Thus, the anticipated increase in supply has not materialized, worsening the demand-supply gap. As a result, we believe existing hoteliers would be at an advantage for the next 3-5 years (given the gestation period to commission hotels), thus implying healthy occupancy levels on an all-India level for premium category rooms.

Exhibit 11: Premium category room supply-demand

8,000

16,000

24,000

32,000

40,000

48,000

56,000

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11E

Mar

-12E

Mar

-13E

Mar

-14E

(Nos)

30

35

40

45

50

55

60

65

70

75(%)

Total Premium Category Rooms Supply (RHS) Total Premium Category Room Demand Occupancy Rate

Source: MOT, Crisil, Centrum Research

14 Hotels

Domestic tourism – set for take-off

India’s rapid economic growth has already set the stage for fundamental changes in the country’s population. With more disposable income, the demand for travel and tourism has also grown. Although, currently domestic tourists constitute a very small chuck of the total tourist pie, the segment is growing. The number of Indians undertaking domestic visits registered 13.6% CAGR over 2002-2008 to 527mn in Dec 2008 from 245mn in Dec 2002 (Source: Ministry of Tourism).

We have modeled in 8% growth in number of domestic visits (lower than the Ministry of Tourism’s estimate of 14%) to 852mn in 2014. Assuming that just 10% of these opt for luxury accommodation on their visits, this would translate to additional demand for 40,000 rooms at a Pan-India level by March 2014.

Exhibit 12: Luxury Room Demand Calculation No. of Domestic Visits (mn) by December 2014 852

Total Premium Category Room Supply (Nos.) by December 2014 in 12 major cities 47,371

Assumption of 10% opting for Luxury accommodation (mn) 85.2

Luxury Room Demand (nos.) by December 2014 58,340

Source: MOT, Centrum Research Estimates

Exhibit 13: Holiday takers as % of total population

2.5 2.62.9

3.23.4

3.9

4.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2000 2001 2002 2003 2004 2005 2006

Source: Travel and Tourism – India: Euromonitor International: Country Market Insight, Nov 2008

Growing business travel to boost demand

India’s fast-growing economy has made it a favourite destination for all industries. The Defense Expo in February 2009 in Bangalore, the Auto Expo in February 2010 and the Textile Expo in April 2010 are prime examples. Luxury hotels reported an unprecedented rise in occupancy levels (~+90 %).

Several foreign trade and business delegations (from the US, UK, France, Bulgaria, Italy, Canada, etc) also visited India during the last 6-7 months. Bangalore, Pune, Chennai and Hyderabad which are home to IT and ITeS industries along with other sunrise industries like biotech, etc have seen their business visibility improve with improving global business fundamentals. These positive developments augur well for the hospitality industry as improving business conditions will have a trickle down effect increasing the demand for hotel rooms.

15 Hotels

Sporting events – Boost to hospitality sector

The Commonwealth Games held in New Delhi in Oct 2010 were meant to be the big tourist attraction. However, the controversy leading up to the event made the event a damp squib from the hospitality perspective. The successful hosting of the games, despite the controversies, has however to certain extent helped in boosting India’s image as a tourist and business destination which is the primary intention of any such global sporting event.

The 2011 Cricket World Cup to be held in Asian subcontinent (India, Sri Lanka and Bangladesh) will be another huge sporting event that will make huge demands for the luxury hospitality industry. The Indian Premier League (IPL) has already shown its effect on room demand in major metros with both room rates and occupancy levels going up. The first Indian F1 Grand Prix will also be held in October 2011 which is a global sport. F1 team contingents are very huge and world over have their followers travel with them. These sporting events will give huge boost to the hospitality business.

Such mega sporting events not only create a short-term positive impact, but have both tangible and intangible long-term effects. The events give national and international exposure. Sports fans who just visit the city to attend the sport event may return later on business/leisure trips raising future tourist revenues. Television as a medium plays a very important role in increasing the visibility and perception of the host city/country and hence television viewers are potential tourists to the host city/country at some time in the future based on what they see during the broadcast of such mega-events.

Worldwide, mega sporting events like the Olympic or Commonwealth games lead to a spurt in spending. This new spending is large in comparison to the total amount of spending as these events attract large audiences from outside the local economy, many of whom come specifically for the event.

The demand for accommodation, food and beverage not only increases during the event but more importantly highlights the prowess of the nation on the world stage in holding such events successfully. This in turn acts as the kicker in getting further revenues through increased tourism and business activity.

16 Hotels

Demand-supply mismatch to continue

Before the economic downturn in 2008, many hotel and real estate companies announced expansion plans. Post slowdown, the lack of credit, delay in construction and high real estate prices forced many companies to defer their expansion plans. The demand-supply mismatch is skewed in favour of demand. The six metros — Mumbai, Delhi, Chennai, Kolkata, Bangalore and Hyderabad — which were earlier scheduled to have a total of 84,000 premium rooms by Dec-12, will now have only ~ 55,000 rooms, 35% less than expected.

Turmoil creates opportunity

The bulk of the expansion plans, which were scheduled to be commissioned in FY10-11, have now been deferred to FY12. Further, they would be coming up in various phases, instead of being bunched. Several real estate companies have abandoned their plans and only the hotel-focused players have remained. For example, DLF, which had announced a tie-up with the Hilton group in November 2006 to operate 65-70 business hotels throughout India, has considerably slowed down its expansion plans. According to the latest update by the company's management, construction work on 17 hotels is underway. As a result, demand would still likely outpace supply and even in the competitive markets of North Mumbai, NCR and Bangalore, where the maximum room additions are taking place. We also believe further delays are likely due to the following reasons.

Severe decline in ARRs during the slowdown and slow recovery could impact business plans

High real estate and construction costs could make some projects economically unviable

Lack of easy funding would increase costs

Regulatory issues causing delays in construction and/or obtaining approvals/clearances

For instance, Bangalore was supposed to have 6,595 luxury rooms by FY12 (Source: Crisil Survey, Sept 2007). However, that projection was scaled down to 4,440 in Jan 2009 and further to 3,275 in Sept 2009. The earlier projected availability of 6,595 rooms would now be achieved only by FY14-15. With FTAs increasing and robust growth in domestic tourism, we believe the supply-demand scenario will be definitely be skewed in favour of demand for the coming 3-5 Yrs.

Exhibit 14: FY12 estimated room supply estimates at different times

6,595

4,440 3,7255,169

2,5912,884

13,326

9,6118,656

7,7216,6786,686

1,500

3,000

4,500

6,000

7,500

9,000

10,500

12,000

13,500

15,000

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Bangalore Hyderabad NCR North Mumbai


17 Hotels

Exhibit 15: Premium category room supply-demand

8,000

16,000

24,000

32,000

40,000

48,000

56,000

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Mar

-10

Mar

-11E

Mar

-12E

Mar

-13E

Mar

-14E

(Nos)

30

35

40

45

50

55

60

65

70

75(%)

Total Premium Category Rooms Supply (RHS) Total Premium Category Room Demand Occupancy Rate

Source: MOT, Crisil, Centrum Research

Domestic hotel majors like Indian Hotels, EIH, ITC and Hotel Leela constitute more than 60% of the current total luxury hospitality supply. Foreign players are entering the market but their expansion plans have been delayed because of the economic downturn. We believe this would benefit incumbents given the healthy scenario expected.

Exhibit 16: Demand-supply projections in major cities

Delhi North Mumbai Chennai Bangalore Hyderabad Kolkata

RD RS % of S RD RS % of S RD RS % of S RD RS % of S RD RS % of S RD RS % of S

FY05 5,170 6,651 77.7 3,245 4,219 76.9 1,109 1,541 72.0 1,212 1,563 77.5 807 1,017 79.4 841 1,244 67.6

FY06 5,430 6,813 79.7 3,534 4,418 80.0 1,287 1,646 78.2 1,222 1,581 77.3 864 1,017 85.0 923 1,249 73.9

FY07 5,045 6,638 76.0 3,716 4,616 80.5 1,262 1,646 76.7 1,700 2,282 74.5 977 1,302 75.0 931 1,249 74.5

FY08 5,051 6,735 75.0 3,452 4,602 75.0 1,420 1,910 74.3 1,743 2,455 71.0 1,046 1,495 70.0 937 1,249 75.0

FY09 4,658 6,380 73.0 3,107 4,832 64.3 1,392 2,142 65.0 1,663 2,558 65.0 1,043 1,799 58.0 849 1,249 68.0

FY10 3,819 6,774 56.4 3,075 5,528 55.6 1,142 2,153 53.0 1,663 3,149 52.8 929 1,977 47.0 773 1,299 59.5

FY11E 4,354 7,304 59.6 3,475 6,201 56.0 1,302 2,248 57.9 1,879 3,373 55.7 1,012 2,310 43.8 804 1,312 61.3

FY12E 5,007 7,786 64.3 4,031 6,678 60.4 1,588 2,615 60.7 2,198 3,725 59.0 1,164 2,591 44.9 860 1,399 61.5


18 Hotels

Valuation

Valuation methodology

We re-initiate coverage on IHCL (Buy, Target Price: Rs135), Hotel Leela (Hold, Target Price Rs39) and EIH (Hold, Target Price: Rs93). We have valued companies using their 9-year average EV/EBITDA multiple. We believe this period encompasses a complete cycle of two economic downturns and an economic boom period, thus normalizing the multiple.

All three companies under coverage had announced their expansion between FY06 and FY08. This is very much evident from the increase in gross block and huge debt on their balance sheets during this period. Hence, factoring in this short period would have unjustifiably valued them at a higher multiple given the worsening economic environment. The growth in balance sheet size because of the expansion undertaken has suppressed return ratios and will also keep the profitability low for further couple of years and hence rules out P/E. Also, a P/BV multiple does not give a rightful value to the existing properties which have very high returns.

We believe that given the high operating leverage of the sector, operational efficiency would be the appropriate parameter to value them on and hence EBITDA. The EV will perfectly capture the changing capital structure given the high financial leverage.

We also don’t think EV/Room is the correct metric to value these companies as the replacement value methodology is more applicable in times of economic stress which is not the case here.

IHCL – Buy, Target Price: Rs135

We initiate coverage on IHCL with a Buy rating. Our SOTP-based value comes to Rs135. We value the standalone entity at 15x FY13E EV/EBITDA to arrive at a fair value of Rs117. We believe that IHCL will be the main beneficiary of an uptick in tourism sector. It would also gain from robust domestic economy given its geographical and category reach. We expect IHCL’s standalone revenue and EBITDA to grow at 17% and 24% CAGR over FY10-13E. Consolidated revenue and EBITDA would register 16% and 38% CAGR over FY10-13E. Despite reeling under losses, the US subsidiary still adds Rs10 per share to the overall value. Budget chain Ginger is at present value decretive to the tune Rs1.2 per share.

Exhibit 17: IHCL – SOTP valuation

Multiple Total Value Net Debt Net Value Per Share

Rs mn Rs mn Rs mn

Value of Standalone Business FY13 EV / E 7,177 15.0 107,650 13,528 94,122 117 Value of Roots Corp. (Ginger) FY13 EV / E 204 12.5 2,554 3,090 (535) (0.7) Value of Listed Entities Current share of Mcap 7,362 70% 5,153 - 5,153 6.4 Value of Other Investments BV 3,155 70% 2,208 2,208 2.7 Value of IHMS (US) BV 16,003 50% 8,001 8,001 9.9 125,567 108,950 135


Exhibit 18: IHCL (Consolidated) - valuation matrix

FY11E FY12E FY13E At Target Price

Price/Book Value 2.3 1.9 1.7 3.0 EV/Adjusted Room 10.8 9.2 8.7 9.9 EV/Sales 3.3 2.8 2.4 3.6


19 Hotels

EIH – Hold, Target Price: Rs93 We initiate coverage on EIH with a Hold rating and target price of Rs93, translating into a potential upside of 6% from the current level. EIH is an established name in the lucrative Mumbai market. Robust demand in the metros and thus strong growth in profitability and low leverage make EIH a good candidate to ride the domestic hospitality story. EIH will see its total room inventory grow from 3,600 in FY10 to 4,640 in FY13E. The incremental growth is only through management contract route and thus not being able to completely take advantage of the pickup in demand. The slow growth in capacity expansion we believe will put the company at a disadvantage vis-à-vis peers in the next boom cycle.

We value EIH at its 20x FY13E EV/EBIDTA (its 9 year average EV/EBITDA multiple) to arrive at our price target. At our target price the stock would trade at Rs 20.8mn FY13E EV/Room. The company 6year average EV/Room value is Rs 21.4mn

Exhibit 19: EIH – valuation matrix


Price/Book (x) 1.7 1.7 1.6 1.9 EV/Adjusted Room (Rs mn) 18.0 17.9 17.7 20.8 EV/Sales (x) 3.9 3.6 3.3 3.9


Hotel Leela – Hold, Target Price: Rs39

We initiate with a Hold rating and target price of Rs39, valuing the stock at 15.3x FY13E EV/EBITDA. The company’s 9-year average EV/EBITDA multiple is 18x. Revival in global and domestic economy is not enough to ease the balance sheet stress caused by the New Delhi property. At more than Rs57mn capital expenditure per room, the New Delhi hotel has cost the company more than three times the cost for a hotel in this category and is a cause for the financial stress. Mumbai and Bangalore will be bread earners witnessing strong occupancy levels but new supply in these cities will put a cap on the growth in ARRs. Consistent delay in opening of the Delhi and Chennai property has made matters worse. The company will continue to have a high D/E of 1.5 in FY12E only showing a marginal drop to 1.4 in FY13E.

Exhibit 20: Hotel Leela – valuation matrix


Price/Adjusted BV 1.6 1.5 1.4 1.5 EV/Room 39.0 30.3 24.9 25.5 EV/Sales 9.9 7.1 5.9 6.1


Exhibit 21: International Peer Comparison

P/BV EV/EBITDA P/E

CY10 CY11E CY12E CY10 CY11E CY12E CY10 CY11E CY12E

STARWOOD HOTELS & RESORTS 5.1 4.5 3.9 16.8 14.6 12.5 53.6 37.5 27.3

MARRIOTT INTERNATIONAL-CL A 8.2 6.5 7.6 13.6 11.7 9.9 26.1 21.0 18.1

ORIENT EXPRESS HOTELS LTD -A 1.3 1.3 1.1 20.7 17.4 14.2 138.4 47.6 31.7

LAS VEGAS SANDS CORP 2.9 2.5 2.1 12.3 10.1 9.2 20.2 16.0 12.9

ACCOR SA 1.7 1.7 1.6 8.3 7.6 6.9 22.4 18.2 16.5

SHANGRI-LA ASIA LTD 5.4 5.1 4.7 20.7 15.9 13.5 298.5 201.6 164.5

WYNDHAM WORLDWIDE CORP 1.9 1.7 1.6 9.9 9.1 8.6 13.9 13.3 12.5

HYATT HOTELS CORP - CL A 1.4 1.4 1.3 13.7 12.1 10.0 125.1 90.2 50.7

Average 3.5 3.1 3.0 14.5 12.3 10.6 87.3 55.7 41.8

Source: Bloomberg, Centrum Research

20 Hotels

Key Risks Slower-than-expected economic growth: Given the overall relationship and dependency of

the growth of the hospitality sector on the GDP growth rate, our estimates and target prices are dependent on GDP growth rate assumptions. A slower-than-expected growth rate would impact our assumptions.

Delays in execution: The liquidity crunch and economic slowdown led to the delay in expansion plans announced by both incumbents and new entrants. However, any further delay by the incumbents in their expansion projects will impact our estimates and target price negatively.

Terrorist attacks: Visitors from developed countries (US and Europe) still form the major chunk of FTAs (>70%). Travel advisories by any of these countries due to terrorist activities and/or healthcare issues would put our estimates and price target under severe stress.

Employee crunch: Given the number of players entering the sector and their major expansion plans, employee retention could be a major risk to the entire industry. The huge inventory of rooms set to hit the market over the next two years could cause an employee crunch. The increase in employee costs for retention of talent could hit margins and hence profitability.

Competition from other tourist destinations: Many south Asian economies have started focusing on Indian tourists with attractive packages. Thus, higher competition from these countries could act as a dampener to our numbers. However, we believe that India offers a different and unique experience and also attracts many business visitors thus having a more diversified clientele.

21 Hotels

Annexure Business model – Old vs new properties

The hospitality industry has a long gestation period and this is especially more pronounced for the luxury players. The soaring land prices add to the woes (currently, ~40% of the total cost for constructing a new deluxe luxury property is land cost). For this reason, hotel players who acquired properties years ago, have a definite advantage vs new players who have set shop in recent years or have declared to set shop.

