institutional equities lemon tree hotels · 2018. 7. 12. · institutional equities 3 lemon tree...

Institutional Equities

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Reuters: LEMO.BO; Bloomberg: LEMONTRE: IN 1.

Lemon Tree Hotels

At The Cusp Of An Upcycle We initiate coverage on Lemon Tree Hotels with a Buy rating and a target price of Rs93 based on 30xFY20E EV/EBITDA. Our optimism on the stock is based on favourable industry environment together with the company’s aggressive strategy focused on middle-income domestic consumers, geographical expansion and cost control.

The main reasons for our optimism are: 1) Cyclical upturn in the hotel sector along with favourable demand-supply dynamics expected to drive the occupancy rate and average room rate (ARR). 2) Strong demand from the domestic middle-income segment.

Lemon Tree Hotels (LTHL) has a focused strategy which has aided in strong growth and is expected to drive future growth. The key elements of the strategy are:

a) Strategy focused on attractive room rates for middle income domestic travellers- ‘Value for Money.’ b) Geographical spread across more than 30 cities in India to reduce exposure to local, seasonal and cyclical fluctuations in demand. c) High operating leverage with a strong focus on cost control. d) Efficient capex management with lower-than-industry capex per room. e) Strong balance sheet with a comfortable net debt to equity ratio, despite high capex. It also has a negative working capital.

We have valued the stock at 30x FY20E EV/EBITDA and arrived at a target price of Rs93.

Cyclical upturn in the industry led to improvement in the occupancy rate: Industry experts are of the opinion that the demand-supply scenario is changing favourably for the hotel industry with overall supply expected to grow 7.9% and middle-income price hotel room supply expected to grow 11.7% until FY21E. Domestic demand in this segment is expected to grow around 18.6% annually until FY21E. The changing supply-demand mix has led to an increase in the overall occupancy rate from 57% in FY13 to 68% in FY18 and is expected to increase further.

Pan-India strategy focused on middle-income guests led to a high occupancy rate: LTHL is focused completely on domestic customers and has three brands: Premier - focus on high-end middle income segment, Lemon Tree (mid-end) and Red Fox (economy) with attractive pricing among its competitors. although 57% of the total rooms are in four cities focused on the IT/ITES industry. LTHL has 4,697 rooms across 30 locations in Tier 1 and Tier 2 cities. Attractive rates and high quality service ensured that the company has an average occupancy rate of approximately 75% compared to industry average of 68%. Changing attitude and rising penchant to travel amid rising salaries is expected to maintain strong growth in demand.

Strong cost control measures and high operating leverage leads to rising EBITDA margin: Our analysis on per room basis shows that compared to total five-year revenue CAGR (FY13-FY18) of 6%, operating expenses posted five-year CAGR of 3% leading to five-year EBITDA CAGR of 16%. EBITDA margin increased from 17% in FY13 to 27% in FY18. We expect the EBITDA margin to rise to 34% in FY21E and forecast EBITDA to post a three-year CAGR (FY18-21E) of 31%.

Healthy balance sheet with negative working capital management: LTHL has a healthy balance sheet with a net debt to equity ratio of 1.2x in FY18 and negative working capital. While we expect the net debt to equity ratio to rise to 1.7x in FY21, we expect the rising operating income to maintain a comfortable interest coverage ratio,thereby allaying our concerns on the rising net debt to equity ratio.

Strong growth in operating cash flow: We expect the operating cash flow to post a three-year CAGR (FY18-FY21E) of 26% because of strong growth in earnings and consistent negative working capital. Historically, we note that operating cash flow rose from Rs838mn in FY15 to Rs1,462mn in FY18.

Earnings to post 72% CAGR (FY18-FY21E): We expect a sharp increase in revenues driven primarily by the cyclical upswing in the industry leading to a rise in RevPar aided by sharp increase in total room inventory. The combined impact of strong revenue growth and cost control is expected to lead to strong earnings growth.

We assign Buy rating with a target price of Rs93: Our target price of Rs93 on LTHL is based on 30x FY20E EV/EBITDA which is supported by EBITDA CAGR of 31% over FY18-FY21E. Our valuation is driven by the cyclical upswing in the hotel sector with improving RevPar, and increase in the number of rooms driving higher revenues. Higher revenues together with relatively muted increase in costs and high operational leverage is expected to lead to strong growth in EBITDA. Our optimism is supported by a healthy balance sheet, supported by negative working capital. Although the net debt to equity ratio is expected to rise with continued capex, we believe the sharp rise in earnings will maintain a comfortable interest coverage ratio.

Risk: Any economic slowdown that could lead to slower-than-expected rise in demand.

