Hotel Stocks: High Expectations Meet Covid Hurdle

The Indian tourism and hospitality industry has emerged as one of the key growth drivers of the services sector in India.

A primary reason for this is the rich cultural heritage that attracts leisure tourists. Another contributing factor is the rising demand for business and medical travel, along with other niche tourism products such as cruises, adventure, sports, MICE, eco-tourism, film, rural, and religious tourism.

Before the pandemic, the Indian hotel industry witnessed a prolonged period of supply-demand mismatch, with a massive supply overhang. This mismatch resulted in the mediocre performance of the domestic hotel industry.

But eventually, the slower new supply in tandem with a revival in demand altered that. The changing dynamics led to the sector growing steadily since 2016, with 2019 being its best-performing year.

Built on a sustained upcycle from 2016, the industry recorded its highest levels of average daily rate (ADR) in 2019.

And then came Covid-19

It hit the economy like a thunderbolt. Every business was affected adversely, with the hospitality industry at the forefront.

What started as a tiny dip in the year 2020, transitioned into a massive drop in the business. Travel and tourism were negligible and weddings were curtailed. These restrictions resulted in a massive loss for hotel companies.

The guest occupancy and average daily rate (ADRs) in the country crashed to 33.8% (50% below FY20) and Rs 4,013 (33% below FY20), respectively.

The heightened losses declared the financial year 2021 as one of the worst-performing years for the hotel industry.

Hotel majors such as Indian Hotels, Lemon Tree, and ITC also experienced a massive dip in revenues, falling by more than 50% in the financial year 2021. Consequently, the stock prices took a hit.

Most hotel stocks underperformed the broad markets by a long shot that year. In April 2021, hotel stocks were hit badly.

While Indian Hotels and EIH fell by 48.2% and 47.1%, Lemon fell by a whopping 70.5% since the beginning of 2022. The BSE Sensex was down 24.9% during the same period.

Eventually, as the economy bounced back, so did the hotel industry. It slowly started to recover, led by an uptick in domestic travel. The narrowing gap between supply and demand also helped, by boosting room occupancies and improving room rates.

But it wasn't going to be a smooth road to recovery for the hotel industry. This surge in business was short-lived. Thanks to the second wave of Covid-19, hotels reported subdued revenues in the financial year 2022.

However, there was light at the end of this tunnel.

Once the world begun to gain respite from the pandemic, the industry came back with a bang. Hotel stocks hit their all-time highs, delivering outsized returns. They made up for any losses investors might have incurred in 2020 and 2021.

This was their time. Hotel occupancy rates were up, and so were the ADRs. Most companies doubled their business reporting a 50% jump in revenues, greatly reducing their losses. This stellar recovery didn't go unnoticed by investors, trickling down to the stock prices.

Hotel Companies Financial Snapshot (2018-2022)

	Pre-Pandemic		Pandemic
	2017-2018	2018-2019	2019-2020	2020-2021	2021-2022
Revenue Growth (%)
Indian Hotels	2.20%	10.20%	-0.10%	-62.10%	84.60%
EIH	5.40%	10.50%	-10.40%	-67.60%	90.90%
Lemon Tree	17.20%	13.50%	20.60%	-59.80%	56.30%
Mahindra Holidays	2.40%	-2.30%	5.90%	-23.70%	17.50%
Net Profit Growth (%)
Indian Hotels	-176.00%	286.80%	43.40%	-297.90%	-68.00%
EIH	68.00%	-23.60%	20.90%	-283.00%	-84.00%
Lemon Tree	-373.00%	297.60%	-118.70%	1657.30%	-24.20%
Mahindra Holidays	-8.60%	-55.30%	-325.70%	-89.50%	-581.90%

Data Source: Ace Equity

Best Hotel stocks outshined most sectors, outperforming the broad markets since the beginning of 2021. While Indian Hotels and EIH were up 166% and 93%, Lemon tree shot up by 102%. The BSE Sensex was up 28% during the same period.

Bear in mind, that this performance comes from the businesses that are yet to reach their pre-Covid levels. This only indicates that investors have great expectations from this sector.

It seems as though we have gone back in time

The recent surge of Covid-19 infections in China has triggered warnings across the world. This comes after the country dismantled its zero-Covid policy, which involved mass testing and strictly targeted lockdowns.

India is also anxious and has recently updated its travel rules. The Ministry of Health and Family Welfare has updated guidelines for travellers entering the country. It has mandated RT-PCR tests for those coming from six Asian countries from first January 2023, onwards.

Some states have imposed a 7-day home quarantine for flyers from high-risk countries such as China, Hong Kong, Japan, South Korea, Singapore, and Thailand.

These fresh sets of restrictions are bound to impact travel and tourism and consequently, hotel stocks

Hotel revenue growth is a function of two primary factors; the level of guest occupancy and the revenue generated per room (ADRs).

The past experiences suggest a revival in room tariffs lags the revival in occupancy. Therefore, once the occupancy levels fall due to the restrictions, it can send the room tariffs plunging. This double whammy can adversely affect profitability, as we have seen in the past.

But a cursory glance at history also tells us there is a good chance the industry will recover once the Covid-19 dust settles.

But this time it's different

The stocks don't seem financially well-placed to weather the storm for a long-time. The hotels have still not regained their pre-Covid glory. They are far from their pre-Covid revenues and profitability numbers. Apart from this, the debt-to-equity ratio and interest coverage ratios have languished.

Hotel Companies Debt Profile (2018-2022)

	2017-2018	2018-2019	2019-2020	2020-2021	2021-2022
Debt to Equity Ratio (x)
Indian Hotels	0.58	0.53	0.6	1	0.28
EIH	0.17	0.18	0.15	0.11	0.11
Lemon Tree	1.63	1.72	1.58	1.84	2.04
Mahindra Holidays	1.16	-1.6	-1.14	1.24	1.13
Interest Coverage Ratio (x)
Indian Hotels	1.66	3.07	2.16	-1.11	0.4
EIH	12.4	5.33	3.99	-8.72	-0.33
Lemon Tree	1.23	1.53	1	-0.13	0.2
Mahindra Holidays	3.51	3.44	2.19	1.03	2.06

Data Source: Ace Equity

The hotel business is highly capital-intensive. It requires a large upfront investment in land and construction costs, most of which is largely funded with debt.

Therefore, the balance sheet of hotel companies is usually riddled with debt. But high levels of debt can flare up in absence of cashflows in troubled times. Indian hotel stocks are all sitting on a pile of debt.

Indian Hotels and EIH have managed to reduce their debt. However, they have done it via raising money and not via internal accruals.

Lemon Tree and Mahindra Holidays have amassed large amounts of debt and operate at a very low-interest coverage ratio exposing them to large risks.

So on the off chance, Covid-19 rears its ugly head again for a prolonged period, these stocks can be in deep trouble.

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