The incremental capital expenditure for old properties is also lower compared to new properties which further aids our view for incumbents. The location advantage, the much cheaper land cost and hence construction costs leads to much higher returns for incumbent players who own these properties. The properties because of their age, location and cheap construction costs are cash cows for the companies with ever improving returns. Our view is stemmed by our argument of real estate players who were in horde to set up luxury hotels cancelling/delaying their plans because of high construction costs and low initial returns.

Ownership vs management contract

The ownership business model in the hospitality industry is a very capital intensive/ asset-heavy and low-return model with a highly long gestation period. Incumbents who have properties at prime locations are at a definite advantage compared to peers in that geography. Also, given that business is highly cyclical the earnings of the players also suffer from fluctuation given that the business has high operating and financial leverage. Thus, expansion plans by existing players in this segment will overall suppress the return ratios for the respective companies and not give the existing high return individual properties of the companies their true value.

The management contract is as asset light model with much higher margins and also less prone to cyclicality. The model typically works wherein the current real estate/hotel owner allows a hotel manager to run the hotel for a base fee say 10% of the hotel revenues and also probably a profit driven incentive fee. The hotel manager uses his brand name to run the hotel. The real estate owner/hotel owner is responsible for all the expenses and capital improvements and hence controls the property.

A modification to management contract is the franchise model wherein hotel owner pays the hotel manager only a royalty fee for using the brand name but runs the hotel on his own. The agreement makes hotel owner run the hotel according to specifications of the hotel manager so as to not dilute the hotel manager’s brand.

Given the high cost of land and hence construction costs, the high capital intensive nature of the business and business cyclicality associated clearly spell out the reason for incumbents and new players’ preference for management contracts for expansion purpose.

22 Hotels


Please refer to important disclosures/disclaimers in Appendix A

Buy Target Price: Rs135

CMP: Rs79*

Upside: 72% *as on 22 March 2011

Rahul Gaggar [email protected] +91 22 4215 9683

Domestic business – Jewel in the Crown We believe Indian Hotels Company (IHCL) is well-positioned to benefit from India’s robust economic growth and buoyancy in business and tourist travel. We estimate 17% revenue and 25% EBIDTA CAGR (standalone) over FY10-13E, aided by increased room count and strong occupancy levels. We initiate coverage with a Buy rating and SOTP-based target price of Rs135. We value the standalone entity at 15x FY13E EV/EBITDA (fair value of Rs117).

Domestic business to drive valuations: Our SOTP-based valuation for the consolidated entity gives us a target price of Rs135 (72% upside from current levels). We value the standalone entity at Rs117/share (15x FY13E EV/EBITDA, the stock’s 9-year average multiple). This translates into an FY13E EV/Room valuation of Rs22.9mn for the standalone entity.

Economic growth to boost occupancy levels, room rates: India’s robust economic growth is expected to drive business travel. Occupancy levels are expected to rise to 69.9% in FY13E from 65.4% in FY10. ARRs are expected grow to Rs9,665 from Rs8,018 over the same period.

Diversified presence and strong brand image: We believe IHCL is well-positioned to leverage its diversified presence in India, strong brand image and proven management capability to capitalise on the growth in the sector. The company plans to increase its room count by 46% to 17,234 over FY10-13E on a consolidated basis. This is expected to result in 16% revenue CAGR to Rs39,314mn from Rs25,210mn.

Marquee properties to bring back colour: The heritage wing of the iconic Taj Mahal Palace & Tower in Mumbai re-opened in May 2010. The Pierre in New York also re-opened after a $100mn renovation. The Pierre is an important property to drive revenue and reduce losses of IHCL’s US subsidiary.

Balance sheet stress a concern: The on-going domestic expansions and international acquisitions have weighed on IHCL’s balance sheet (FY10 D/E at 1.8x). The recent capital infusion of Rs8,500mn along with improving operating metrics would help reduce the debt-equity ratio to 1.0x in FY13E from 1.8x in FY10.

Key Risks: Upside – Faster turnaround of US properties. Downside – Slowdown in the economy, delayed execution.

Key Data

Bloomberg Code IH IN

Reuters Code IHTL.BO



Mkt Cap (Rsbn/USDbn) 59.5/1.3

52 Wk H / L (Rs) 118/76

Daily Vol. (3M NSE Avg.) 1,166,469

Face Value (Rs) 1

USD = Rs44.9

Shareholding Pattern (%)

Public & Others27.7%

Institutions27.0%

Foreign investors15.0%

Promoters30.3%

As on 31 Dec 2010

One Year Indexed Stock Performance

50

75

100

125

150

175

Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11

INDIAN HOTELS CO NSE S&P CNX NIFTY INDEX

Price Performance (%)

1M 6M 1Yr

Indian Hotel (4.7) (24.6) (22.4)

NIFTY (1.0) (9.6) 4.0

Source: Bloomberg, Centrum Research *as on 22 March 2011

Y/E Mar (Rsmn) (Consolidated)

Rev YoY (%) EBITDA EBITDA (%) Adj PAT YoY (%) Fully DEPS RoE (%) RoCE (%) P/E (x) EV/EBITDA (x)

FY09 26,861 (8.0) 4,880 18.2 125 (96.8) 0.2 (0.6) (0.4) 508.7 16.0FY10 25,210 (6.1) 3,860 15.3 (1,369) NA (1.7) (4.9) 1.4 (46.3) 20.0FY11E 29,822 18.3 5,874 19.7 570 NA 0.7 1.9 3.2 111.3 16.8FY12E 34,659 16.2 7,920 22.9 2,063 262.2 2.6 6.4 4.9 30.7 12.3FY13E 39,314 13.4 9,743 24.8 3,537 71.4 4.4 9.7 6.4 17.9 9.9


Hotels

Initiation 22 March 2011

INDIA

Indian Hotels Company

24 Indian Hotels Company

Shareholding pattern (%)

Q4FY10 Q1FY11 Q2FY11 Q3FY11

Promoters 29.5 29.5 29.5 30.3

Foreign investors 13.3 13.9 14.2 15.0

Institutions 28.9 28.6 28.6 27.0

Public & Others 28.4 27.9 27.7 27.7

Total 100.0 100.0 100.0 100.0

Source: NSE

Company Background The Indian Hotels Company (IHCL) and its subsidiaries are collectively known as Taj Hotels Resorts and Palaces and recognised as one of Asia’s largest and finest hotel company. The Taj Mahal Palace Hotel, Mumbai, was started in the year 1903, which was the company’s property. IHCL encompasses 52 destinations, 12 countries, five continents, 77 hotels, seven authentic palaces, 12 resorts and Spas, 3 personal jets and luxury yachts. The company has an international hotel each in the Maldives, Mauritius, Malaysia, UK, US, Bhutan, Sri Lanka, Africa, the Middle East and Australia. The hotels are classified under three categories – the Luxury Division, Business Hotel Division and Leisure Division.

IHCL group structure

Associates Joint Ventures

Domestic InternationalRoots Corp - 100% International Hotel Management Services Inc. - 100% Benares Hotels Ltd. - 49.5% Taj GVK Hotels & Resorts Ltd. - 25.52%KTC Hotels - 100% IHMS (Australia) Pty. Ltd. - 100% Piem Hotels Ltd. - 46.2% Taj Karnataka Hotels & Resorts Ltd. - 40%Tifco Holdings - 100% Samsara Properties - 100% Oriental Hotels Ltd. - 33.8% Taj Kerala Hotels & Resorts Ltd. - 28.3%Taj International Hotels (H.K) Ltd. - 100% St. James Court Hotels Ltd. - 54% Taj Lanka Resorts Ltd. - 24.2% Taj Safaris Ltd. - 33.33%United Hotels - 55% Taj Lanka Hotels Ltd. - 24.6%Taj SATS Air Catering Ltd. - 51%Residency Foods & Beverages - 98.7%Innovative Foods Ltd. - 67.9%

Subsidiaries

Indian Hotels


Key management personnel

Person Designation Background and profile

Raymond N Bickson

Managing Director

Raymond Bickson’s experience in hospitality spans 30 years and four continents. In January 2003, Mr. Bickson moved to India and joined the Board as Executive Director & Chief Operating Officer of Taj Luxury Hotels, overseeing the operations of all luxury properties and playing a key role in the global expansion and development of future hotels. He assumed the role as Managing Director & Chief Executive Officer of The Indian Hotels Company Limited in July 2003.

Anil P Goel

Executive Director (Finance)

Anil Goel manages the Taj Group’s Finance, Mergers and Acquisitions, Purchase and Legal & Secretarial functions. He has over 25 years of experience in the Tata Group in various financial roles, including Chief Financial Officer of Tata Tea. Anil is also a Non-Executive Director in Taj GVK Limited, Oriental Hotels Limited, amongst others. Anil graduated with Honors from Shri Ram College of Commerce in Delhi and is a Chartered Accountant.

Ajoy K. Misra

Sr. Vice President, Sales and Marketing

Ajoy Misra has worked in various capacities, from sales and marketing to operations for the past 28years in the Tata Group. Ajoy joined the Taj in 1980 in the Corporate Sales and Marketing Department. He served as General Manager of the Taj President in Mumbai and Area Director in the Sri Lanka and Maldives regions. Today, Ajoy represents Taj in industry organizations such as the World Travel and Tourism Council, India Initiative (WTTC II), World Tourism Organisation (WTO), Hotel Association of India (HAI), Bombay Chamber of Commerce and Industry, and the Confederation of Indian Industry (CII).Ajoy Misra holds a degree in Civil Engineering and an MBA from Delhi University.

Abhijit Mukerji Executive Director (Operation) Abhijit Mukerji oversees hotel operations of the Taj Hotels Resorts and Palaces which includes Taj Luxury Hotels – India and International, Taj Business Hotels, Taj Leisure Hotels, Taj Spas, Taj Trade and Transport and Inditravels. A career hotelier, Mr. Mukerji’s experience spans 22 years and four continents. His last assignment was as Chief Operating Officer – Taj Luxury Hotels, India. Mr. Mukerji is an alumnus of Cornell (ESSEC) and Harvard Business School (GMP), and has a flair for European languages.

Source: Company


Standalone revenue & revenue growth Investment Rationale Domestic business to be main value driver for IHCL. The standalone

entity’s (India operations) valuation comes out to be Rs117/share(15x FY13E EV/EBIDTA)

We estimate 17% standalone revenue CAGR over FY10-13E to Rs23.8bn from Rs14.8bn. Room revenues to increase 19% CAGR over the same period with room count increasing to 4,707 by FY13from ~3,518 in FY10

Standalone EBITDA margin expected rise to 30.2% in FY13E from 25.2% in FY10 and PAT to register 32% CAGR to Rs3.5bn from Rs1.5bn over the same period

15.614.5

38.1

24.3

12.3

(8.2) (9.0)

3,000

6,500

10,000

13,500

17,000

20,500

24,000

FY07 FY08 FY09 FY10 FY11E FY12E FY13E

(Rsmn)

(20)

(10)

-

10

20

30

40

50(%)

Room Revenue F&B Revenue Other Services Net Sales Growth


Summary Financials Y/E March (Rsmn) (Consolidated) FY09 FY10 FY11E FY12E FY13E

Key Income Statement

Revenue 26,861 25,210 29,822 34,659 39,314

YoY growth (%) (8.0) (6.1) 18.3 16.2 13.4

EBITDA 4,880 3,860 5,874 7,920 9,743

YoY growth (%) (44.1) (20.9) 52.2 34.8 23.0

EBITDA Margin 18.2 15.3 19.7 22.9 24.8

Depreciation 1,885 2,185 2,260 2,367 2,586

Interest expenses 2,292 3,061 3,566 3,505 3,148

Other non operating income 705 852 691 881 1,072

PBT 1,407 (535) 739 2,929 5,080

Provision for tax 1,558 847 245 973 1,688

Minority interest 413 93 391 483 595

PAT (adjusted) 125 (1,369) 570 2,063 3,537

YoY growth (%) (96.8) NA NA 262.2 71.4

PAT margin (0.6) (5.5) 1.7 5.6 8.6

Key CF Statement

Cash generated from operations 6,703 5,799 3,390 4,272 4,939

Cash flow from investing activities (11,611) (1,025) (4,947) (1,856) (3,507)

Cash flow from financing activities 12,316 (4,192) (363) (7,159) (5,411)

Net cash increase/decrease 4,095 (945) (370) (1,401) (805)

Key Balance Sheet Data

Shareholders' fund 31,663 24,293 29,103 33,605 36,108

Debt 46,469 44,607 44,538 37,933 36,136

Total Capital Employed 83,916 73,216 76,756 74,484 74,853

Fixed Assets 48,156 48,035 50,721 50,211 51,131

Investments 24,077 19,054 19,054 19,054 19,054

Net current assets 6,242 548 1,402 (359) (911)

Total Assets 83,916 73,216 76,756 74,484 74,853

Key Ratio (%)

ROCE (0.4) 1.4 3.2 4.9 6.4

ROIC (0.5) 1.5 3.5 5.2 6.7

ROE (0.6) (4.9) 1.9 6.4 9.7

Per share Ratios (Rs)

Fully diluted EPS 0.2 (1.7) 0.7 2.6 4.4

CEPS 2.1 1.0 3.4 5.4 7.4

Book value 39.2 30.1 34.5 41.6 44.7

Solvency Ratio (x)

Debt-equity 1.5 1.8 1.5 1.1 1.0

Interest coverage ratio 1.3 0.5 1.0 1.6 2.3

Valuation parameters(x)

P/E (Fully Diluted) 505.5 (46.0) 110.6 30.5 17.8

P/BV 2.0 2.6 2.3 1.9 1.7

EV/EBITDA 16.0 19.9 16.8 12.3 9.9

EV/Sales 2.9 3.0 3.3 2.8 2.4

EV/Room (Rs mn) 7.0 6.5 7.4 6.0 5.6


International operations weigh on the consolidated entity and thus slow improvement in EBITDA margins


Investment Argument

Domestic business to be main value driver In the near to medium-term, the domestic business would be the main value driver for IHCL. The standalone (domestic luxury hospitality operations) valuation gives us a fair value of Rs117. We have valued the standalone business at 15x FY13E EV/EBIDTA, which is the stock’s 9-year average EV/EBITDA multiple. This translates into an FY13E EV/adjusted room valuation of Rs22.9mn.

Our SOTP-based value for the consolidated entity is Rs135 per share. At this price, IHCL would trade at 3.0x FY13E P/BV and FY13E EV/adjusted room of Rs9.8mn.

Exhibit 1: IHCL’s SOTP valuation

Multiple Total Value Net Debt Net Value Per Share

Rsmn Rsmn Rsmn Rsmn Rs

Value of Standalone Business FY13 EV / E 7,177 15.0 107,650 13,528 94,122 117

Value of Roots Corp. (Ginger) FY13 EV / E 204 12.5 2,554 3,090 (535) (0.7)

Value of Listed Entites Current share of Mcap 7,362 70% 5,153 - 5,153 6.4

Value of Other Investments BV 3,155 70% 2,208 2,208 2.7

Value of IHMS (US) BV 16,003 50% 8,001 8,001 9.9

125,567 108,950 135


We estimate the standalone business to register 17.3% CAGR over FY10-13E to Rs24.3bn. The high operating leverage of the business along with improvement in ARRs and occupancy will boost EBITDA from Rs3.7bn in FY10 to Rs7.2bn in FY13E (24.5% CAGR). The growth in EBITDA will be accompanied by margin expansion from 25.2% to 30.4%. We believe our estimates are conservative. Even during the downturn (FY08-10), the standalone business did not report any loss. This reinforces the strength of IHCL’s diversification across different price points and regions. We forecast 32.2% CAGR in profitability over FY10-13E to Rs3.5bn from Rs1.5bn.