BUY

Sector: Hotel

CMP: Rs74

Target Price: Rs93

Upside: 25%

Amit Agarwal Research Analyst [email protected] +91-22-6273 8033

Akash Mehta Research Associate [email protected] +91-22-6273 8062

Key Data

Current Shares O/S (mn) 786.4

Mkt Cap (Rsbn/US$mn) 58.8/854.7

52 Wk H / L (Rs) 91/57

Daily Vol. (3M NSE Avg.) 3,131,196

Share holding (%) 2QFY18 3QFY18 4QFY18

Promoter 31.0 31.0 31.0

DII - - -

General Public 69.0 69.0 69.0

One Year Indexed Stock Performance

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LEMON TREE HOTEL Nifty 50

Price Performance (%)

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Nifty Index 1.5 2.8 11.9

Source: Bloomberg

Y/E March (Rsmn) FY17 FY18 FY19E FY20E FY21E

Revenues 4,119 4,843 6,427 7,371 8,948 YoY (%) 12.0 17.6 32.7 14.7 21.4 EBITDA 1,164 1,327 2,085 2,451 3,003 EBITDA Margin (%) 28.3 27.4 32.4 33.3 33.6 PAT (82) 107 388 460 536 YoY (%) N/A N/A 270.4 18.4 16.5 EPS (Rs) (0.10) 0.14 0.5 0.6 0.7 RoE (%) (1.0) 1.3 4.5 5.1 5.6 EV/EBITDA (x) 56 49 31 27 22 P/E (x) (700.4) 534.3 147.2 124.4 106.7

Source: Company, Nirmal Bang Institutional Equities Research

11 July 2018


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Exhibit 1: Lemon Tree Hotels price chart versus Sensex versus peers

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Investment summary

We initiate coverage on LTHL with a Buy rating. Our optimism on the stock is driven by the following factors:

Cyclical upswing in hotel industry to drive room revenues: The hotel industry is showing clear signs of revival and we believe the cyclical upswing is based on a favourable demand-supply balance. The weakness in the sector was caused by demand-supply imbalance in FY07-FY17. During the period while demand registered a CAGR of 12.4%, supply witnessed a CAGR of 13%, creating a demand-supply mismatch. The room occupancy rate declined to 57% in FY13 from 69% in FY07. The imbalance has now started reversing. The occupancy rate increased to 65% in FY17. If history is an indicator, then in the previous upcycle (FY03-FY08), ARR posted a CAGR of 20% and the occupancy rate registered a CAGR of 4%.

Company’s strategy focused on middle-income Indian guests to benefit from improving demographics, rising salaries and increased propensity to spend: Approximately 86% of LTHL’s total guests were domestic (as of FY16-end), clearly indicating that the company is focused primarily on domestic customers. Consequently, in our view, LTHL is expected to benefit from: 1)Strong growth in the middle class population in India. 2) Rising propensity to travel and stay in hotels instead of staying with relatives/friends. 3. Rising salary level and affordability.

Strategy focused on pan-India geographical expansion to cater to leisure and business travellers will reduce locational risk: LTHL has 4,697 rooms spread across 30 cities in India and it is expected to set up 2,587 rooms across 28 cities. However, approximately 57% of the rooms are in four cities which are primarily known as IT/ITES centres. The other cities include those known for leisure and religious tourism. The vast geographical spread across cities in Tier 1 to Tier 4 cities will help the company to reduce exposure to local, seasonal and cyclical fluctuations.

Strategy focused on room revenues to help improve margins: In a clearly stated strategy and in contrast to other hotel chains in India, LTHL focuses primarily on room revenues with a relatively lower focus on food and beverage (F&B). Analysis of historical results show that F&B (including banquet) revenues, as percentage of room revenues, declined from 31% in FY13 to 22% in FY18.

Strategy of cost control amid rising revenues to drive EBITDA CAGR of 31% over FY18-FY21E: We expect LTHL’s revenues to post a CAGR of 23% over FY18-FY21E. However, with strong cost control, we expect operating costs to post a relatively lower CAGR of 19%. This will help drive EBITDA CAGR of 31% over the same period. Our per room analysis of the income statement clearly indicates that the company has strong cost control measures.

Healthy balance sheet supported by comfortable net debt to equity ratio, negative working capital: LTHL has a healthy balance sheet with a net debt to equity of ratio of 1.2x in FY18. We expect the net debt to equity ratio to increase to 1.7x by FY21E. However, we draw comfort from the fact that rising operating income is expected to improve the interest coverage ratio from 1x in FY18 to 1.5x in FY21E, thus allaying any concerns on the rising net debt to equity ratio. Further, the company also has negative working capital which helped reduce the stress on the balance sheet.


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Strong operating cash flow to fund capex for expansion: LTHL has shown strong growth in operating cash flow with a CAGR of 20% over FY15-FY18. We expect the earnings growth and negative working capital to help increase operating cash flow CAGR (FY18-FY21E) to 26%.

Attractive valuation given the strong anticipated growth: Our target price of Rs93 on LTHL is based on 30x FY20E EV/EBITDA which is supported by EBITDA CAGR of 31% over FY18-FY21E. Our valuation is driven by the cyclical upswing in the hotel sector with improving RevPar, and increase in the number of rooms driving higher revenues. Higher revenues together with relatively muted increase in costs and high operational leverage is expected to lead to strong growth in EBITDA. Our optimism is supported by a healthy balance sheet, supported by negative working capital. Although the net debt to equity ratio is expected to rise with continued capex, we believe the sharp rise in operating income will maintain a comfortable interest coverage ratio.


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Hotel industry at the beginning of a revival phase

The hotel industry has transitioned from an upcycle since mid-2002 to mid-2008 followed by a downcycle which bottomed out in 2015. During this period, overall room supply posted a 10% CAGR over FY02-FY17, where the highest room addition was in the mid-scale economy segment with a CAGR of 19.8% and luxury upper upscale witnessing the lowest room addition at a 7.9% CAGR over FY02-FY17.

Going forward, industry experts expect room addition to register a 7.9% CAGR over FY17-FY21E. However, industry experts forecast demand CAGR of 12.4% over FY17-FY21E. Demand growth in the upper scale segment is expected to post a 15.6% CAGR over FY17-FY21E whereas the mid-scale and economy segments are expected to register a 18.6% CAGR over the same period.