Exhibit 2: IHCL standalone financials

Y/E March (Rs mn) FY08 FY09 FY10 FY11E FY12E FY13E

Net Sales 17,645 16,196 14,733 16,547 20,568 23,780

-Growth (%) 14.5 -8.2 -9.0 12.3 24.3 15.6

EBITDA 6,902 4,561 3,719 4,165 6,058 7,177

EBITDA Margin (%) 39.1 28.2 25.2 25.2 29.5 30.2

Net Profit 3,775 2,874 1,531 1,503 2,762 3,541

-Growth (%) 17.3 -23.9 -46.7 -1.8 83.7 28.2

PAT Margin 21.4 17.7 10.4 9.1 13.4 14.9

ROCE (%) 12.5 5.6 3.6 3.6 5.6 6.8

ROE (%) 19.7 11.3 5.3 4.9 7.6 9.0

Diluted EPS (Rs) 4.7 3.6 1.9 1.9 3.4 4.4


Turnaround of US subsidiary to take time We believe the worst is not yet over for International Hotel Management Services (IHMS), IHCL’s US subsidiary, and it would turnaround only in FY13E. IHMS reported revenue of Rs3,512mn in FY10 and incurred a net loss of Rs1,838mn. The Pierre, the iconic flagship of Taj Hotels on New York’s Fifth Avenue overlooking Central Park, re-opened in June 2009. The hotel is priced at a premium to other 5-star luxury hotels operating there and will take time to become profitable. We believe that the US market would in the ensuing future be weak and hence see the US subsidiary breaking even only post FY13. IHCL has so far invested Rs16bn in IHMS. IHMS has accumulated losses of ~ Rs5.5bn as of FY10. Our estimates suggest that the accumulated losses would rise to ~Rs8.7bn by FY13E, which is approximately 50% of the book value investment. Even after accounting for the accumulated losses, IHMS still incrementally contributes Rs10 per share as part of the consolidated entity.


Exhibit 3: US subsidiary – slow growth in RevPAR

4,251 3,466 3,512 4,679 4,823 5,215

19,943

16,25816,971

22,61123,305

25,199

2,500

3,000

3,500

4,000

4,500

5,000

5,500

FY08 FY09 FY10 FY11E FY12E FY13E

(Rsmn)

7,000

9,000

11,000

13,000

15,000

17,000

19,000

21,000

23,000

25,000

27,000(Rs)

Revenue (LHS) RevPAR (RHS)

Source: Company, Centrum Research Estimates The company targets to achieve $650-$700 room rates per night for the renovated Pierre. Although the hotel has shown improvement in occupancy levels and room rates, we believe it would sometime before it achieves such rates. The main kicker for the Pierre would be the banqueting business as that would bring in good margins and also help in filling up the rooms. The Pierre currently contributes ~56% of the total revenues and we believe this proportion will rise to ~64% by FY13E. At the gross profit level, the Pierre’s contribution will go up from ~38% in FY10 to ~51% in FY13E.

Exhibit 4: Improving RevPAR leading to reducing EBITDA losses

127

162

233 243263

(27.6)

(33.9)

(18.2)

(12.8)

(6.3)

50

95

140

185

230

275

FY09 FY10 FY11E FY12E FY13E

($)

(40)

(35)

(30)

(25)

(20)

(15)

(10)

(5)

-(%)

RevPAR (LHS) EBITDA Margin (RHS)



Budget chain Ginger – taking time to reap benefits

IHCL’s budget/economy chain – Ginger – is run through its wholly owned subsidiary called Roots Corporation. Factoring in accumulated losses, we believe Roots Corporation would be value decretive in the medium-term. The company had a negative PAT margin (4.1%) in FY10 taking into account an extra-ordinary gain of Rs57mn. Adjusted for this amount the PAT margin came in at (14%). As of end FY10, it was operating 21 hotels with ~1,985 rooms. We believe that Ginger is still some time away from PAT break even and do not see it prior to FY14E.

Exhibit 5: Ginger chain – rapid growth

1,194 1,891 1,985 2,600 3,100 3,600

262384

581

731

896

1,062

600

1,100

1,600

2,100

2,600

3,100

3,600

4,100


(Nos.)

50

250

450

650

850

1,050

1,250(Rsmn)

Rooms (LHS) Revenues (RHS)


Our study indicates that budget category hotels offer higher and faster returns than the luxury hotels because of their far lower operating leverage and lower maintenance costs. However, an important thing to point out is that this category has far lower margins vis-à-vis luxury hospitality because of their lower price tags.

Exhibit 6: Ginger chain – steadily improving margins

557

700 720 735738

(20.7)

11.616.2

19.0 19.2

350400450500550600650700750800

FY09 FY10 FY11E FY12E FY13E

(Rs)

(25)(20)(15)(10)(5)-510152025

(%)

RevPAR (LHS) EBITDA Margin (RHS)



Robust growth in India’s economy to boost ARR, occupancy levels

The recovery in the domestic hospitality sector has been slow. Although occupancy levels are rising and approaching their pre-slowdown days, ARRs are still far from their peak levels. ARRs bottomed out in Q3/Q4FY10 and have been flat since then. We believe that the worst is behind us and FY11 will see a marginal rise in ARRs. However, this time growth in ARRs would be region-specific depending on the supply slated to enter the respective markets. We are positive on ARRs improving as the supply of new rooms is expected to be staggered, thereby offsetting the crowding out effect. Our estimates suggest that ARRs for IHCL’s standalone operations would rise by 8% from Rs8,018 in FY10 to Rs8,987 in FY11E and remain almost flat at Rs 9,275 in FY12E. We believe ARR would improve slowly as the new properties take to stabilize and supply comes into the market.

Exhibit 7: Standalone operations – ARRs, occupancy levels and RevPAR 9,

233

10,5

21

9,25

1

8,01

8

8,98

7

9,27

5

9,66

5

6,74

0

7,83

6

5,73

9

5,24

5

6,45

1

6,40

2

6,75

4

73.074.5

62.0

65.4

71.8

69.069.9

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000


(Rs )

58

60

62

64

66

68

70

72

74

76(%)

ARR (LHS) RevPAR (LHS) Occupany Levels (%)

Source: Company, Centrum Research Estimates IHCL derives a major benefit because of its brand name and hence is able to attract a lot of diplomatic convoys. Its hotels are always amongst the top choices for any foreign delegation visiting India. Our interactions with industry sources indicate that the company’s properties in Mumbai/Delhi/Bangalore have consistently played host to various foreign delegations over the past 12-18 months. With India becoming a major investment and business hub, we believe that the future will see many more such delegations/business conferences happening in India more frequently which in turn will be a key positive for the company.

Exhibit 8: Occupancy and ARR assumptions in major cities

Occupancy levels (%) ARRs (Rs)

Region FY11E FY12E FY13E FY11E FY12E FY13E

South Mumbai 70.5 70.5 70.5 9,698 10,141 10,849

North Mumbai 72.5 71.8 73.3 9,666 10,031 10,753

Delhi 78.5 73.3 75.0 11,336 11,103 11,644

Bangalore 72.0 73.0 71.8 9,639 10,067 10,719

Kolkata 72.8 73.5 73.8 6,419 6,786 7,260

Goa 69.5 70.8 71.5 7,076 7,570 8,096

Chennai 71.0 70.3 71.5 6,740 7,093 7,405

Hyderabad 71.3 71.3 72.0 5,927 6,176 6,578



Diversified presence and strong brand image

IHCL is well-positioned to leverage its dominant position in the sector (it’s the biggest player in the Indian hospitality sector), well-diversified presence across the country, strong brand image and proven management capability to capitalize on the recovery in the sector. It currently operates more than 11,000 rooms across geographies and categories. The company plans to increase its room count by 56% to 17,234 over FY10-13E on a consolidated basis. The standalone entity currently operates 3,518 rooms in the 5-star luxury and 5-star business segments. The room count will increase to 4,707 rooms by FY13E.

IHCL has been consistently bagging awards in the hospitality sector over the years for its service excellence and significant contribution to the travel and tourism industry, in the region. It has also successfully created a global name for itself with operations in more than 12 countries.

Exhibit 9: Room count to increase 56% over FY10-13E

3,411 3,477 3,477 3,398 3,518 3,856 4,417 4,7071,113 1,686 2,296 2,833 3,197

3,6984,363 4,563

1,7121,712

1,800 1,800 1,8101,836

2,016 2,016

1,0871,111

1,1111,427 1,427

1,5991,774 1,774

1,3551,475

1,4751,658 1,828

2,283

3,5084,174

1,000

3,000

5,000

7,000

9,000

11,000

13,000

15,000

17,000

19,000

FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Owned Subsidiary Associates JV Management Contracts


Exhibit 10: Room Concentration (ex-management contract)

City FY11E FY12E FY13E

Mumbai 1,406 1,406 1,406

NCR 903 903 1,193

Kolkata 228 228 228

Chennai 718 718 718

Bangalore 738 854 854

Hyderabad 589 864 864



Asset-light model to improve profitability

IHCL has employed an asset-light strategy of expanding through management contracts. Most of the domestic management contracts are under the ‘Gateway’ brand. Going forward, most expansions would be through ‘sale and lease back’ agreements, joint ventures, management contracts and associate companies to improve profitability and increase brand presence without additionally burdening the balance sheet.

Exhibit 11: Expansion through management contracts

1,475 1,4751,658

1,828

2,283

3,508

4,174

800

1,300

1,800

2,300

2,800

3,300

3,800

4,300

4,800


(Nos.)


The company is also following this strategy for expansion on the international front. The company plans to have two properties in China, another two in the Middle East and one in North Africa in the next three years.

Exhibit 12: International management contracts in pipeline

Country Expected by Rooms

Taj Palace Temple of Heaven China Mar-12 45 (Phase I)

Taj Palace, Hainan China Dec-13 458

Exotica Resort & Spa, Palm Island Dubai Dec-12 262

Taj Exotica Resort & Spa, Doha Qatar Dec-12 150

Taj Tangiers Morocco Dec-12 60

Source: Company, Centrum Research Estimates Multiple price points to enlarge customer base

In recent years, IHCL has been focusing on the economy segment under its ‘Ginger’ brand. Basic facilities, consistency and affordability (priced at around Rs1,200-1,500 per night) are hallmarks of this brand targeted at travellers who value simplicity and self-service. These hotels are operated by its fully-owned subsidiary, Roots Corporation.

The rationale for targeting this segment is the management’s belief of severe supply shortage in the segment in both Tier 2 and Tier 3 cities and huge pent up demand. The management was not keen on associating the ‘Taj’ brand with this segment because it did not want to dilute the luxury brand name and at the same time create a niche for the ‘Ginger’ brand. The company currently operates around ~21 hotels under this brand and aims to grow this by 5-6 hotels per year.


Exhibit 13: Ginger to expand room count

796 1,194 1,891 1,985 2,600 3,100 3,600

812

19 20

26

31

36

250

750

1,250

1,750

2,250

2,750

3,250

3,750

4,250


(Nos.)

2

7

12

17

22

27

32

37

42(Nos.)

Rooms (LHS) No. of Hotels (RHS)

Source: Company, Centrum Research Estimates By offering hotel variants at multiple price points, IHCL has adopted a clustered approach to expand its reach. The objective is to target companies at various price points, right from the top management to the junior level.

The company has also undertaken an exercise to phase out the ‘Residency’ brand and bring in the new and more contemporary ‘Vivanta’ brand. This brand will focus on the upper luxury segment and as per management discussions has been very well-received.

Exhibit 14: Ginger Hotel - Delhi



Increasing global footprint to help diversify revenue base

IHCL has significantly expanded its geographic footprint worldwide with hotels in the US, UK, Australia and South Africa. It has lined up projects up in China, the Middle East and North Africa. We believe with the probability of a double-dip recession receding, the global economy would register growth, albeit a tepid one. This in turn would help revive growth in the global hospitality industry and IHCL boost revenues and improve margins.

Going forward, IHCL hopes to increase the share of its international operations to a third of its revenues. We estimate that ~ 22% of IHCL’s total revenues in FY12E would accrue from its international operations. We have taken a very conservative view in terms of estimates given the uncertainty regarding the economic recovery specifically with regards to the US economy.

Exhibit 15: International revenues to form a major portion

0%

20%

40%

60%

80%

100%

FY10 FY11E FY12E FY13EDomestic International

Source: Company, Centrum Research Estimates Nevertheless, IHCL’s revenue mix would continue to be skewed in favour of domestic revenue. The main reasons for this are the large of number of properties that IHCL operates domestically vs internationally, stronger growth in the domestic market and a time lag before the international properties stabilize.

Marquee properties to bring back the colour

IHCL re-opened the heritage wing of the iconic Taj Mahal Palace & Tower, Mumbai, in May 2010 with ~278 additional rooms coming on board. The hotel was one of the targets of the Nov 2008 terrorist attacks and has undergone a complete overhaul. The Taj Mahal Palace (heritage wing) was completely shut down post the terrorist attacks. The tower wing was opened 30 days after the attacks with ~268 rooms being available. The company has till date received around Rs1.8bn as insurance claims for the damage of property and business interruption. The total growth in room revenues for the standalone entity is 28% from FY10 to FY11E. We estimate the opening of this property (546 rooms) would add ~35% to revenue. This property would also be the highest contributor to IHCL’s standalone revenue (15.7% in FY11E and 14.6% in FY12E). Given its loyal client base, we expect buoyant occupancy levels and firm ARRs right from the opening. The lack of supply in the South Mumbai market would also benefit the hotel.


Exhibit 16: Standalone revenue and revenue growth

15.614.5

38.1

24.3

12.3

(8.2) (9.0)

3,000

6,500

10,000

13,500

17,000

20,500

24,000


(Rsmn)

(20)

(10)

-

10

20

30

40

50(%)

Room Revenue F&B Revenue Other Services Net Sales Growth

Source: Company, Centrum Research Estimates IHCL also re-opened The Pierre, New York, after a massive US$100mn renovation. The hotel was re-modelled and number of rooms reduced from 201 to 189. The hotel also has 49 guest suites and is situated in an upscale location in New York. The company had shut down the hotel in July 2008 for renovation which got completed in October 2009. The total cost of the renovation would be capitalized and amortized over a period of 40 years. The Pierre will play a very important role in IHCL’s international portfolio. Based on management commentary and the US hospitality demand-supply scenario, we believe that the US market would register a slow recovery. The Pierre will contribute in excess of 52% of the total US room revenues (Rs2,153mn in FY12E) and would drive growth in revenues in the US. A faster-than-expected GDP growth rate in US and hence its cascading effect on the US hospitality industry will be a perfect kicker for the Pierre and the other properties in the US.


Financial Analysis

16% consolidated revenue CAGR over FY10-13E

We expect the company to register 15.9% consolidated revenue CAGR over FY10-13E to Rs39.3bn. The growth will be primarily driven by the domestic portfolio, bolstered by the re-opening of the heritage wing of Taj Palace, Mumbai, and the US portfolio. The various cost-cutting measures undertaken during the tough times in 2008-09 and increase in ARRs would help expand EBITDA margin to 24.7% in FY13E from 15.7% in FY10.

Exhibit 17: Revenue, EBIDTA margin and PAT margin trend

18,373 25,063 29,200 25,210 29,822 34,659 39,31426,861

24.8

13.4 14.7

0.5

-5.4

1.96.0

9.0

22.9

18.8

15.7

19.7

29.928.427.2

13.4

4,000

9,000

14,000

19,000

24,000

29,000

34,000

39,000


Rs mn

-10

-5

0

5

10

15

20

25

30

35%

Revenue EBITDA Margins PAT Margins

Source: Company, Centrum Research Estimates IHCL’s room count would register 14% CAGR over FY10-13E from ~11,815 to ~17,234. The major increase in room count is from management contract basis wherein rooms under management contract would increase from ~1,863 in FY10 to ~4,174 rooms in FY13E.

Exhibit 18: Consolidated room inventory increase

3,411 3,477 3,477 3,398 3,518 3,856 4,417 4,7071,113 1,686 2,296 2,833 3,197 3,698

4,363 4,563

1,7121,712

1,800 1,800 1,8101,836

2,016 2,016

1,0871,111

1,1111,427 1,427

1,5991,774 1,774

1,3551,475

1,4751,658 1,828

2,283

3,5084,174

1,000

3,000

5,000

7,000

9,000

11,000

13,000

15,000

17,000

19,000

FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13EOwned Subsidiary Associates JV Management Contracts


We estimate 18% CAGR in standalone revenue from Rs14.8bn in FY10 to Rs24.3bn in FY13E. The growth in revenues will be driven by 38% growth in room count from 3,518 in FY10 to 4,857 in FY13E and ARR growth from Rs8,018 to Rs9,693. EBITDA margins would grow by 25% over the same period.


Exhibit 19: Standalone revenue, EBIDTA margin and PAT margin trend

11,162 15,409 17,645 14,733 16,547 20,568 23,78016,196

30.2

16.2

20.917.7

10.4 9.1

13.4 14.9

29.5

28.2

25.2 25.2

39.136.3

27.9

21.4

5,000

10,000

15,000

20,000

25,000

30,000


(Rsmn)

0

5

10

15

20

25

30

35

40

45

(%)

Revenue EBITDA Margins PAT Margins

Source: Company, Centrum Research Estimates Consolidated entity’s high leverage a cause for concern IHCL undertook an aggressive expansion in the pre-slowdown era to expand its domestic and international presence. This expansion and the buyout of Sea Rock, Mumbai, was primarily funded through debt which pushed the debt-equity ratio to 1.84x in FY10 from 1.05x in FY07. However, the company has undertaken measures to reduce their debt burden. The Sea Rock acquisition has been hived off into a special purpose vehicle along with other Tata group companies to de-leverage IHCL’s balance sheet. The company has also recently issued 36mn preferential shares to the promoter entity Tata Sons to boost equity. In addition, the company has also allotted 48mn warrants convertible to one equity share per warrant to Tata Sons convertible only post 1 April 2011. Through both of these equity infusions the company will end up raising ~Rs8.5bn. The company clearly mentioned that the primary aim of this equity infusion was to reduce debt. The main succour to IHCL would be a strong revival in the US and UK hospitality markets. IHCL has majority of its debt on its international subsidiary books and hence, an improved US portfolio would help reduce debt drastically. The company’s primary focus has to be on time-bound completion of projects to avoid any cost escalations thereby aggravating the already-strained balance sheet. This will also help in increasing revenues and provide much-needed cash flows.

Exhibit 20: Consolidated interest coverage

3,715 5,515 7,055 7,1565,5532,9941,675

3,614

2.3

3.6

4.5

3.5

1.3

0.51.0

1.6

500

1,500

2,500

3,500

4,500

5,500

6,500

7,500


(Rsmn)

0.00.5

1.01.5

2.02.53.0

3.54.0

4.55.0(x)

EBIT Interest Coverage Ratio



On a standalone basis, the company’s D/E would decrease from 1.0x in FY10 to 0.4x in FY13E driven by improved cash flows from the domestic market.

Exhibit 21: Standalone Leverage

11,342 17,665 26,506 24,189 17,821 16,521

0.6 0.6

1.0

0.7

0.50.4

3,000

8,000

13,000

18,000

23,000

28,000


(Rsmn)

0.0

0.2

0.4

0.6

0.8

1.0

1.2(x)

Debt D/E

Source: Company, Centrum Research Estimates Strategic sale – A possibility

IHCL could also be looking at strategic sale of some its international properties to allay balance sheet concerns. The company had in 2007 bought ~11% stake in Orient Express for ~Rs12.5bn. Orient Express Hotels runs a chain of 35 properties in more than 25 countries. IHCL had tried, albeit unsuccessfully, to persuade the Orient Express management to enter into a strategic alliance with IHCL. IHCL did not participate in Orient Express Hotels’ rights offer which leaves a question mark over its intentions with regards to Orient Express. The IHCL management says that the deal is a long-term strategic investment but given the lack of clarity we believe that this ’long-term strategic investment’ will be an overhang on IHCL’s valuations given the value of the stock is down 70% from what IHCL bought it at.


Valuation Analysis IHCL has some of most iconic and well renowned properties across all major Indian cities and most of these properties are in operation for over 40 years. For instance, the Taj Mahal Palace in Mumbai has been in operation for than 100 years. These old properties constitute a majority of IHCL’s standalone portfolio and are cash cows for the company on the whole. The cash flows from these properties have been a major reason for IHCL’s survival though the economic slowdown. Moreover, it allowed IHCL to continue with its expansion plans even in trying times. We have valued the standalone entity which operates in the domestic circuit at its 8-year average EV/EBITDA multiple of 15x to arrive at a price target of Rs117.

Exhibit 22: Standalone EV/EBITDA

8

11

14

17

20

23

26

Apr-02

Nov-02

Jun-

03

Jan-

04

Aug-0

4

Mar-05

Oct-05

May-0

6

Dec-0

6Ju

l-07

Feb-0

8

Sep-0

8

Apr-09

Nov-0

9

Jun-

10

Jan-

11

EV/EBITDA Mean Median

Source: NSE, Company, Centrum Research Estimates At our price target the stock would trade at Rs 22.9mn FY13E EV/Room. The stock has 6year average EV/Room multiple of Rs 21.6mn which is close to our implied multiple.

Exhibit 23: Standalone EV/Room

5

10

15

20

25

30

35

40

Apr

-04

Aug

-04

Dec

-04

Apr

-05

Aug

-05

Dec

-05

Apr

-06

Aug

-06

Dec

-06

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Aug

-10

Dec

-10

EV/Room (Rsmn) Mean Median

Source: NSE, Company, Centrum Research Estimates

Exhibit 24: Standalone Valuation Matrix


Price/Book Value 2.0 1.7 1.6 2.3 EV/Adjusted Room 27.4 22.7 21.1 22.9

EV/Sales 6.4 4.9 4.2 4.5



Key Risks

Overleveraged

High leverage on the balance sheet possesses a substantial risk in the event that the economic recovery is slower than anticipated. Any more debt-laden expansion would also be a major cause for concern.

International portfolio – US operations key to turnaround

IHCL reported a loss of Rs1.5bn on revenue of Rs6bn in FY09 from its international business. The US operations were the main cause of the losses and hence an uptick in the US hospitality markets is critical and will play a very important role in eliminating losses and reducing leverage.

Execution risk

Delayed commissioning of new hotels would impact our estimates and thus our valuations.


Financials (Consolidated)

Exhibit 25: Income Statement Y/E March (Rsmn) FY09 FY10 FY11E FY12E FY13E

Net Sales 26,861 25,210 29,822 34,659 39,314

-Growth (%) (8.0) (6.1) 18.3 16.2 13.4

Salary expenses 8,564 8,477 9,429 10,257 11,323

% of sales 31.9 33.6 31.6 29.6 28.8

Food and Beverages consumed 2,772 2,547 3,038 3,522 3,914

% of sales 10.3 10.1 10.2 10.2 10.0

Other operating expenses 10,645 10,326 11,482 12,960 14,334

% of sales 39.6 41.0 38.5 37.4 36.5

EBITDA 4,880 3,860 5,874 7,920 9,743

EBITDA Margin 18.2 15.3 19.7 22.9 24.8

Depreciation and Amortisation 1,885 2,185 2,260 2,367 2,586

EBIT 2,994 1,675 3,614 5,553 7,156

Interest Expenses 2,292 3,061 3,566 3,505 3,148

PBT from operations 702 (1,387) 48 2,048 4,008

Other Income 705 852 691 881 1,072

PBT before extraordinary items 1,407 (535) 739 2,929 5,080

-PBT margin (%) 5.2 (2.1) 2.5 8.5 12.9

Provision for tax 1,558 847 245 973 1,688

Effective tax rate (%) 110.7 34.0 33.2 33.2 33.2Share of profit from associates & minority int. 413 93 391 483 595

Net Profit (Adjusted) 125 (1,369) 570 2,063 3,537

-Growth (%) (96.8) NA NA 262.2 71.4

-NPM (%) (0.6) (5.5) 1.7 5.6 8.6


Exhibit 26: Balance Sheet Y/E March (Rsmn) FY09 FY10 FY11E FY12E FY13E

Share Capital 723 723 759 807 807

Reserves and Surplus 30,939 23,570 27,112 32,798 35,300

Total shareholders fund 31,663 24,293 29,103 33,605 36,108

Minority Interest 2,741 2,727 2,727 2,557 2,221

Loan fund 46,469 44,607 44,538 37,933 36,136

Total capital employed 83,916 73,216 76,756 74,484 74,853

Gross block 53,761 58,142 62,786 65,750 69,898

Less: Accumulated depreciation 13,041 14,407 16,667 19,034 21,620

Net block 40,720 43,735 46,119 46,716 48,277

Capital WIP 7,435 4,300 4,602 3,495 2,854

Net fixed assets 48,156 48,035 50,721 50,211 51,131

Investments 24,077 19,054 19,054 19,054 19,054

Cash and bank 2,528 5,488 5,350 3,949 3,143

Inventories 641 597 630 756 855

Debtors 1,778 2,055 2,147 2,599 2,949

Other current assets & loans & adv. 8,865 5,654 6,859 6,932 7,863

Total current assets 13,812 13,793 14,986 14,236 14,810

Current liabilities and Provision 7,570 13,245 13,584 14,595 15,721

Net current assets 6,242 548 1,402 (359) (911)

Total assets 83,916 73,216 76,756 74,484 74,853


Exhibit 27: Cash flow Y/E March (Rsmn) FY09 FY10 FY11E FY12E FY13E

Cash Flow from operating

Profit before tax 1,585 (337) 739 2,929 5,080

Depreciation 1,885 2,185 2,260 2,367 2,586

Interest expenses 2,305 3,061 3,566 3,505 3,148

Op. profit before WC change 5,626 4,302 6,175 8,227 10,055

Working capital adjustments (322) 501 (991) 360 (254)

Direct tax paid (1,914) (532) (245) (973) (1,688)

Net cash from operating 6,703 5,799 3,390 4,272 4,939

Cash flow from investing

Capex (7,808) (4,478) (4,947) (1,856) (3,507)

Investments (3,401) 2,152 - - -

Net cash from investment (11,611) (1,025) (4,947) (1,856) (3,507)

Cash flow from financing

Procds from share cap.l & premium 9,439 10 3,763 3,743 -

Borrowings/(Repayments) 6,453 325 (69) (6,605) (1,003)

Interest paid (2,301) (3,200) (3,566) (3,505) (3,148)

Dividend paid (1,455) (1,075) (491) (792) (1,260)

Net cash flow from financing 12,316 (4,192) (363) (7,159) (5,411)

Net cash increase/(decrease) 4,095 (945) (370) (1,401) (805)


Exhibit 28: Key Ratios Y/E March FY09 FY10E FY11E FY12E FY13E

Margin Ratio (%)

EBITDA Margin 18.8 15.7 19.7 22.9 24.8

PBIT Margin 11.5 6.8 12.1 16.0 18.2

PBT Margin 5.4 (2.2) 2.5 8.5 12.9

PAT Margin (0.6) (5.6) 1.7 5.6 8.6

Growth Ratio (%)

Revenue (8.0) (6.1) 18.3 16.2 13.4

EBITDA (44.1) (20.9) 52.2 34.8 23.0

Net Profit (104.3) 818.3 (135.7) 296.6 73.4

Return Ratios (%)

ROCE (0.4) 1.4 3.2 4.9 6.4

ROIC (0.5) 1.5 3.5 5.2 6.7

ROE (0.6) (4.9) 1.9 6.4 9.7

Turnover Ratios

Asset turnover ratio (x) 0.4 0.3 0.4 0.5 0.5

Working capital cycle (days) (331.4) (415.9) (386.8) (369.3) (371.6)

Average collection period (days) 27.1 28.5 25.7 25.0 25.8

Average payment period (days) 366.7 453.5 420.1 401.6 404.8

Per share (Rs)

Fully diluted EPS 0.2 (1.7) 0.7 2.6 4.4

CEPS 2.1 1.0 3.4 5.4 7.4

Book value 38.7 30.0 34.4 41.5 44.6

Solvency Ratio

Debt-equity 1.5 1.8 1.5 1.1 1.0


Valuation

P/E 505.5 (46.0) 110.6 30.5 17.8

P/BV 2.0 2.6 2.3 1.9 1.7

EV/EBITDA 16.0 19.9 16.8 12.3 9.9

EV/Sales 2.9 3.0 3.3 2.8 2.4

EV/Room (Rs mn) 7.0 6.5 7.4 6.0 5.6



Hold Target Price: Rs93

CMP: Rs81*


Rahul Gaggar [email protected] 91 22 4215 9683

(Slow and) steady growth We believe EIH’s excellent positioning in the lucrative Mumbai market, coupled with good demand in metros, would translate into robust 36% earnings growth over FY10-13E. The company’s tardy expansion pace will act as major dampener to take on rivals when the tourism sector kicks up. We initiate coverage with a Hold rating and target price of Rs93 (valuing the stock at 19.9 x FY13E EV/EBIDTA). At our target price the stock would trade at Rs20.8mn FY13E EV/Room.

Established name in Mumbai: The lucrative Mumbai market accounts for 38.5% of EIH’s total room inventory and is expected to contribute over 50% of its total room revenue in FY11E and FY12E. Although the company’s exposure to the Mumbai market is high, it’s also a very lucrative market.

Stable revenue, robust PAT growth: We estimate 21.3% CAGR in room revenue over FY10-13E with overall revenue registering 18.6% CAGR from Rs8.4bn to Rs14.1bn over the same period. The growth in ARRs would positively impact EBITDA margin, which we expect would expand from 12% in FY10 to 19.5% in FY13E. PAT growth will be even more robust (36.4% CAGR from Rs0.7bn in FY10 to Rs 1.7bn in FY13E).

Tardy room expansion a dampener: EIH’s total room inventory is expected to grow from 3,600 in FY10 to 4,640 in FY13E. The incremental growth is only through management contract route. The slow growth in room expansion will according to us be a negative in growing market like India. Also, the company’s delayed delivery schedule makes us more skeptical of the upcoming projects commissioning on time.

Boardroom matters: The ongoing corporate battle between the existing promoters, Reliance Industries (backed by the promoters), and ITC would unfold in the ensuing months. This will definitely have an overhang on the valuations.

Buy with a target price of Rs93: We have valued the stock at 19.9x FY13E EV/EBIDTA (implied EV/Room of Rs20.8mn FY13E), translating into a target price of Rs93. We initiate coverage with a Hold rating.

Key Risk: Upside – stronger economic growth and any corporate action. Downside – delayed execution plans

Key Data

Bloomberg Code EIH IN

Reuters Code EIHO.BO




52 Wk H / L (Rs) 181/74


Face Value (Rs) 2

USD = Rs44.9


Promoter49.3%

Foreign10.3%

Institutions1.2%


As on 31 December 2010


50

75

100

125

150

175


EIH LTD NSE S&P CNX NIFTY INDEX


1M 6M 1Yr

EIH (6.7) (35.0) (25.3)

NIFTY (1.0) (9.6) 4.0


Y/E Mar(Rsmn) Rev YoY (%) EBITDA EBITDA (%) Adj PAT YoY (%) Fully DEPS RoE (%) RoCE (%) P/E (x) EV/EBITDA (x)

FY09 9,679 (16.7) 2,017 20.8 1,700 (24.4) 3.0 12.8 3.0 27.3 20.8FY10 8,451 (12.7) 1,012 12.0 663 (61.0) 1.2 4.7 0.3 70.0 44.8FY11E 12,264 45.1 2,233 18.2 970 46.2 1.7 4.8 2.3 47.9 21.2FY12E 13,197 7.6 2,457 18.6 1,306 34.7 2.3 4.8 2.2 35.5 19.2FY13E 14,098 6.8 2,750 19.5 1,683 28.8 2.9 6.0 2.6 27.6 16.9


Hotels


INDIA

EIH

42 EIH



Promoter 49.3 49.3 49.3 49.3

Foreign 5.5 10.7 10.1 10.3

Institutions 1.9 1.2 0.5 1.2

Public & Others 43.4 38.9 40.1 39.3

Total 100.0 100.0 100.0 100.0

Source: NSE

Company Background EIH, the flagship company of Oberoi group, is one of the largest luxury hotel chains in India. The group’s services include airline catering, management of restaurants and airport bars, travel and tour services, car rentals, projectmanagement and corporate air charters. EIH operate hotels under the Oberoi and Trident brand names. It currently runs 32 properties in India and overseas on its own and through subsidiaries and associates. Oberoi Hotels & Resorts wasrated the leading luxury hotel brand in Asia in a Travel agents’ poll at the World Travel Awards, 2007. Trident Hotels was rated the best first class hotel brand inIndia at the Galileo-Express Travel World Awards, 2007.

EIH – Group structure

Subsidiaries Associates Joint Ventures

Mercury Car Rentals Ltd - 66.7% EIH Associated Hotels Ltd -36.1% CCA Leisure Services Pvt Ltd - 30%Mashobra Resort Ltd - 78.8% L&T Bangalore Airport Hotel Ltd - 26%Oberoi Kerala Hotels and Resorts Ltd - 80%Mumtaz Hotels Ltd - 60%EIH International Ltd - 100%EIH Flight Services Limited, Mauritius -100%

EIH




P R S Oberoi

Chairman & Chief Executive

He is Chairman & CEO of EIH, the flagship company of Oberoi group. Mr. Oberoi has been at the helm of affairs at EIH since many years and has been instrumental in guiding the growth of EIH.