We believe the demand growth will be driven by:

1) Rising contribution of tourism and travel to India’s GDP.

2) Increase in working age population to boost the value of discretionary spending.

3) With a rise in annual gross income per capita income, discretionary spending per capita will also increase.

4) Stable unemployment rate to support the rising working age population.

5) Transition of population from rural areas to Tier 3 & Tier 4 cities to create demand for expected room addition in the middle-income segment.

6) Rise in nuclear family structure to increase per capita spending.

7) Increase in foreign tourist arrival (FTA) supported by e-visa facility to boost the room occupancy rate.

8) M-visa to lead to a rise in FTA, thereby creating demand for existing and expected room additions.

9) India ranks sixth based on the number of heritage sites and has 36 heritage sites which draw domestic and foreign travellers.

10) UDAN (Ude Desh Ka Aam Nagrik) scheme to boost domestic travel.

11) Improved connectivity and infrastructure to create demand for upcoming hotels in underserved/unserved regions.


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1) Rising contribution of tourism and travel sector to India’s GDP

The travel and tourism sector’s contribution to India’s GDP, at US$208.9bn in 2016, represents around 9.6% of total GDP. India had 1,614mn domestic travellers visits in 2016, posting a 13.25% CAGR over 2000-16.

Exhibit 2: Travel and tourism sector’s contribution to India’s GDP

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Source: Nirmal Bang Institutional Equities Research, IBEF, WTCC

Exhibit 3: Domestic travellers Exhibit 4: Domestic spending

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Source: Nirmal Bang Institutional Equities Research, India Tourism Statistics 2017

2) Increase in working age population to boost the value of discretionary spending

The median age of the working population in 2001, 2011, 2021 and 2031 is expected to be 22, 24, 28 and 31 years, respectively. The rise in median age of the working population indicates that per capita income will also increase supported by better appraisals, incentives and bonus. Rise in per capita income and students passing out of college and joining the work force are the driving forces behind the rise in spending and acting as a tailwind to the travel and tour business. As per Exhibit 5, the work force in the age group of 15-34 years was 35% in 2011 and is expected to remain almost the same at 34% in 2021. However, the working class population in the age group of 35-64 years is expected to increase from 29% in 2011 to 33% in 2021, indicating higher per capita spending driven by relatively higher salaries.


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Exhibit 5: Rise in working age population

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Source: Nirmal Bang Institutional Equities Research, MOSPI

3) With a rise in annual per capita gross income, discretionary per capita spending to also increase

The income level of the five categories are as follows: Elite – annual gross income greater than US$30,800, Affluent – annual gross income greater than US$15,400 but less than US$30,800, Aspirer - annual gross income greater than US$7,700 but less than US$15,400, Next Billion – annual income greater than US$2,300 but less than US$7,700, and Strugglers – annual gross income less than US$2,300.

In 2016, Next Billion accounted for 45% of the total population which is expected to remain the same going into 2025, at 46%. But looking at the bottom category, Strugglers who accounted for 31% of the total population in 2016, are expected to decline to 18% by 2025. However, we see growth in Elite, Affluent and Aspirer categories - which represented 2%, 6% and 15% share , respectively, of the total population in 2016 - to increase to 5%, 11% and 20%, respectively, by 2025. The rise in the percentage of Elite, Affluent and Aspirer categories amongst the total population will lead to a rise in overall income level, thereby translating into higher value of discretionary spending over the next few years.

Exhibit 6: Increase in annual gross income

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Elite Affluent Aspirers Next Billion Strugglers

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2005 2016 2025E Source: Nirmal Bang Institutional Equities Research, BCG


Lemon Tree Hotels 7

4) Stable unemployment rate to aid rising working age population

Unemployment rate in India is expected to remain stable at 3.5% in 2019, similar to the 2017 level. Stable unemployment rate asserts the fact that the increase in working age population translates into actual employment which leads to a rise in the value of discretionary spending.

5) Population shift from rural areas to Tier 3 & Tier 4 cities to create demand for expected room addition in the middle-income segment

In Exhibit 7, we see that the total population living in rural areas is expected to decline from 51% in 2016 to 42% by 2018-end. We can see the rise in population in Tier 1, 3 and 4 cities. Tier 1, 3 and 4 cities represent 10%, 10% and 13%, respectively, of the total population in 2016 which is expected to rise to 13%, 12% and 17%, respectively, by 2018-end. Hotel addition over the next few years will be focused on the middle-income segment. This addition will not only be in the metropolitan region, but also in various tiers. Despite supply addition in various tiers, the expected rise in population in Tier 1, 3 and 4 cities is expected to support the room occupancy rate and ARR in respective regions.

Exhibit 7: Transition of population from rural areas to Tier 3 & Tier 4 cities

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Source: Nirmal Bang Institutional Equities Research, BCG

6) Rise in nuclear family structure to increase per capita spending

Nuclear families represented 68% of the total families in 2016. However, in 2025 we expect nuclear families to rise and represent 74% of total families by 2025. Nuclear families, on an average, spend 20%-30% more per capita than joint families which supports the fact that discretionary spending will increase in the near future.