Vikram Oberoi

Joint Managing Director

Mr. Vikram Oberoi has completed his graduation from Pepperdine University, California, USA. He joined the group in 1991 and since then has traversed many a roles to get a thorough understanding of the business

Source: Company, Centrum Reseearch

43 EIH

Bombay Contribution Investment Rationale Strong presence in the lucrative Mumbai market would help

profitability grow at 36% CAGR over FY10-13E

Steady 18.6% revenue CAGR over FY10-13E. EBITDA margin to expand from 12% in FY10 to 19.5% in FY13E. The high cost structure will be a dampener on the margin front

Lack of Aggressive Expansion – Only 3 new properties in Bangalore, NCR and Hyderabad on management contract basis. No Greenfield expansion in sight will act as a bane when the tourism sector kicks up

1,2602,730 3,120 3,411

2,6802,804 2,775 2,967

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY10 FY11E FY12E FY13E

Bombay Rest


Summary Financials Y/E March (Rsmn) FY09 FY10 FY11E FY12E FY13E

Key Income Statement (Rsmn)

Revenue 9,679 8,451 12,264 13,197 14,098

YoY growth (%) (16.7) (12.7) 45.1 7.6 6.8

EBITDA 2,017 1,012 2,233 2,457 2,750

YoY growth (%) (49.2) (49.8) 120.6 10.1 11.9

EBITDA Margin (%) 20.8 12.0 18.2 18.6 19.5

Depreciation 767 878 988 1,056 1,123

Interest expenses 953 1,103 1,339 1,159 979

Other non operating income 2,472 2,027 1,628 1,740 1,894

PBT 2,769 1,058 1,533 1,982 2,542

Provision for tax 1,074 348 521 674 864

Minority interest 49 65 30 85 78

PAT (adjusted) 1,700 663 970 1,306 1,683

YoY growth (%) -24.4 -61.0 46.2 34.7 28.8

PAT margin 17.6 7.8 7.9 9.9 11.9

Key CF Statement

Cash generated from operations 2286 782 2757 3473 3338

Cash flow from investing activities (3,300) (3,416) (1,637) (1,581) (1,077)

Cash flow from financing activities 1,342 2,445 10,544 (3,704) (3,633)

Net cash increase/decrease 328 (189) 11,665 (1,813) (1,372)

Key Balance Sheet Data

Shareholders' fund 14,125 13,947 26,646 27,371 28,365

Debt 11,445 14,357 14,882 12,882 10,882

Total Capital Employed 27,052 30,039 42,940 41,709 40,739

Fixed Assets 22,032 24,929 25,705 26,369 26,505

Investments 2,659 2,411 2,411 2,411 2,411

Net current assets 2,176 2,465 14,590 12,695 11,589

Total Assets 27,052 30,039 42,940 41,709 40,739

Key Ratio (%)

ROCE 3.0 0.3 2.3 2.2 2.6

ROIC 3.4 0.3 2.9 3.2 3.6

ROE 12.8 4.7 4.8 4.8 6.0

Per share Ratios (Rs)

Fully diluted EPS 3.0 1.2 1.7 2.3 2.9

Book value 24.7 24.4 46.6 47.9 49.6

Solvency Ratio (x)

Debt-equity 0.9 1.1 0.6 0.5 0.4


Valuation parameters(x)

P/E (Fully Diluted) 27.3 70.0 47.9 35.5 27.6

P/BV 4.0 4.0 1.7 1.7 1.6

EV/EBITDA 20.8 44.8 21.2 19.2 16.9

EV/Sales 4.3 5.4 3.9 3.6 3.3

EV/Room (Rs mn) 20.1 18.3 18.0 17.9 17.7


Higher operating leverage would lead to faster pickup in margins

44 EIH

Investment Argument

Established player in lucrative Mumbai market

EIH owns a prime sea-facing property in Nariman Point, Mumbai’s main business district. The company has both two hotels – Oberoi and Trident – next to each other. Now, with the opening of the property at Bandra-Kurla Complex (BKC), a fledging business district, EIH has expanded its presence beyond south Mumbai. The BKC property is located close to both the national and international airports, which makes it an ideal choice for business clientele who prefer accommodation close to the airport and have their business work in the suburbs. We expect the Mumbai market would contribute in excess of 50% to EIH’s total room revenue, going forward.

Exhibit 1: Mumbai inventory contribution FY10 Exhibit 2: Mumbai inventory contribution FY13E

Bombay52%

Rest48%

Rest60%

Bombay40%

Source: Company, Centrum Research Source: Company, Centrum Research Estimates

Exhibit 3: City-wise revenue breakup

1,260

2,730 3,120 3,411

2,6802,804 2,775 2,967

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY10 FY11E FY12E FY13E

Bombay Rest Source: Company, Centrum Research Estimates Both the Trident and Oberoi hotels were the targets of the Nov 2008 terrorist attacks in Mumbai. The 551-room Trident was completely shut for 25 days and witnessed dismal occupancies of 13%-15% when it reopened Dec 2009. The occupancy levels did improve to ~30-40% during Q4FY10, but the real improvement only started coming post Oct 2009. The Oberoi also suffered severe devastation. It was earlier scheduled to re-open around Nov 2009, a year after the attacks, but has only begun in April 2010. The company indicated that the property had not undergone any renovation since its inception and hence some renovation was also undertaken which will bring down the number of rooms from 325 to 287. The number of suites will be increased by 50 to 73 to cater to leisure clientele who constitute 10% of EIH’s clientele. The opening of the Trident at BKC, Mumbai will help EIH get back its corporate clientele which had moved out post the terrorist strikes. More importantly, the company targets to get back and increase its share of the airline crew clientele. The airline crew corporate account had consistently contributed over 20% of the Trident’s Nariman Point revenue and had moved out after the 2008 terrorist strikes.

45 EIH

Exhibit 4: Guest composition across categories

Composition 5-star D 5-star 4-star 3-star 2-star 1-star Heritage Others All India Avg

Airline Crew 6.3 4 1.7 1.7 0.7 0.3 0.2 0.6 1.5

Business Traveler – Domestic 16.6 23.5 31.5 40 38.4 46.9 10.5 54.6 37.7

Business Traveler – Foreign 26.8 22.9 18.7 9.7 7.2 8.4 4.1 6.4 10.4

Complimentary Rooms 1.9 1 1.9 1.7 1.6 0.8 1.7 2.2 1.6

Domestic – Tourist / Leisure 9 10.1 11.6 16.4 25.9 21.4 26.7 20.8 19.3

Foreign – Tourist / Leisure 15.5 11.4 6.9 6.9 6.5 5.5 28.9 3.2 7.7

Meeting Participants (<100) 4.8 1.8 4.8 3.5 2.7 1.6 3.4 0.6 3.1

Meeting Participants (>100) 9.3 8.8 7.5 6.5 5.5 4.3 4 2.5 6

Tour Group – Domestic 2.3 3.4 5.1 6.2 7.2 5.9 5 5.2 6.1

Tour Group – Foreign 5.6 10.2 8.6 5.3 3.0 2.6 15.0 1.4 5.0

Others 2 3.1 1.8 2.1 1.3 2.3 0.5 2.5 1.6

Source: HVS, Centrum Research The cost of the BKC property (~Rs6-7bn) is at the lower-end given the fact that the company had bought the land prior to real estate boom. We believe this property will add a lot of value to EIH given the incremental cash flows from this property. EIH’s heavy dependence on the Mumbai market make its case much more sensitive than say Hotel Leela which although has a smaller geographic presence but still has much less dependency on a particular market.

Exhibit 5: Occupancy and ARR assumptions for major cities

Occupancy (%) ARR (Rs)

Region FY11E FY12E FY13E FY11E FY12E FY13E

Mumbai 67.5 69.7 71.5 9,182 9,721 10,353

NCR 76.7 72.0 73.2 10,399 9,544 10,191

Bangalore 70.5 71.0 73.0 10,001 10,501 11,551

Kolkata 72.0 74.0 74.0 7,293 7,804 7,999

Source: Company, Centrum Research Estimates Metros to drive growth

EIH is the third largest listed hotel chain in India after IHCL and ITC (who are also its main competitors along with the unlisted Bharat Hotels). The company has 86% of its total room inventory in the metros with as Mumbai commanding the prime spot. Improving business climate will be the perfect kicker for EIH. The company caters to two segments – super premium and premium and is represented by the Oberoi and Trident brand respectively in these two categories. The Trident is marketed by the EIH group as a business hotel whereas the Oberoi brand is more of a luxury hotel and hence the Oberoi is priced at a premium to Trident. Both the brands have created a niche for themselves and always have been a top choice for foreign clientele who constitute in excess of 75% of the total clientele. The company also caters very regularly to foreign delegations and is always amongst the preferred choices for the same. The company currently has a portfolio of 10 properties across Indian on ownership basis with 2286 rooms under its belt. The company also owns two subsidiaries who own hotels in Shimla and Agra. The Himachal Pradesh government is minority partner in the former.

46 EIH

Exhibit 6: EIH’s portfolio

Hotel Location Rooms

The Oberoi Bangalore 160

The Oberoi Grand Kolkata 213

The Oberoi Mumbai 285

The Oberoi New Delhi 279

The Oberoi Vanyavilas Ranthambore 25

The Oberoi Udaivilas Udaipur 87

Motor Vessel Vrinda Cochin 8

Maidens Hotel Delhi 56

Trident (Nariman Point) Mumbai 550

Trident (BKC) Mumbai 436

Oberoi Amarvilas (60% stake) Agra 102

Wildflower Hall (78% stake) Shimla 85

Source: Company, Centrum Research Estimates Uncertainty and losses at the Wildflower Hall

EIH is locked in a bitter dispute with the Himachal Pradesh government, its JV partner for a property in Shimla (Wildflower Resort). The resort had been reporting losses until FY09. For FY10, the company reported a marginal profit of Rs12mn on sales of Rs183mn. However, the accumulated losses (Rs472mn till date) and the still-to-be-resolved issues with the Himachal Pradesh government have created doubts over EIH’s Rs1.4bn (Rs0.26bn equity and Rs1.13bn debt) investment in the resort. EIH has been honoring all its debt obligations even as the dispute is in the court.

EIH also holds 36% stake in EIH Associated Hotels which has a portfolio of 8 properties across India having 880 rooms. Along with the stake, EIH also acts as manager for these properties. EIH Associated Hotels has most of its properties under the Trident brand.

Exhibit 7: EIH Associated Hotel’s portfolio Hotel Location Rooms

Trident Agra 138

Trident Bhubaneswar 62

Trident Chennai 167

Trident Cochin 85

The Oberoi Rajvilas Jaipur 71

Trident Jaipur 137

The Oberoi Cecil Shimla 79

Trident Udaipur 143

Source: Company, Centrum Research Estimates EIH Associated Hotels currently has 136 rooms in India under management contract and over 300 rooms internationally. For further expansion, it has chosen to go the asset light way and signed up management contracts for properties coming up in Gurgaon (Oberoi), Bangalore (Trident) and Hyderabad (Trident). It currently has a 2,908-room inventory with Mumbai accounting for 987 rooms.

Exhibit 8: Inventory Growth

1,846 1,705 1,705 1,7052,099 2,099 2,099 2,099

187 187 187 187

187 187 187 187238882 880 880

8801,181 1,181 1,181

136

136 136 136

136136

8641,173

650

1,250

1,850

2,450

3,050

3,650

4,250

4,850


Owned Subsidiary Associates Management Contracts


47 EIH

Lack of capacity addition to be a bane

EIH did not see any capacity addition in FY07, FY08 and FY09, thus missing out on the boom in the hospitality sector. The company missed the last boom cycle and most likely will not be in position to take advantage of the forthcoming one as well. It added the Trident BKC at Mumbai to its portfolio in Dec 2009. This 436-room property has given the company a foot print in the North Mumbai market and will give the existing players of that region – IHCL, Marriott, Hotel Leela, Intercontinental and Hyatt – stiff competition. Ironically, the slow expansion, although a negative in growing market like India, helped the company lower its leverage and pull on through the tough times. But we believe that with the tables about to be turned the lack of capacity expansion will be a bane for EIH and it will not be in a position to take advantage of the situation.

Exhibit 9: Tardy inventory growth

0 0

394

301

728

309

0

100

200

300

400

500

600

700

800


Through Acquisition

Through Mgmt Contracts

Source: Company, Centrum Research Estimates Exhibit 10: Trident at BKC, Mumbai


Could miss out on next opportunity

EIH would be adding just three properties (in Bangalore, NCR and Hyderabad) over FY11-12 and that too only on management contract. We believe this tardy expansion means that the company would fail to capitalize on opportunities in the future. The company will add 609 rooms in FY11E, staggered over the year. The Oberoi Hyderabad is the only property that is supposed to open in EIH. The company has chosen to expand its presence through management contracts and has not indicated any expansion plans on ownership basis. The Bangalore and Hyderabad properties are joint ventures (EIH holds 26% stake in the Bangalore property and 16% in the Hyderabad property). The company has made an equity contribution of approximately Rs1bn for the Hyderabad property and about Rs230mn for the Bangalore project till date. The Bangalore project is slated to come up in two phases with

48 EIH

phase1 (getting completed in FY11E) consisting of 153 rooms and phase 2 (FY12-13E) comprising 167 rooms. EIH has also signed a joint venture with entrepreneur and owner of Max Healthcare Mr. Analjit Singh in his personal capacity to set up a hotel in Dehra Dun, but the details have not been finalized and would be again on management contract basis. The company although in better financial position compared to peers has chosen the management contract route for capacity expansion which is surprise to us and hasn’t been aggressive enough to sign up more hotels on management contract basis.

Exhibit 11: Upcoming projects

Hotel Room Count Ownership* Expected Launch

Oberoi Gurgaon 130 MC Q3FY11

Trident Bangalore Phase 1 - 153 Q2FY11

Phase 2 - 167 MC/JV (26% stake)

Q4FY12

Oberoi Hyderabad 225 Q4FY12

Trident Hyderabad 326 MC/JV (16% stake)

Q4FY11

*MC – Management Contract ; JV – Joint Venture Source: Company, Centrum Research Estimates The Trident BKC was originally scheduled to open in Jan 2009. But the launch was delayed and it finally opened in Dec 2009. Given the execution track record of the company, we do believe that there could be a good possibility of delay in the above projects which strengthens our point that EIH would again be a late starter and not be able to cash in from the hospitality boom. International operations EIH, through EIH International, a wholly-owned subsidiary has presence in Egypt, Mauritius and Indonesia through 4 hotels (301 rooms) and a cruise. EIH International through its step down subsidiary, EIH Holdings, with 55% stake holds equity stakes in all of these properties with an investment of Rs1.8bn. Until last year, EIH’s consolidated numbers did not reflect the financial performance of any of these properties due to British Virgin Islands regulations where it is registered. EIH use to only recognize dividend income from these investments in its financials. In June 2010, the company bought out the 46% stake held by Amex Investments in EIH Holdings for US$45mn. The acquisition makes EIH Holdings a fully-owned subsidiary of EIH International, which in turn is a 100% subsidiary of EIH.

Exhibit 12: International properties

Country Stake (%)

The Oberoi, Sahl Hasheesh Egypt 7.3

The Oberoi, Bali Indonesia 42.2

The Oberoi, Lombok Indonesia 40.9

The Oberoi Mauritius 38.9

Source: Company, Centrum Research Estimates The company has also signed management contracts for 6 new hotels spread across UAE, Morocco, Greece and Mauritius.

49 EIH

Ongoing corporate saga complicates ownership issue

RIL pitted against ITC

EIH is at the crossroads regarding its ownership. Tobacco and FMCG major ITC has held a 14.98% stake in the company for quite sometime. This is just below that threshold limit that would triggeran open offer under Sebi norms. It should be noted that ITC is a cash-rich company with over Rs80bn in cash and Rs 30bn in investments on its balance sheet. EIH also makes perfect business sense for ITC given that it will directly add 3,000 rooms to ITC’s hotel portfolio. More importantly, it will give ITC access to quite a few number of marquee properties owned by EIH in the main metros. The visibility and brand awareness that ITC will get by owning those landmark properties would propel it to the top league and seriously challenge IHCL’s dominance. However, ITC chairman Mr YC Deveshwar has clearly stated that he would not like to go for a hostile takeover of EIH but would want to increase stake. In a surprise development Reliance Industries (RIL) acquired a 14.12% stake in EIH. RIL bought the shares from Oberoi Hotels Pvt Ltd and certain other promoters of EIH, at a total cost of about Rs10.21bn, translating into Rs185 per share. This investment does not add any strategic value in its overall business profile. If RIL and EIH do enter into a formal agreement, it would most likely in the form of RIL holding the physical assets and EIH operating and managing the properties. EIH has recently completed its rights issue wherein it has intended to raise ~Rs 11.2bn. The rights issue price is Rs 66 and terms of the deal are 5shares for every 11 shares held. The issue was attractively priced at ~20% discount to its current market value and hence we believe that existing major shareholders (RIL and ITC) would have subscribed to the issue to keep their shareholding intact. The promoters – Oberoi family had mentioned prior to opening of the rights issue that they would subscribe for any of the unsubscribed portion of the rights issue. The management has also not explicitly indicated the reason for raising this money but we believe that the amount be to ease the liquidity situation in the company. The promoters have also said they would be willing to subscribe to even the unsubscribed portion of the rights issue. ITC and Reliance have not made any statements about their plans but we believe that given the attractive pricing and not wanting to dilute their stakes both of them would indeed subscribe to the issue. Merger of EIH and EIH Associated Hotels

EIH currently holds 36.1% stake in EIH Associated Hotels and the Oberoi group holds 3%. The Raheja Group holds 37% stake. The total promoter holding in EIH Associates stands at 75%. EIH Associates currently has most of the Trident brand hotels under its umbrella. A merger between the two would be beneficial to EIH given that it will have direct control over the entire entity. The merger would also be beneficial in the event that the Oberoi group intends to book profits in its investments and just hold onto a strategic stake.

50 EIH

Financial Analysis

18.6% consolidated revenue CAGR over FY10-13E We expect 18.6% consolidated revenue CAGR over FY10-13E to Rs14.1bn. Given the high operating leverage of the business, the increase in revenue will help boost EBITDA margin by over 750bps from 12% in FY10 to 19.5% in FY13E. The EBITDA will register a 39.5% CAGR over FY10-13E from Rs1bn in FY10 to Rs2.8bn in FY13E. We believe that the company has missed the opportunity of the economic slowdown to make the cost structure much leaner. We thus believe that there is further scope to cut costs and thus boost EBITDA and EBIT margins going forward. Significant uptick in the margins will only be seen with significant rise in ARRs which don’t see happening in the ensuing couple of years.

Exhibit 13: Revenue, EBIDTA margin and PAT margin trend

8,135 10,042 11,620 9,679 8,451 12,264 13,197 14,098

33.1 32.234.2

20.8

12.0

18.2 19.519.2 17.9 19.417.6

7.8 7.99.9

11.9

18.6

0

5

10

15

20

25

30

35

40


%

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000Rs mn

Revenue (LHS) EBITDA Margin (RHS) PAT Margin (RHS)

Source: Company, Centrum Research Estimates EIH has had historically higher contribution of F&B revenue (over 70%) vs to room revenue. We expect this to continue going forward. The higher proportion F&B revenue also acts as a margin cushion given the high margins in this business segment.

Exhibit 14: Revenue by category

4,085

5,174

6,089

4,738

3,740

5,4055,747

6,237

3,0903,727

4,1573,522 3,188

4,2164,670 5,020

933 1,140 1,373 1,419 1,522 1,661 1,840 1,978

500

1,500

2,500

3,500

4,500

5,500

6,500

7,500

FY06

FY07

FY08

FY09

FY10

FY11

E

FY12

E

FY13

E

(Rsmn)

Room Revenue F&B Revenue Other Services

Source: Company, Centrum Research Estimates The main revenue driver for EIH would be the up-tick in ARRs in metros, especially Mumbai. The company has recognized Rs 528mn as revenue from insurance claim for damage of property during the Nov 2008 terrorist attacks and business interruption for FY10. The company had recognized Rs967mn as insurance claim for damage of property and business interruption for FY09. The opening of the Oberoi would be a major kicker for EIH as together with the Trident at Nariman Point and BKC, the Bombay region would contribute in excess of 50% of EIH’s room revenue by FY12E. On a blended basis, we expect the occupancy levels to rise from 58.9% in FY10 to 61.4% by FY12E. We do not see a significant growth in overall ARRs given that the Mumbai market itself will see slow growth in ARRs.

51 EIH

Exhibit 15: ARR and occupancy levels

8,705 9,931 10,581 9,615 7,787 8,014 8,368 8,855

65.5

70.1 70.3

62.560.1 61.2 62.5

58.9

35

40

45

50

55

60

65

70

75


(%)

2,0003,0004,0005,0006,0007,0008,0009,00010,00011,00012,000

(Rs)

Implied ARR Implied RevPAR Implied Occupancy

Source: Company, Centrum Research Estimates Car rental and printing press business

As part of Other Services, EIH operates the car rental business, air chartering services, air catering and printing press. The company had started the printing press business only for in-house services but seeing the potential growth and pent up demand for those services the company has started catering to outside clientele and has done tremendously well for EIH. Only ~20% of the printing press revenue now is from the EIH group. The car rental business is more of a derivative of the hospitality business and hence undergoes the same cyclicality as the hospitality business. EIH holds 67% stake in the car rental business. The care rental contributes ~4.5% to total consolidated revenue. We expect 5.7% revenue CAGR from Rs757mn in FY10 to Rs 893mn in FY13E. Return ratios to improve

EIH will see its consolidated profit soar at 44.4% CAGR over FY10-13E. Given the high operating leverage of the business, the company’s profitability will improve from Rs 710mn in FY10 to Rs 2bn in FY13E. The company’s net profit margins will see significant expansion of 640bps from 7.8% in FY10 to 14.2% in FY13E. The company has historically achieved margins in excess of 19% during the boom times of 2007 and 2008.

Exhibit 16: Return ratios

16.8 17.119.0

12.8

6.67.6

9.0

3.0

0.3

2.6

4.76.0

4.84.8

2.22.3

100

400

700

1,000

1,300

1,600

1,900

2,200

2,500


(Rsmn)

-1

4

9

14

19

24(%)

Profit (LHS) RoE (RHS) RoCE (RHS)


52 EIH

Leverage to improve EIH’s debt-equity ratio would fall from 1.1x in FY10 to 0.9x in FY13E. The low D/E ratio does not impress us given the fact that there has been lack of expansion and yet EIH hasn’t been able to lower it, indicating an inability to generate actual cash flows.

Exhibit 17: Low debt-equity ratio

1.0 0.9 0.8 0.9 0.6 0.5 0.41.1

2.2

1.31.7

3.6

2.1

0.9

0.1

1.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2


(x)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0(x)

D/E (LHS) Interest Coverage (RHS)


53 EIH

Valuation Analysis We value EIH at 19.9x FY13E EV/EBIDTA (its 8-year average multiple), translating into a target price of Rs93. The high multiple is because of the category it operates in, only 5-star business and 5-star luxury segments, along with corporate overhang and lack of free float. EIH has always traded at a premium to IHCL due to the above mentioned reasons along with the fact that all of its hotels all located at prime locations in the cities they operate. We do not believe that the stock should trade any higher than this because of lack of expansion and no upside triggers. The only reason for the stock to go up is any sort of corporate action.

Exhibit 18: EV/EBITDA

6

15

24

33

42

51

60

69

78

Apr-02

Nov-02

Jun-0

3

Jan-0

4

Aug-0

4

Mar-05

Oct-05

May-06

Dec-0

6Ju

l-07

Feb-0

8

Sep-0

8

Apr-09

Nov-0

9

Jun-1

0

Jan-

11

(x)



At our price target the stock trade at Rs 20.8mn FY13E EV/Room. The stock has 6year average EV/Room multiple of 21.4mn which almost in line with our implied multiple.

Exhibit 19: EV/Adjusted Room

7

14

21

28

35

42

49

56

Apr

-04

Jul-0

4

Oct

-04

Jan-

05

Apr

-05

Jul-0

5

Oct

-05

Jan-

06

Apr

-06

Jul-0

6

Oct

-06

Jan-

07

Apr

-07

Jul-0

7

Oct

-07

Jan-

08

Apr

-08

Jul-0

8

Oct

-08

Jan-

09

Apr

-09

Jul-0

9

Oct

-09

Jan-

10

Apr

-10

Jul-1

0

Oct

-10

Jan-

11

EV/Room (Rsmn) Mean Median


The valuation of the stock according to various parameters is given below.

Exhibit 20: Valuation Matrix


Price/Book (x) 1.7 1.7 1.6 1.9 EV/Adjusted Room (Rs mn) 18.0 17.9 17.7 20.8 EV/Sales (x) 3.9 3.6 3.3 3.9


54 EIH

Key Risks Upside Risk

Potential sale by the promoters at a premium to market price would cause a short term uptick in the price. Downside Risk

Further execution delays of new properties would affect our revenue estimates negatively.

55 EIH

Financials


Net Sales 9,679 8,451 12,264 13,197 14,098

-Growth (%) -16.7 -12.7 45.1 7.6 6.8

Employee Expense 2,726 2,658 3,547 3,817 4,088

% of sales 28.2 31.5 28.9 28.9 29.0

F&B Expense 1,138 1,236 1,320 1,401 1,481

% of sales 11.8 14.6 10.8 10.6 10.5

Upkeep & Other Expenses 3,798 3,544 5,164 5,522 5,779

% of sales 39.2 41.9 42.1 41.8 41.0

EBITDA 2,017 1,012 2,233 2,457 2,750

EBITDA Margin (%) 20.8 12.0 18.2 18.6 19.5

Depreciation and Amortisation 767 878 988 1,056 1,123

EBIT 1,250 134 1,245 1,402 1,627

Interest Expenses 953 1,103 1,339 1,159 979

PBT from operations 297 (969) (94) 242 647

Other non operating income 2,472 2,027 1,628 1,740 1,894

PBT before extraordinary items 2,769 1,058 1,533 1,982 2,542

Extraordinary income/(exp.) - - - - -

PBT 2,769 1,058 1,533 1,982 2,542

-PBT margin (%) 28.6 12.5 12.5 15.0 18.0

Provision for tax 1,074 348 521 674 864

Effective tax rate (%) 38.8 32.9 34.0 34.0 34.0Share of profit from associates and minority int. 49 65 30 85 78

Net Profit (Adjusted) 1,700 663 970 1,306 1,683

-Growth (%) -24.4 -61.0 46.2 34.7 28.8

-NPM (%) 17.6 7.8 7.9 9.9 11.9



Share Capital 786 786 1143 1143 1143



Loan fund 11,445 14,357 14,882 12,882 10,882


Gross block 21,102 27,687 29,052 31,046 33,040Less: Accumulated depreciation 5,241 5,852 6,840 7,896 9,019

Net block 15,860 21,835 22,212 23,150 24,021

Capital WIP 6,171 3,093 3,493 3,218 2,484

Net fixed assets 22,032 24,929 25,705 26,369 26,505

Investments 2,659 2,411 2,411 2,411 2,411

Cash and bank 788 648 12,313 10,501 9,129

Inventories 345 337 487 495 525

Debtors 1,062 1,159 1,472 1,584 1,833

Loans & Advances 3,162 3,110 3,434 3,563 3,807

Total current assets 5,360 5,258 17,709 16,147 15,296

Current liabilities and Provision 3,184 2,792 3,119 3,451 3,708

Net current assets 2,176 2,465 14,590 12,695 11,589

Total assets 27,052 30,039 42,940 41,709 40,739



Cash Flow from Operating

Profit before tax 2,769 1,058 1,533 1,982 2,542

Depreciation 767 878 988 1,056 1,123

Interest expenses 953 1,103 1,339 1,159 979

Operating profit before WC change 4,906 2,661 3,738 4,065 4,468

Working capital adjustments (589) (495) (460) 82 (265)

Direct tax paid (1,047) (295) (521) (674) (864)

Net cash from Operating 2,286 782 2,757 3,473 3,338

Cash flow from Investing

Capex (2,896) (3,508) (1,764) (1,719) (1,260)

Investments (149) 248 - - -

Net cash from Investment (3,300) (3,416) (1,637) (1,581) (1,077)

Cash flow from Financing

Procds from share capital & premium - 25 11,789 - -

Borrowings/(Repayments) 6,137 5,203 525 (2,000) (2,000)

Dividend paid (709) (482) (430) (545) (654)

Net cash flow Financing 1,342 2,445 10,544 (3,704) (3,633)

Net cash increase/(decrease) 328 (189) 11,665 (1,813) (1,372)

Cash & Cash Equivalents At End of Year 788 648 12,313 10,501 9,129


Exhibit 24: Key Ratios Y/E March FY09 FY10 FY11E FY12E FY13E

Margin Ratio (%)

EBITDA Margin 20.8 12.0 18.2 18.6 19.5

PBIT Margin 12.9 1.6 10.2 10.6 11.5

PBT Margin 28.6 12.5 12.5 15.0 18.0

PAT Margin 17.6 7.8 7.9 9.9 11.9

Growth Ratio (%)

Revenue (16.7) (12.7) 45.1 7.6 6.8

EBITDA (49.2) (49.8) 120.6 10.1 11.9

Net Profit (25.3) (58.1) 42.6 29.3 28.2

Return Ratios (%)

ROCE 3.0 0.3 2.3 2.2 2.6

ROIC 3.4 0.3 2.9 3.2 3.6

ROE 12.8 4.7 4.8 4.8 6.0

Turnover Ratios

Asset turnover ratio (x) 0.4 0.3 0.3 0.3 0.3

Working capital cycle (days) (43.1) (38.2) (17.8) (20.2) (21.0)

Average collection period (days) 44.7 48.0 39.1 42.3 44.2

Average payment period (days) 101.4 100.9 69.2 76.0 78.4

Average Inventory period (days) 26.9 24.8 29.8 26.9 27.6

Per share (Rs)

Fully diluted EPS 4.3 1.7 1.7 2.3 2.9

CEPS 6.3 4.0 3.5 4.1 4.9

Book value 35.9 35.5 46.6 47.9 49.6

Adjusted Book Value 29.9 29.5 41.9 43.2 45.0

Solvency Ratio

Debt-equity 0.9 1.1 0.6 0.5 0.4


Valuation

P/E 27.3 70.0 47.9 35.5 27.6

P/BV 3.3 3.3 1.7 1.7 1.6

EV/EBITDA 20.8 44.8 21.2 19.2 16.9

EV/Sales 4.3 5.4 3.9 3.6 3.3

EV/Room (Rs mn) 20.1 18.3 18.0 17.9 17.7


56 EIH



Hold Target Price: Rs39

CMP: Rs37*


Rahul Gaggar [email protected] 91 22 4215 9683

Expensive luxury Despite the revival in Indian hospitality industry, we believe Hotel Leela’s balance sheet would continue to be stressed, mainly due the high cost of its upcoming hotel in New Delhi. Its main revenue earning properties are in Mumbai and Bangalore and the increased room supply in these metros means that ARR growth would be capped despite rising occupancy levels. Delays over commissioning its hotels in Delhi and Chennai would make matters worse. We initiate coverage with a Hold and target price of Rs39.

Locational woes: Hotel Leela’s has limited geographic reach. It hotels are concentrated in Mumbai, Goa, Bangalore, Kovalam (Kerala), Udaipur and Gurgaon (management contract). Revival in domestic and global economic activity would help improve occupancy levels, but we see little appreciation in ARRs given the increased supply in its major markets of Mumbai and Bangalore. The continued delay in the opening of the Delhi (290 rooms) and Chennai (385 rooms) hotels doesn’t boost confidence either.

Huge cost for New Delhi property: Hotel Leela is yet to launch its 290-room New Delhi property. The hotel located in a posh locale of Chanakyapuri in Delhi is a diplomatic enclave and is in close vicinity of all major central government offices. The location will give a huge boost to the brand and will have the advantage of practically “being” in-season through out the year. However, the huge amount of ~Rs17bn invested defies economic rationale. At more than Rs 57mn capital expenditure per room, the cost of this hotel is almost three times for other similar properties.

Balance sheet stressed: Hotel Leela’s debt-burdened balance sheet has always been a cause of concern. We believe this will be the case going forward as well. The company will continue to have a high D/E ratio of 1.6x in FY12E only showing a marginal drop to 1.5x in FY13E.

Expensive valuation; Hold: We believe Hotel Leela’s high premium vs Indian Hotels (1year forward EV/EBITDA of 18x vs. 15.7x for IHCL) is unjustified given limited geographic reach, brand name, stressed balance sheet and worse financial ratios. We have valued the stock at 15.3x FY13E EV/EBITDA, a 15% discount to its 8-year average multiple of 18x, to arrive at target price of Rs 39. We believe Hotel Leela will take time to come out of this financial stress and initiate with a Hold rating.