Exhibit 8: Nuclear families versus other family structures

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Source: Nirmal Bang Institutional Equities Research, BCG


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7) Increase in foreign tourist arrival (FTA) supported by e-visa facility to boost room occupancy rate

Foreign tourist arrivals in India registered a 10.2% CAGR over 2002-17 and stood at 10.2mn in 2017. With the introduction of e-visa facility on 27 November 2014, FTA through e-visa facility registered a CAGR of 252% over 2014-17 and stood at ~1.7mn in 2017. The e-visa facility is available in three sub-categories - e-tourist visa, e-business visa and e-medical visa - and is extended to nationals of 163 countries. The duration of e-visa has also been increased from 30 days to 60 days. Under the e-visa, a foreign national has to submit an application for a visit in India, after which the applicant gets an authorisation via e-mail. The foreign national has to just show the authorisation printout to the immigration authorities in India on arrival. The ease with which a foreign national can get entry into India via the e-visa route is expected to boost FTA. Foreign tourist spending in 2017 stood at Rs16,50,000mn and posted a 15% CAGR over 2000-17. We believe the value of foreign tourist spending will increase with the rise in FTA.

Exhibit 9: Foreign tourist arrival

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Source: Nirmal Bang Institutional Equities Research, Industry

Exhibit 10: E-visa arrival

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Source: Nirmal Bang Institutional Equities Research, Ministry of Tourism


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Exhibit 11: Foreign tourist spending

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Source: Nirmal Bang Institutional Equities Research, Industry

8) M-visa to lead to a rise in FTA, thereby creating demand for existing and expected room addition

M-visa FTA in 2016 stood at 4,27,014 and posted a 21% CAGR over 2009-16. Most medical tourists arrive from Bangladesh, Afghanistan, Maldives, Nigeria, Kenya etc. Medical tourists generally go for joint replacement, cardiac surgery, dental surgery and cosmetic surgery. Medical tourism is mostly driven by the private sector and the Ministry of Tourism acts as a facilitator in marketing and spreading awareness. Medical tourism in India has been promoted on various international platforms like World Travel Mart, London, Berlin and Arabian Travel Mart. Within medical visas, there is a category called e-medical visa which is introduced to boost medical tourism. Medical tourism has gained popularity over the past few years and we believe the trend will continue because of the availability of relatively low-cost medical treatment in India and lack of qualified doctors and equipment in some countries.

Exhibit 12: M-visa FTA

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Source: Nirmal Bang Institutional Equities Research, Press Information Bereau


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9) India ranks 6th based on the number of heritage sites and it has 36 heritage sites which draw domestic and foreign travellers

Italy has 53 heritage sites, as per UNESCO,taking the number one position. India, with 36 heritage sites, takes the number 6 position just after Germany. In 2016, archaeological site at Nalanda, Bihar, archaeological work of Le Corburier, Chandigarh, and Khangchendzonga National Park, Sikkim were added. In 2017, UNESCO added the historic city of Ahmedabad as a heritage site. The number of visitors to centrally-protected and ticketed monuments stood at 43mn, posting a CAGR of 22% over 2002-17. We have seen a few years of decline in visitors, especially foreign visitors, over the past few year, but domestic visitor growth remains strong and registered a decline only in 2007, 2013 and 2016. The Adopt a Heritage Scheme of the Ministry of Tourism was launched on 27 September 2017 by the President of India. The ministry has invited private sector companies, public sector companies, and corporate individuals to help in conservation and development of heritage sites. Seven short-listed companies have been given a Letter of Intent for 14 monuments. We believe that India has a lot of heritage value and we expect the steps taken by the Ministry of Tourism to conserve and develop heritage sites will fuel domestic and foreign visitor growth over the next few years.

Exhibit 13: Countries with the highest number of heritage sites as per UNESCO

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Source: Nirmal Bang Institutional Equities Research, UNESCO

Exhibit 14: Visitors to centrally-protected and ticketed monuments

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10) UDAN (Ude Desh Ka Aam Nagrik) scheme to boost domestic travel

In 2012, low-cost carriers (LCCs) accounted for 50.6% seats in domestic market while full-service airlines accounted for 49.4%. However, in 2017, LCCs accounted for 67.2% of total seats in the domestic market. UDAN scheme was launched on 27 April 2017 with the objective of improving connectivity with the operation and revival of airports in underserved and unserved areas and introducing viability gap funding for RCS (Regional Connectivity Scheme) flights to fill the gap between the cost of airline operations and expected revenues on unserved/underserved routes. UDAN scheme provides a dual benefit for the hotel industry by improving connectivity to bottom-tier cities from where expansion of middle-income hotels is expected and increasing the affordability for domestic travellers to visit bottom-tier cities. The rise in LCCs and implementation of the UDAN scheme will provide significant support to domestic travel growth, thereby creating demand for middle-income hotels.

11) Improved connectivity and infrastructure to create demand for upcoming hotels in underserved/unserved regions

Upto 2013, AAI (Airports Authority of India) was the major player in developing and upgrading the airports in India, but now private players have also started participating. 1) GMR is undertaking development of Hyderabad airport and mordenisation of Delhi international airport. 2) GVK will undertake modernisation of Mumbai airport. 3) Siemens, Larsen & Toubro and UNIQUE will develop Bengaluru international airport. 4) Maytas Infra to develop Shimoga and Gulbarga airports in Karnataka.

Budget allocation for the infrastructure segment in 2018-19 has been increased to .597 mn crore from .494 mn crore in 2017-18. The government is going to use this budget for improving road, rail, air and waterways infrastructure and connectivity. Budget allocation for the Ministry of Road Transport and Railways has been increased from Rs649bn in 2017-18 to Rs710bn in 2018-19. National highways exceeding 9,000km are expected to be completed under the Bharatmala scheme in 2018-19 out of the total 35,000km. Indian Railways has also been allocated with .148 mn crore for 2018-19. With development and upgradation of airports and increased government spending on improving the infrastructure and connectivity, one of the biggest drawbacks for the domestic hotel industry will get converted into a tailwind.



Hotel industry trends

RevPar, occupancy rate and ARR

After a downcycle that ended in 2002-03, there was a beginning of an upcycle which lasted till the middle of 2008. The upcycle was driven by multiple factors like: 1) Travel to South-East Asia getting impacted because of SARS (Severe Acute Respiratory Syndrome). 2) India’s GDP grew more than 8%. 3) Domestic travellers’ contribution started picking up. 4) The US declared a war on Iraq (impacting the tourism in the Middle-East). 5) The number of branded hotels increased from 27,000 to 47,000, representing a supply CAGR of 12% per annum. However, the demand during the period posted a 16% CAGR. This led the occupcancy rate and ARR to post a CAGR of 4% and 20%, respectively. Post 2008, horrific events like 26/11 in the US impacted the demand side, but demand growth remained relatively stable. The downcycle mainly began on account of excess supply coming in from under-construction branded hotels in 2005-06 becoming operational in 2008, and international hotel players entering the Indian market using an asset-light model (management contract). Going forward, with the demand factors mentioned earlier and relatively less supply addition over the next two to three years, we believe the hotel industry is in a bull cycle.

Overall RevPar was the highest in 2007-08 at Rs5,496. RevPar of 4-star and 3-star rooms also peaked at Rs5,142 and Rs3,942, respectively, in 2007-08. The upcycle that began in 2002-03 ended in 2007-08. The downcycle bottomed out in 2013-14 where overall RevPar touched Rs3,275, whereas 4-star and 3-star hotels registered RevPar of Rs2,643 and Rs1,786, respectively. The increase and then the decline of RevPar is a result of both occupancy rate and ARR increasing and then declining.

Exhibit 15: RevPar trend

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Source: Nirmal Bang Institutional Equities Research, Hotelivate

The overall occupancy rate was 52% in 2001-02, which peaked at 72% in 2005-06 (during the 2002-03 to 2007-08 upcycle). The 4-star and 3-star hotel occupancy rate at 73% and 69% touched their peak in 2005-06 and 2006-07, respectively. Post 2007-08, during the downcycle, the occupancy rate bottomed out at 58% in 2012-13, whereas during the same year 4-star and 3-star hotels reported occupancy rate of 58% and 57%, respectively.



Exhibit 16: Room occupancy rate trend

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Overall Average 4 Star 3 Star Source: Nirmal Bang Institutional Equities Research, Hotelivate

During the 2002-03 and 2007-08 peaks, overall ARR peaked in 2007-08 at Rs7,989, but ARR for 4-star and 3-star hotels peaked at Rs5,745 and Rs3,530, respectively, in 2008-09. However, post 2007-08, during the downcycle, ARR bottomed at Rs5,527 in 2015-16 and at Rs4,361 and Rs3,039 in case of 4-star and 3-star hotels, respectively, in 2014-15.

Exhibit 17: ARR trend

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Overall Average 4 Star 3 Star Source: Nirmal Bang Institutional Equities Research, Hotelivate



Room supply trend and supply addition expected over 2021-22

Since 2007/08, room supply has shown a CAGR of 11% and the number of branded rooms increased from 47,612 in 2007-08 to 119,219 in 2016-17. However, going forward, we can expect the number of branded rooms to increase to 166,286 by 2021-22, representing a CAGR of 7%. We believe that demand growth will outperform supply growth, leading to an upward movement in ARR and occupancy rate.

Exhibit 18: Total room addition expected

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Source: Nirmal Bang Institutional Equities Research, Hotelivate

We have selected top four cities where LTHL will have the maximum presence by 2021-22 and based on that we have given a graphical presentation in Exhibit 19 of the city-wise room addition trend and expected supply. The branded rooms in Bengaluru,Hyderabad, Mumbai and NCR stood at 11,995, 6,254, 13,494 and 20,981, respectively, in 2016-17, registering a CAGR of 15%,10%,10% and 11%, respectively, (over 2007-08 to 2016-17). But over the next five years the supply in Bengaluru, Hyderabad, Mumbai and NCR is expected to post a CAGR of 4%,4%,5% and 4%, respectively, which is relatively lower than the growth witnessed in the previous nine years.

Exhibit 19: Room addition in top cities

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Bengaluru Hyderabad Mumbai NCR Source: Nirmal Bang Institutional Equities Research, Hotelivate

LTHL is expected to have ~50% of the rooms in Bengaluru, Hyderabad, Mumbai and NCR by 2021-22. In NCR, Hyderabad and Mumbai it is planning to add 372, 84 and 736 rooms, respectively, by 2021-22. The room addition in these cities represents ~50% of total room addition. Mumbai and Hyderabad room addition will be through the owned/lease route, but NCR room addition will be through management contracts.