Key Data

Bloomberg Code LELA IN

Reuters Code HTLE.BO




52 Wk H / L (Rs) 59/34


Face Value (Rs) 2

USD = Rs44.9



Institutions6.6% Foreign

3.6%

Promoter54.5%

As on 31 December 2010


50

75

100

125

150

175


HOTEL LEELA VENT NSE S&P CNX NIFTY INDEX


1M 6M 1Yr

Hotel Leela (4.9) (34.9) (23.1)

NIFTY (1.0) (9.6) 4.0


Y/E Mar (Rsmn) Rev YoY (%) EBITDA EBITDA (%) Adj PAT YoY (%) Fully DEPS ROE (%) ROCE (%) EV/EBITDA (x) EV/Room (Rsmn)

FY09 4,541 -11.7 1,583 34.9 1,461 -2.9 3.5 10.2 1.9 24.7 35.8FY10 4,301 -5.3 1,249 29.0 454 (68.9) 1.1 2.3 0.8 35.0 37.8FY11E 4,739 10.2 1,575 33.2 327 -28.0 0.8 1.6 1.0 29.7 39.0FY12E 6,546 38.1 2,579 39.4 708 116.6 1.7 3.3 1.8 18.0 30.3FY13E 7,858 20.0 3,119 39.7 946 33.5 2.3 4.2 2.3 14.9 24.9


Hotels


INDIA

Hotel Leela Venture

58 Hotel Leela Venture



Promoter 52.7 53.3 53.4 54.6

Foreign 3.2 2.5 2.6 3.6

Institutions 7.2 7.3 6.8 6.6

Public & Others 47.3 46.7 46.6 35.4

Total 100.0 100.0 100.0 100.0

Source: NSE

Company Background Hotel Leela Venture is one of the leading players in the Indian hospitality industry. The company operates in both the leisure and business sectors. TheLeela Palaces & Resorts include a chain of five- star luxury hotels and resorts. The company currently operates in Mumbai, Bangalore, Delhi, Goa, Kovalam(Kerala), Udaipur and Gurgaon. The company is currently constructing anotherproperty at Chennai and will be operational within this year.

Property wise revenue breakup

0%

20%

40%

60%

80%

100%


Bangalore Udaipur Goa Kovalam Mumbai Gurgaon Chennai New Delhi




C P Krishnan Nair Chairman Capt. Nair pioneered the export of fabrics to the USA in the late 1950s with the “Bleeding Madras” fabric. He was the first in the organized sector to set up a unit to produce cotton laces in India with Scottish Collaboration in Leela Scottish Lace Private Limited. He promoted The Leela Kempinski Mumbai in 1986, The Leela Kempinski Goa in 1990 and The Leela Palace Kempinski Bangalore in 2001.

Vivek Nair Vice Chairman & M.D. Mr. Vivek Nair has passed from St. Xavier, Mumbai and then done a post graduate programme in Hotel Management from Cornell University's school of Hotel Administration in Ithaca, New York, USA and has over 31 years experience. He is also the Honorary Secretary of the Federation of Hotels & Restaurants Association of India, which represents 1800 hotels and 800 restaurants in the country.

Dinesh Nair Joint Managing Director Mr. Dinesh was instrumental in ensuring rapid growth in sales, transforming Leela Scottish Lace Private Limited into one of the largest manufacturer and exporter of fashion garments from India to the USA. Mr. Nair has been associated with the Company since its inception, and has 32 years' experience in management, administration, exports, marketing, materials and hotel management.

Venu Krishnan

Deputy Managing Director

Mr. Krishnan has extensive experience in project implementation, commercial and administrative matters. He led the project team that implemented the Goa Hotel Project in 1991. He is currently responsible for the commercial operations of Leela Scottish Lace Private Limited and is also involved in the commercial and legal issues of the Company.

V L Ganesh

Director (Finance) & CFO

Mr. Ganesh has over 27 years extensive experience in the field of Finance, Taxation,Corporate Laws, Strategic Planning,Handling IPOs, M&A, Overseas funding and Financial Restructuring. He has worked with well known Companies like Rolta,Kores,Metal Box and GIC of India. He has been associated with the Company since November 2006. He is currently responsible for the Accounts, Finance and Taxation matters of the Company

Source: Company


Return Ratios – In mid single digits Investment Rationale Extremely low return ratios and high operating expenses for

foreseeable future go against the company.

Mumbai and Bangalore will be key contributors to revenue.However, the cities have witnessed new supply thus restricting growth in ARRs.

Balance sheet stress will not ease up with debt increasing from Rs28bn in FY10 to Rs33bn by FY13E, a major cause for the low returns. Further dilution is a major possibility and risk to ease balance sheet.

13.0

16.5

10.2

1.64.6 4.9

4.23.3

2.31.9

0.8

1.01.8 2.3-

200

400

600

800

1,000

1,200

1,400

1,600


(Rsmn)

0

2

4

6

8

10

12

14

16

18(%)

Net Profit RoE RoCE


Summary Financial Y/E March FY09 FY10 FY11E FY12E FY13E Key Income Statement Revenue 4,541 4,301 4,739 6,546 7,858 YoY growth (%) (11.7) (5.3) 10.2 38.1 20.0 EBITDA 1,583 1,249 1,575 2,579 3,119 YoY growth (%) (31.2) (21.1) 26.1 63.8 21.0 EBITDA Margin (%) 34.9 29.0 33.2 39.4 39.7 Depreciation 654 683 745 1,018 1,141 Interest expenses 272 245 684 882 989 Other non operating income 1,280 329 344 382 426 PBT 1,937 650 490 1,061 1,416 Provision for tax 476 196 163 352 470 PAT (adjusted) 1,461 454 327 708 946 YoY growth (%) -2.9 -68.9 -28.0 116.6 33.5 PAT margin 32.2 10.6 6.9 10.8 12.0 Key CF Statement Cash generated from operations 1,202 2,030 889 1,237 2,273 Cash flow from investing activities (8,638) (6,045) (6,029) (4,896) (1,051) Cash flow from financing activities 1,373 4,968 8,839 (5,032) (2,123) Net cash increase/decrease (2,642) (172) 5,179 (3,810) (967) Key Balance Sheet Data Shareholders' fund 19,399 20,540 21,294 21,899 22,706 Debt 24,505 28,787 37,903 33,902 32,967 Total Capital Employed 45,011 50,654 60,524 57,128 57,000 Fixed Assets 44,231 49,443 53,861 54,188 54,101 Investments 1 1 1 1 1 Net current assets 1,111 3,833 780 1,210 6,662 Total Assets 45,012 50,654 60,525 57,129 57,002 Key Ratio (%) ROCE 1.9 0.8 1.0 1.8 2.3 ROIC 1.9 0.8 1.0 1.9 2.4 ROE 10.2 2.3 1.6 3.3 4.2 Per share Ratios (Rs) Fully diluted EPS 3.8 1.2 0.8 1.8 2.4 Book value 50.0 53.0 54.9 56.5 58.6 Book Value (Adjusted) 18.1 21.3 23.3 24.9 26.9 Cash EPS 5.5 2.9 2.8 4.5 5.4 Solvency Ratio (x) Debt-equity 1.3 1.4 1.8 1.5 1.5 Interest coverage ratio 3.4 2.3 1.2 1.8 2.0 Valuation parameters(x) P/E (Fully Diluted) 9.7 31.2 43.3 20.0 15.0 P/Adj. BV 2.0 1.7 1.6 1.5 1.4 EV/EBITDA 24.7 35.0 29.7 18.0 14.9 EV/Sales 8.6 10.2 9.9 7.1 5.9 EV/Room (Rs mn) 35.8 37.8 39.0 30.3 24.9


PAT margins no where close to historical highs


Investment Argument

Concentration in Mumbai, Bangalore to cap ARR growth

Hotel Leela has properties at Mumbai (396 rooms), Bangalore (357 rooms), Udaipur (81 rooms), Kovalam (182 rooms) and Gurgaon (409 rooms) (management contract). The company will benefit from the revival in the domestic and global economy as more than 80% of its clientele are foreigners. However, the improvement would be visible in terms of only strengthened occupancy rates. The ARRs would be capped on the upper end given the supply that is slated to come up in Mumbai and Bangalore. The Bangalore property has seen the highest ARR anywhere in India (over Rs18,000) during the boom (2007) and we do not expect the ARRs to reach anywhere close to these levels in the next 2-3 years. There has been delay in launching of new properties by competitors in the highly competitive markets of Mumbai and Bangalore but there is enough supply to keep ARR growth subdued over the next 12-18 months.

Exhibit 1: City-wise revenue breakup

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000


(Rsmn)

Bangalore Goa Mumbai Kovalam Gurgaon Udaipur Chennai New Delhi


We estimate 23% revenue CAGR over FY10-13E from Rs4,301mn to Rs7,858mn. Increase in ARRs, would help boost EBITDA margin from 29.5% in FY10 to 39.7% in FY13E. We do not see the company achieving historical margins in excess of 44% over the next three years as the Mumbai and Bangalore markets, which are the main contributors to revenue, will see limited ARR growth. We believe that the company has a bloated cost structure vis-à-vis peers and hence any cost rationalization exercises will help in improving margins. We expect 25% room revenue CAGR over FY10-13E from Rs2,499mn to Rs4,856mn. The increase in room revenue is primarily driven by increase in room count (16%), healthy occupancy levels and meager ARR growth. The F&B revenue will grow at 20% CAGR from Rs1,256mn in FY10 to Rs2,183mn in FY13E.

Exhibit 2: Category-wise revenue break-up

2,778 3,476 2,991 2,499 2,811 4,037 4,856

1,057

1,3011,175

1,2561,330

1,815

2,183

321

368360

482523

612

729

1,500

2,500

3,500

4,500

5,500

6,500

7,500

8,500


(Rsmn)

Room Revenue F&B Revenue Other Services



We estimate Hotel Leela’s blended RevPARs to grow from Rs5,997 in FY10 to Rs7,078 in FY13E. Though this looks impressive, the growth is primarily because of the base effect and is still more than 20% below the level in the boom period. At the company level, we expect blended occupancy rates to rise from 62.8% in FY10 to 65.4% for FY12E and 69.1% in FY13E. Opening of new properties in Delhi and Chennai and hence time take for them to stabilize, new supply in Mumbai and Bangalore markets are the main reasons for the slow growth in ARRs and hence RevPAR.

Exhibit 3: Implied Occupancy & ARR

7,14

2

8,66

5

9,10

1

7,65

1

6,62

9

6,24

0

7,07

8

9,59

0

11,5

50

12,1

80

9,55

5

9,54

5

10,2

38

5,99

7

11,7

85

10,0

1 8

74.7

64.9 66.2 65.4

69.1

75.074.5

62.8

3,500

5,000

6,500

8,000

9,500

11,000

12,500

14,000


(Rs)

40

45

50

55

60

65

70

75

80(%)

Implied Blended Avg RevPar Implied Blended ARR Implied Blended Occupancy


Our sensitivity analysis indicates that a 5% increase in occupancy levels from our base of 57% for FY11E increases the room revenues of the company by 7% keeping the average room rate constant. On the other hand, if there is 10% increase in room rates from our base case of Rs9,967 we see an increase in room revenues by 10% for FY11E keeping occupancy constant.

Exhibit 4: ARR and Occupancy Sensitivity for FY11E

ARR/Occ (5)% (1)% Base Case 1% 5%

(10)% (17.9) (11.6) (10.0) (8.4) (0.5)

(5)% (13.3) (6.7) (5.0) (3.3) 5.0

Base case (8.8) (1.8) NA 1.8 10.5

+5% (4.2) 3.2 5.0 6.8 16.0

+10% 0.4 8.1 10.0 11.9 21.6


Future expansion still far away

The management knows that in order to grow, the company would have to scale up its presence across India. The company will undertake the construction of new properties only post the completion and opening of Delhi and Chennai properties. Given the debt level, we don’t think it would be feasible for the company to begin construction earlier than that.

The company has prime location land in Agra, Hyderabad and Pune which it bought in 2005 much prior to real estate boom and hence at cheaper prices. The property in Hyderabad is in the prime location of Banjara Hills whereas the Pune land is located close to the airport. The company in order to de-leverage its balance sheet has scrapped its plan of coming up with a hotel in Pune and Hyderabad and has opted for commercial/residential development of the land. The company would tie up with a real estate developer whereby the land would belong to the company and the construction part would be the responsibility of the developer.

The 4-acre Pune property will be developed as a residential property. The development will give company access to ~5lac sq.ft of saleable space. The construction work on the property would most likely begin in Q2FY12. The development plans for the Hyderabad property are not completely finalized but will be on similar lines to the Pune property. We believe that these efforts will definitely yield in reducing the debt of the company over the next couple of years. The Pune property could yield in excess of Rs 1.2bn at the conservative end for the company. We have however not included the cash flows from these activities in our financials as their timing is still uncertain.

The company has also tied-up with Rajmahal Palace in Jaipur and intends to bring it under its fold by FY13.


Huge cost for developing New Delhi property The much hyped about Delhi property (290 rooms) is yet to open its doors. The hotel was first slated to open in June-July 2010, which got postponed to Sept 2010. The company had aimed to complete the project much in advance of the Commonwealth Games so as to take advantage of the rush then but that definitely has not being the case. The company only recently did a soft commissioning of the property with the full fledged opening only in April 2011.

The hotel is located in the Chanakyapuri area, a diplomatic area of Delhi and close to all the Government of India offices. The location of the hotel is apt given India’s strong coming of age as a business destination and hence will ensure very high visibility for the brand along with strong occupancy and room rates through out the year. We believe that this property will command a premium vis-à-vis its peers because of its location. However, the property has come at a huge cost to the company and one of the main reasons for the high debt pile up on the books.

Exhibit 5: Delhi Property Cost Analysis

(Rsmn)

No. of Rooms 290

Land Cost (~) 6,500

Construction Cost (~) 10,000 Total COST 16,500 Cost Per Room 56.9


Although land costs do constitute a major portion of the total cost for any hotel project, the average replacement cost for a 5-star and 5-star deluxe luxury player like Hotel Leela on per-room basis even on an optimistic basis should be around Rs15-20mn. Given that Hotel Leela will end up paying almost three times that, Hotel Leela does not seem a viable investment opportunity for the foreseeable future. Hotel Leela’s capital expenditure per room basis is Rs22-27mn which is on the higher side compared to peers and hence even on this metric the property seems very expensive.

The Gurgaon property (management contract) has since inception witnessed occupancy levels to the tune of 80%+ due to supply constraints, but supply has increased of late and hence will put pressure on the existing players. Also, post the Commonwealth Games there is likely to be a supply glut which will put pressure on ARRs for at least 12-18months.

Hotel Leela was slated to open its new property in Chennai most likely at the fag end of Q3FY11 or early Q4FY11. However the commissioning of this property has also been delayed and now is most likely to open in July 2011. This 385-room property is a sea-facing property near the famous Marina beach. We believe that luxury hospitality market in Chennai will stay weak for the next 12-18months given the demography and the supply that has come up in that market (Taj GVK). The Chennai property we thus believe will take longer than usual to stabilize and hence lead to added costs without commensurate incremental revenue in the near term.

Exhibit 6: Delayed Expansion Plans

Location No. of Rooms Expected Launch by Status

Delhi 290 Q1FY12 Soft Commission

Chennai 385 Q2FY12 Delayed



Mumbai & Bangalore to be bread winners!

The Mumbai and Bangalore properties at present contribute in excess of 60% of Hotel Leela’s revenues and ~50% of Hotel Leela’s total room count. Exhibit 7: Room Breakup FY10 Exhibit 8: Room Breakup FY13E

Udaipur81

Gurgaon (mgmt contract)

409

Kovalam182

Mumbai396

Goa181

Bangalore357

Bangalore357

Goa181

Mumbai396

Kovalam182

Gurgaon (mgmt contract)

409

Udaipur81

Chennai385

New Delhi290

Source: Company, Centrum Research Source: Company, Centrum Research Estimatesx

Mumbai and Bangalore have seen the addition of new hotel properties and would continue to see addition of new properties in the foreseeable future. Given the supply, we believe ARR growth in these two cities will be capped. The earliest we could expect ARR growth in these two cities would be FY13E.

The Mumbai market has already witnessed opening of Trident, Westin, Novotel, Courtyard and Holiday Inn recently and will see further brand additions. The Mumbai and Bangalore market will both see room additions to the tune of around 700+ rooms over FY11-13E. The opening of the two new properties (Courtyard by Marriot and Holiday Inn) near the Mumbai airport has already had a crowding out effect and we believe that the region will require at the very least around 12 months for the supply to get assimilated and ARRs to stabilize.