Exhibit 20: Top city room addition of Lemon Tree Hotels

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Source: Nirmal Bang Institutional Equities Research, Lemon Tree Hotels DRHP

ARR, occupancy rate and RevPar trend in top 4 cities (based on LTHL’s presence)

During 2007-08, cities like Mumbai, Hyderabad, Bengaluru and NCR achieved their highest ARR over the past 15 years. Mumbai, Hyderabad, Bengaluru and NCR registered ARR of Rs10,932, Rs6,271, Rs9,827 and Rs10,429, respectively, in 2007-08. Post 2007-08, during the downcycle, ARR bottomed out in 2014-15 and 2015-16. In the past five years, Mumbai, Hyderabad, Bengaluru and NCR achieved lowest ARR of Rs7,158, Rs4,556, Rs5,379 and Rs6,774 respectively. However, there has been some recovery in ARR post 2015-16.

Exhibit 21: ARR – Top 4 cities (based on LTHL’s presence)

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During the 2002-08 upcycle, cities achieved peak occupancy rate in different years. Mumbai achieved peak occupancy rate of 78% in 2006-07, while Hyderabad and NCR achieved peak occupancy rate of 82% and 81%, respectively, in 2005-06 and Bengaluru achieved peak occupancy rate of 81% in 2004-05. Post 2007-08 upcycle, various cities witnessed a sharp decline in the occupancy rate. Mumbai saw its occupancy rate declining to 61% in 2008-09, Bengaluru posted its lowest occupancy rate of 53% in 2009-10, while the occupancy rate in Hyderabad and NCR bottomed out at 49% and 60%, respectively, in 2012-13. After this decline, there has been a modest recovery in the occupancy rate in these cities.



Exhibit 22: Occupancy rate – Top 4 cities (based on LTHL’s presence)

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Bengaluru and Hyderabad achieved highest RevPar of Rs7,544 and Rs4,299, respectively, in 2006-07 while Mumbai and NCR achieved highest RevPar of Rs8,155 and Rs7,707, respectively, in 2007-08. Post 2007-08, RevPar of Hyderabad and NCR bottomed out at Rs2,589 and Rs3,883, repectively, in 2014-15. RevPar of Mumbai and Bengaluru stood at Rs4,795 and Rs3,104, respectively, in 2013-14, the lowest during the downcycle. However, there was some recovery in RevPar with the improvement in ARR and occupancy rate.

Exhibit 23: RevPar – Top 4 cities (based on LTHL’s presence)

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Source: Nirmal Bang Institutional Equities, Hotelivate



Valuation

We have valued LTHL based on 30x FY20E EV/EBITDA to arrive at a target price of Rs93.

Exhibit 24: EV/EBITDA – Peer Companies vs Lemon Tree

EV/EBITDA (x) FY14 FY15 FY16 FY17 FY18 FY19E

Indian Hotels 31 31 30 24 26 20

EIH 28 32 52 33 33 24

Lemon Tree 285 128 64 56 49 31

Source: Nirmal Bang Institutional Equities, Bloomberg

We have valued LTHL at 30x FY20E EV/EBITDA. We believe the stock deserves a premium valuation multiple as:

1) Revenues are expected to post a 23% CAGR over FY18-FY21E supported by increase in ARR and room addition.

2) Hotel industry going through an upcycle providing support by way of ARR increase in existing as well as newer hotels, thereby helping in achieving a higher occupancy rate in newly added and upcoming hotels.

3) Maintaining a low cost structure to help achieve EBITDA margin of 34% in FY21E (an increase from 27% in FY18). We expect EBITDA CAGR of 31% over FY18-FY21E.

4) Earnings expected to post a 72% CAGR over FY18-FY21E.

5) Operating cash flow expected to post a 26% CAGR over FY18-FY21E, driven by a sharp rise in earnings and negative working capital cycle

If history is an indicator:

Our assumptions, (given below) are conservative if history is an indicator. We note that while we have assumed an ARR increase of only 5%-7% annually for all the three brands, in the previous upcycle the ARR posted a five-year CAGR (FY03-FY08) of 20%. The average ARR (overall) increased from Rs3,267/room in FY03 to Rs7,989/room in FY08.

Competitor analysis

Exhibit 25: EBITDA margin of competitors versus LTHL

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Indian Hotels EIH Lemon Tree Source: Nirmal Bang Institutional Equities, Bloomberg



Exhibit 26: Peer comparison based on EV/room

Companies EV/room (Rsmn)

Lemon Tree Hotels 14.14

EIH 20.95

Indian Hotels 10.01

Hotel Leela 18.45

Taj GVK 14.25

Advani Hotels 11.80

Sinclair Hotels 6.83

Average 13.78

Source: Nirmal Bang Institutional Equities Research, Respective Companies

We note that on EV/room basis, the stock is trading at approximately average of the comparative valuations of other hotels in the listed space. While the EBITDA margins for EIH was in the range of 15-20%, it was trading at a premium to Lemon Tree which is an anomaly in our view. We expect the anomaly to be corrected soon.



Key assumptions

Exhibit 27: Revenues Assumptions:

Revenue FY15 FY16 FY17 FY18 FY19 FY20 FY21

Lemon Tree Premier

Occupancy (%) 68% 78% 75% 77% 75% 74% 73%

ARR 3,635 3,834 4,123 4,773 5,012 5,262 5,525

Growth (%) - 5% 8% 16% 5% 5% 5%

Rooms 681 843 877 957 1438 1719 2296

Rental revenue Lemon Tree Premier 615 924 982 1,284 1,967 2,443 3,371

Growth (%) - 50% 6% 31% 53% 24% 38%

Lemon Tree

Occupancy (%) 68% 73% 77% 74% 77% 77% 74%

ARR 3175 3,321 3,522 3,848 4,079 4,283 4,583

Growth (%) - 5% 6% 9% 6% 5% 7%

Rooms 1,306 1,306 1,351 1,550 1,550 1,550 1,629

Rental Revenue Lemon Tree 1,025 1,160 1,335 1,609 1,772 1,866 2,011

Growth (%) - 13% 15% 20% 10% 5% 8%

Red Fox

Occupancy (%) 68% 75% 77% 76% 74% 76% 76%

ARR 2,179 2,278 2,372 2,860 3,146 3,398 3,669

Growth (%) - 5% 4% 21% 10% 8% 8%

Rooms 589 605 605 759 850 850 850

Rental Revenue Red Fox 318 377 402 601 720 801 863

Growth (%) - 19% 7% 49% 20% 11% 8%

Food and Beverage Revenue 625 743 786 756 892 1,022 1,249

Growth (%) - 19% 6% -4% 18% 15% 22%

As a % of room revenues 33% 31% 29% 22% 20% 20% 20%

Liquor and Wine 63 89 97 96 126 144 176

Growth (%) - 40% 9% 0% 31% 15% 22%


Banquet Rentals 9 11 17 11 14 16 20

Growth (%) - 18% 51% -36% 31% 15% 22%


Telephone and Telex 7 7 10 4 5 6 8

Growth (%) - 4% 42% -59% 31% 15% 22%


Other Services 268 329 362 495 646 740 904

Growth (%) - 23% 10% 37% 31% 15% 22%


Management Fee 64 88 131 176 283 332 347

Growth (%) - 38% 48% 34% 61% 17% 4%

Occupancy 68% 76% 76% 76% 75% 76% 74%

ARR 2,697 2,830 3,005 3,444 3,671 3,883 4,133

Room Revenue 183 360 703 1,513 2,442 2,864 2,987

Revenue based on multiplier 265 522 1,019 2,194 3,541 4,153 4,331

Commission Income 1 1 1 0 0 0 0

Growth (%) - 11% -29% -23% 0% 0% 0%

Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP



Exhibit 28: Expense Assumptions

Expenses FY15 FY16 FY17 FY18 FY19 FY20 FY21

Food and beverage expenses 261 315 319 401 473 542 662

Growth (%) - 20% 1% 26% 18% 15% 22%

As a % of food and beverages revenues 42% 42% 41% 53% 53% 53% 53%

Consumption of liqour & wine 23 31 35 35 45 52 63

Growth (%) - 35% 12% 1% 29% 15% 22%

As a % of liqour & wine revenues 36% 35% 36% 36% 36% 36% 36%

Power and fuel cost 341 370 384 485 638 731 894

Growth (%)

8% 4% 26% 32% 15% 22%

As a % of revenues* 12% 10% 10% 10% 10% 10% 10%

Consumption of stores, cutlery and linen 115 124 130 154 198 226 277

Growth (%) - 8% 5% 18% 28% 15% 22%

As a % of revenues** 4% 4% 4% 4% 4% 4% 4%

Licence fees 36 38 40 40 40 40 40

Growth (%) - 6% 6% 0% 0% 0% 0%

Other direct- spa exp+guest transportation 98 102 103 130 170 194 238

Growth (%) - 4% 1% 26% 31% 15% 22%

As a % of room rentals 5% 4% 4% 4% 4% 4% 4%

Employee expenses 782 854 969 1,096 1,352 1,530 1,879

Growth (%) - 9% 13% 13% 23% 13% 23%

Average cost per employee 0.31 0.29 0.32 0.32 0.33 0.35 0.37

Growth (%) - -5% 11% -2% 5% 5% 5%

Number of employess 2,554 2,925 2,984 3,447 4,052 4,366 5,106

Rent expenses 155 165 235 306 322 338 355

Growth (%)

7% 42% 31% 5% 5% 5%

Rent expenses per room 0.06 0.06 0.08 0.09 0.08 0.08 0.07

Growth (%) - 0% 38% 13% -11% -2% -9%

Commission expenses 22 37 56 70 91 105 128

Growth (%) - 72% 50% 26% 31% 15% 22%

Commission expenses per room 0.01 0.01 0.02 0.02 0.02 0.03 0.03

Growth (%) - 61% 46% 9% 11% 7% 5%


Advertising expenses 31 28 30 38 50 57 70

Growth (%) - -10% 7% 26% 31% 15% 22%

Advertising expenses per room 0.01 0.01 0.01 0.01 0.01 0.01 0.01

Growth (%) - -16% 4% 9% 11% 7% 5%


Other expenses 533 604 654 726 963 1,105 1,341

Growth (%) - 13% 8% 11% 33% 15% 21%

Other expenses per room 0.21 0.22 0.23 0.22 0.25 0.27 0.28

Growth (%) - 6% 5% -4% 13% 7% 5%

As a % of total revenues 18% 16% 16% 15% 15% 15% 15%


* Excluding revenue generated from Management Contract and Commission Income

**Excluding Management Contract, Commission Income, Telephone Charges and Other Services



Strategy

We expect earnings to post a CAGR (FY18-FY21E) of 72%. The key drivers of growth are:

1. A strategy based on pan-India expansion focused on the mid-high to economy Indian traveller.

2. Well-located hotels across India.

3. Strong measures of operational cost control.

4. Revival of the hotel sector with a favourable demand-supply environment.

Further, LTHL has managed a strong balance sheet with a comfortable net debt to equity ratio helped by lower capex per room and negative working capital.