Exhibit 9: Revenue Breakup FY10 Exhibit 10: Revenue Breakup FY13E

Bangalore35%

Goa17%

Mumbai30%

Kovalam 14%

Gurgaon3%

Udaipur1%

New Delhi15%

Chennai12%

Udaipur5%

Gurgaon2%

Kovalam 9%

Mumbai22%

Goa12%

Bangalore23%

Source: Company, Centrum Research Source: Company, Centrum Research Estimates

Post the opening of the Delhi and Chennai properties, Hotel Leela would have a much more diversified base. Nevertheless, the Mumbai and Bangalore properties would still be key contributors to the top-line and bottom-line. Our estimates make us believe that Hotel Leela’s revenue share from Mumbai and Bangalore properties would come down from 65% in FY10 to 44% by FY12E. The room count share from these two properties would fall from ~50% in FY09 to 33% in FY12E.


Financial Analysis Balance sheet de-stressing required The Delhi property is an expensive proposition for Hotel Leela given the huge premium the company paid for the land. The total cost of the project is estimated to be close to Rs17bn. The huge cost incurred by the company in executing the Delhi and Chennai properties simultaneously is clearly visible in the balance sheet and is cause for concern given the high operating and financial leverage. The painfully slow pick at Udaipur has also added to the woes of the company. Our estimates make us believe that the company would have to raise debt from the current Rs28bn (FY10) to Rs37bn (FY11E) before reducing marginally to Rs 34bn (FY12E) and Rs 33bn (FY13E). The company has board approval for raising $150mn by way of QIP/debt/FCCB in the future. It will need to raise capital to fund its working and execute its expansion plans at the same time. The high level of debt will surely put to test Hotel Leela’s debt-servicing ability.

We believe that Hotel Leela would have to undertake drastic cost cutting measure along with sale of some assets in order to pare down its debt. The company could potentially have a sale of its Chennai IT Park which will help ease some cash flow pressures. Along with that, the company might look at selling its land banks at Pune/Hyderabad/Agra to help it further reduce the strain. Based on its financial scenario the company is not in a position to undertake any further expansion projects and hence these assets would just lie on the books without yielding any returns.

Exhibit 11: Debt and D/E Exhibit 12: Interest Coverage

20,3

57

24,5

05

28,7

87

37,9

03

33,9

02

32,9

67

10,0

35

1.1

2.2

1.31.4

1.81.5

1.5

4,000

8,000

12,000

16,000

20,000

24,000

28,000

32,000


(Rsmn)

0.2

0.6

1.0

1.4

1.8

2.2

2.6(x)

Debt Debt/Equity

1,55

1

1,84

6

929

566

830

1,56

1

1,97

9

3.4

2.3

5.2

3.5

1.21.8

2.0

200

400

600

8001,000

1,200

1,400

1,600

1,800

2,000

2,200


(Rsmn)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

(x)

EBIT Interest Coverage Ratio Source: Company, Centrum Research Estimates Source: Company, Centrum Research Estimates

The balance sheet becomes even more leveraged if one adjusts it for revaluation reserve. The D/E jumps from 1.4 in FY10 to 3.5 for the same year.

Exhibit 13: Adjusted D/E

10,0

35

20,3

57

24,5

05

28,7

87

37,9

03

33,9

02

32,9

67

1.5

2.8

3.5 3.53.2

4.2

3.5

2,0006,000

10,00014,000

18,00022,000

26,00030,000

34,00038,000

42,000


(Rsmn)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

(x)

Debt D/E (adjusted)


Low return ratios The increased balance sheet size has its effect on the return ratios which will remain subdued at the very least till FY13E. The RoE and RoCE will remain in mid single digits according to our estimates till FY13E.


Exhibit 14: Return Ratios Too Low

13.0

16.5

10.2

1.64.6 4.9

4.23.3

2.31.9

0.8

1.01.8 2.3-

200

400

600

800

1,000

1,200

1,400

1,600


(Rsmn)

0

2

4

6

8

10

12

14

16

18(%)

Net Profit RoE RoCE


Even if we were to adjust the return ratios for revaluation reserve and CWIP the picture does not change very drastically.

Exhibit 15: Return on Equity


Standard 13.0 16.5 10.2 2.3 1.6 3.3 4.2

Ex-Reval Reserve 17.5 21.5 20.6 5.9 3.8 7.6 9.4


Exhibit 16: Return on Capital Employed


Standard 4.6 4.9 1.9 0.8 1.0 1.8 2.3

Ex-Reval Reserve, CWIP 5.7 6.2 2.9 1.5 1.8 2.8 3.3


The management did show its astuteness in using the RBI guidelines to its advantage to buy back some of the outstanding FCCBs at a significant discount to its conversion price. This has helped the company ease its balance sheet stress to some extent. Hotel Leela had bought back €12.2mn of the €60mn outstanding FCCB and $58.2mn of the $100mn FCCB outstanding. The buy back helped the company save the redemption amount that it would have incurred on maturity to the tune of 46.6% for dollar-denominated FCCB and 25.5% for the euro-denominated FCCB. Hotel Leela has since then redeemed €39.2mn FCCB outstanding which were due in September 2010 convertible at Rs 46.65 per share. The company now has $41.8mn FCCB outstanding which is due in April 2012 and is convertible at price of Rs72 per share. Given our view on the stock the conversion of this tranche of FCCB seems highly unlikely and hence Hotel Leela would have to muster up cash flows to redeem the outstanding FCCBs.


Valuation Analysis We have valued Hotel Leela at 15.3x FY13E EV/EBITDA (15% discount to its 9-year average of 18x) to arrive at our target price of Rs39. The discount is because of Hotel Leela’s extremely subdued return ratios, lack of geographic reach, brand name and stressed balance sheet. At our price target, the stock would trade Rs 25.5mn FY13E EV/Adjusted Room which we believe is fair value for Hotel Leela. Exhibit 17: 1year forward EV/EBITDA chart

5

10

15

20

25

30

35

40

Apr-02

Nov-0

2

Jun-

03

Jan-

04

Aug-04

Mar-

05

Oct-05

May-0

6

Dec-0

6

Jul-0

7

Feb-

08

Sep-

08

Apr-09

Nov-0

9

Jun-

10

Jan-

11

(x)



The table below summarizes the valuation of the stock according to various parameters and at our target price

Exhibit 18: Valuation Matrix


Price/Adjusted BV 1.6 1.5 1.4 1.5 EV/Room 39.0 30.3 24.9 25.5 EV/Sales 9.9 7.1 5.9 6.1


On EV/Room Basis, the stock currently trades at Rs 24.9mn FY13E vs. 6year historical average of Rs 32.3mn which we believe is grossly overvalued. The implied EV/Room using our method is 25.5 FY12E which we believe is fair given the category Hotel Leela operates in. The stock should not be trading at its historical valuations given the stress on its balance sheet. Easing of balance sheet stress and higher than expected strengthening of ARRs would be key indicators for us to change our view.

Exhibit 19: 1year forward EV/Room chart

29mn

32mn

35mn

38mn

10

20

30

40

50

60

70

80

90

100

Apr

-05

Jul-0

5

Oct

-05

Jan-

06

Apr

-06

Jul-0

6

Oct

-06

Jan-

07

Apr

-07

Jul-0

7

Oct

-07

Jan-

08

Apr

-08

Jul-0

8

Oct

-08

Jan-

09

Apr

-09

Jul-0

9

Oct

-09

Jan-

10

Apr

-10

Jul-1

0

Oct

-10

Jan-

11

Close Price 29mn 32mn 35mn 38mn Source: Company, Centrum Research Estimates


Key Risks: Balance Sheet Risk

High balance sheet leverage poses a substantial risk in case of slower than expected economic recovery.

Dilution Risk

The management of Hotel Leela recently passed a resolution to raise money (~Rs 6bn) either through QIP or FCCB to pay off debt on its balance sheet. A QIP would lead to further dilution thus further limiting earnings growth while an FCCB would add more debt to the balance sheet.

Execution Risk

Further delay in opening of Delhi and Chennai property will affect revenue and profitability estimates.


Financials


Net Sales 4,541 4,301 4,739 6,546 7,858

-Growth (%) -11.7 -5.3 10.2 38.1 20.0

Food & Beverage Consumed 288 306 319 455 530

% of sales 6.3 7.1 6.7 7.0 6.7

Employee Expense 894 954 1,059 1,266 1,472

% of sales 19.7 22.2 22.3 19.3 18.7

Other Expenditure 1,776 1,792 1,787 2,246 2,737

% of sales 39.1 41.7 37.7 34.3 34.8

EBITDA 1,583 1,249 1,575 2,579 3,119

EBITDA Margin 34.9 29.0 33.2 39.4 39.7

Depreciation & Amortization 654 683 745 1,018 1,141

EBIT 929 566 830 1,561 1,979

Interest Expenses 272 245 684 882 989

PBT from operations 657 321 146 679 990

Other non operating income 1,280 329 344 382 426

PBT 1,937 650 490 1,061 1,416

-PBT margin (%) 42.7 15.1 10.3 16.2 18.0

Provision for tax 476 196 163 352 470

Effective tax rate (%) 24.6 34.0 33.2 33.2 33.2

Net Profit (Adjusted) 1,461 454 327 708 946

-Growth (%) -2.9 -68.9 -28.0 116.6 33.5

-NPM (%) 32.2 10.6 6.9 10.8 12.0



Share Capital 756 756 776 776 776



Loan fund 24,505 28,787 37,903 33,902 32,967


Gross block 38,870 42,000 45,663 56,163 57,888Less: Accumulated depreciation 3,985 4,769 5,514 6,532 7,672

Net block 34,885 37,231 40,149 49,631 50,216

Capital WIP 9,345 12,212 13,712 4,557 3,885

Net fixed assets 44,231 49,443 53,861 54,188 54,101

Investments 1 1 1 1 1

Cash and Cash Equivalents 316 144 5324 1512 545

Inventories 420 434 412 477 567

Debtors 315 379 415 540 589

Loans & Advances 2,950 2,984 2,843 3,142 3,143

Total current assets 4,001 3,942 8,994 5,671 4,844Current liabilities and Provisions 3,221 2,731 2,331 2,732 1,946

Net current assets 780 1,210 6,662 2,939 2,899

Total assets 45,012 50,654 60,525 57,128 57,000



Cash flow from operating

Profit before tax 1,934 647 490 1,061 1,416

Depreciation 549 683 745 1,018 1,141

Interest expenses 238 229 684 882 989

Op. profit bef. WC change 1,613 1,261 1,651 2,667 3,223

Working capital adjustment 572 (199) (273) (88) (927)

Direct taxes paid (154) (173) (141) (306) (409)

Cash from operations 2,030 889 1,237 2,273 1,887

Cash flow from investing

Capex (6,535) (6,284) (5,164) (1,345) (1,053)

Investment 0 (0) - - -

Cash from investment (6,045) (6,029) (4,896) (1,051) (731)

Cash flow from financing

Proceeds from sh. Cap.& premium - - 20 - -

Borrowings/ (Repayments) 1,913 5,556 9,116 (4,001) (935)

Interest paid (201) (248) (684) (882) (989)

Dividend paid (219) (176) (38) (104) (138)

Cash from financing 1,373 4,968 8,839 (5,033) (2,124)

Net cash increase/ (decrease) (2,642) (172) 5,179 (3,811) (968)

Closing Cash Balance 316 144 5,324 1,512 545


Exhibit 23: Key Ratios Y/E March FY09 FY10 FY11E FY12E FY13E

Margin Ratios (%) EBITDA Margin 35.0 29.5 33.8 39.9 40.2PBIT Margin 20.5 13.4 17.8 24.1 25.5PBT Margin 42.8 15.3 10.5 16.4 18.2PAT Margin 32.3 10.7 7.0 11.0 12.2Growth Ratios (%) Revenues -11.7 -5.3 10.2 38.1 20.0EBITDA -31.2 -21.1 26.1 63.8 21.0Net Profit (2.9) (68.9) (28.0) 116.6 33.5Return Ratios (%) ROCE 1.9 0.8 1.0 1.8 2.3ROIC 1.9 0.8 1.0 1.9 2.4ROE 10.2 2.3 1.6 3.3 4.2Turnover Ratios Asset turnover ratio (x) 0.1 0.1 0.1 0.1 0.1Working capital cycle (days) (558.7) (693.7) (623.0) (422.9) (275.1)Average collection period (days) 28.3 29.9 31.1 27.0 26.5Average payment period (days) 619.5 760.4 687.2 474.9 326.2Per share (Rs) Fully diluted EPS 3.5 1.1 0.8 1.7 2.3CEPS 5.5 2.9 2.8 4.5 5.4Reported Book Value 50.0 53.0 54.9 56.5 58.6Adjusted Book Value 18.1 21.3 23.3 24.9 26.9Solvency ratios Debt/ Equity 1.3 1.4 1.8 1.5 1.5Interest coverage 3.4 2.3 1.2 1.8 2.0Valuation parameters (x) P/E 9.7 31.2 43.3 20.0 15.0

P/Reported BV 0.7 0.7 0.7 0.6 0.6

EV/ EBITDA 24.7 35.0 29.7 18.0 14.9

EV/ Sales 8.6 10.2 9.9 7.1 5.9

EV/Room(Rs mn) 35.8 37.8 39.0 30.3 24.9



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Certain transactions including those involving futures, options, and other derivatives as well as non-investment-grade securities give rise to substantial risk and are not suitable for all investors. Please ensure that you have read and understood the current risk disclosure documents before entering into any derivative transactions. This report/document has been prepared by Centrum, based upon information available to the public and sources, believed to be reliable. No representation or warranty, express or implied is made that it is accurate or complete. Centrum has reviewed the report and, in so far as it includes current or historical information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed. The opinions expressed in this document/material are subject to change without notice and have no obligation to tell you when opinions or information in this report change. 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The distribution of this document in other jurisdictions may be restricted by law, and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions. Neither Centrum nor its directors, employees, agents or representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. This document does not constitute an offer or invitation to subscribe for or purchase or deal in any securities and neither this document nor anything contained herein shall form the basis of any contract or commitment whatsoever. This document is strictly confidential and is being furnished to you solely for your information, may not be distributed to the press or other media and may not be reproduced or redistributed to any other person. The distribution of this report in other jurisdictions may be restricted by law and persons into whose possession this report comes should inform themselves about, and observe any such restrictions. By accepting this report, you agree to be bound by the fore going limitations. No representation is made that this report is accurate or complete. The opinions and projections expressed herein are entirely those of the author and are given as part of the normal research activity of Centrum Broking and are given as of this date and are subject to change without notice. Any opinion estimate or projection herein constitutes a view as of the date of this report and there can be no assurance that future results or events will be consistent with any such opinions, estimate or projection. This document has not been prepared by or in conjunction with or on behalf of or at the instigation of, or by arrangement with the company or any of its directors or any other person. Information in this document must not be relied upon as having been authorized or approved by the company or its directors or any other person. Any opinions and projections contained herein are entirely those of the authors. None of the company or its directors or any other person accepts any liability whatsoever for any loss arising from any use of this document or its contents or otherwise arising in connection therewith. Centrum and its affiliates have not managed or co-managed a public offering for the subject company in the preceding twelve months. Centrum and affiliates have not received compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for service in respect of public offerings, corporate finance, debt restructuring, investment banking or other advisory services in a merger/acquisition or some other sort of specific transaction. As per the declarations given by him, Mr. Rahul Gaggar, research analysts and the authors of this report and/or any of their family members do not serve as an officer, director or any way connected to the company/companies mentioned in this report. Further, as declared by them, they have not received any compensation from the above companies in the preceding twelve months. Our entire research professionals are our employees and are paid a salary. They do not have any other material conflict of interest of the research analyst or member of which the research analyst knows of has reason to know at the time of publication of the research report or at the time of the public appearance. While we would endeavor to update the information herein on a reasonable basis, Centrum, its associated companies, their directors and employees are under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent Centrum from doing so. Non-rated securities indicate that rating on a particular security has been suspended temporarily and such suspension is in compliance with applicable regulations and/or Centrum policies, in circumstances where Centrum is acting in an advisory capacity to this company, or any certain other circumstances

Key to Centrum Investment Rankings Buy: Expected outperform Nifty by>15%, Accumulate: Expected to outperform Nifty by +5 to 15%, Hold: Expected to outperform Nifty by -5% to +5%, Reduce: Expected to underperform Nifty by 5 to 15%, Sell: Expected to underperform Nifty by>15%


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