Growth driven by:

1. Strategy focused on middle-income domestic guests.

2. Focus on key geographical locations catering to different segments.

3. Strategy focused on room revenues.

4. Change in the guest mix to help improve ARR.

5. Balance sheet management- comfortable net debt to equity ratio, partnership with P/E firm, lower capex.

6. Cost control to improve operational efficiency.

1. Strategy focused on middle-income domestic guest segment

LTHL is focused on the niche travel segment of domestic travellers from mid high-end to the economy segment. Approximately 86% of the guests are domestic compared to an industry average of 77%. We note that with changing norms following rising urbanisation and higher disposable income, domestic travel posted a CAGR of 13.7% over CY01-CY16. The Horwath report has indicated the trend is expected to continue. On a comparative basis, industry sources are of the opinion that the increase in the number of rooms is expected to post a CAGR of 7.9% only over FY18-FY21E, which is expected to drive the rise in ARR and occupancy rate.

2. Focus on key geographical locations catering to different segments

LTHL currently has 4,697 rooms (as per its website) in 30 cities across India. However, 57% of the rooms are in four major cities such as Jaipur, Hyderabad, Bengaluru and NCR. The company has a pipeline of 2,587 upcoming rooms across 28 different cities. The cities are from both Tier 1 and Tier 2 segments across India. While historically the company has exposure primarily in business cities, it s also expanding into leisure and vacation markets. This is expected to help the company reduce its exposure to local, seasonal and cyclical fluctuations and help in getting a diversified guest base.

3. Strategy focused on room revenues and not F&B revenues

LTHL has adopted a strategy primarily focussed on room revenues compared to other hotel companies which are also focused on food and beverage or F&B. The contribution of F&B revenues as a percentage of room revenues declined in the past five years from 31% in FY13 to 22% in FY18. Gross operating profit in terms of room revenues is approximately 80% compared to 40%-50% in case of F&B.

4. Change in guest mix to help improve ARR

The guest mix of LTHL comprises 33% corporates, 33% MSMEs and the rest are walk-ins, bookings via website and OTA. With the increase in occupancy rate, the company is in a better position to bargain with buyers and therefore plans to change the guest mix to improve ARR. For example, the rooms rented to airline crew (pay low) is likely to be reduced and the share of MSMEs expected to be increased.



Financials

Profit and Loss account

Historically, LTHL has shown a strong improvement in earnings. The company incurred a loss of Rs200mn in FY13 which turned into a profit of Rs105mn in FY18. The strong growth in earnings has been a result of:

1. Strong growth in revenues - The growth in revenues was driven by increase in room rate, increase in occupancy rate, increase in the number of rooms under operation that are fully owned or leased, and lastly the increase in rooms under management contracts.

2. Cost control led to a rise in operating cost by only 14% CAGR over FY13-FY18. This led to strong growth in EBITDA from Rs375mn in FY13 to Rs1,327mn in FY18.

3. However, the rise in EBITDA because of strong revenue growth and better operational performance was partially negated by the rise in depreciation and interest expenses.

We expect LTHL’s earnings to post a three-year CAGR of 72% until FY21E. We expect the earnings growth to be driven by driven by revenue growth and cost control.

The strong growth in earnings will be driven by revenues posting a three-year CAGR of 23% and relatively lower growth in operating costs at a three-year CAGR of 19%.

Exhibit 29: Net profit of LTHL

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Exhibit 30: Revenues of LTHL Exhibit 31: Total operating costs

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Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP



Strong growth in revenues

Favourable shift in the demand-supply scenario, focused strategy of LTHL on the burgeoning middle class implying attractive room rates and increasing domestic tourism led to a five-year revenue CAGR (FY13-FY18) of 18%. The revenue growth is primarily driven by the growth in room revenues with lower contribution of food and beverage segment.

We expect the revenue growth to continue over FY18-21E at a three-year CAGR of 23%, primarily driven by continued growth in room revenues. We give below the details of the historical reasons for revenue growth and the reasons for revenue growth over FY18-FY21E.

Key revenue drivers

1. RevPar- driven by the occupancy rate, rising ADR - change in guest mix.

2. Increase in the number of rooms.

Increase in Revpar

Change in Revpar is driven by the change in average daily rate (ADR) and the increase in occupancy rate. With a steady occupancy rate of all brands of LTHL at more than 70%, we expect one of the key revenue drivers to be the rise in ADR. We expect the rise in ADR to be driven by change in the client mix and overall rise in ADR with a changing demand-supply scenario.

We have show below the strong occupancy rate and the rise in ADR of LTHL.

Occupancy rate

We note that in the past three years the overall occupancy rate of LTHL rose sharply from 68% in FY15 to 75% in FY18. The marginal decline in FY18 is primarily because of addition of owned/leased rooms. Any addition of new rooms in the wake of addition of new hotels takes about two to three years to stabilise and has a lower occupancy rate compared to other hotels that have been running. The overall addition of rooms is given in the chart below. We note that the increase in the number of rooms in FY18 by more than 400 led to a decline in overall occupancy rate from 76% to 75%.

Exhibit 32: Occupancy Rates Exhibit 33: Room Additions

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In the charts below, we have given the occupancy rate and the addition of rooms in each of the three brands of LTHL.

Brand- Premier

The charts below show that while the occupancy rate rose in FY16 partially because of growth in demand with a changing demand-supply scenario for the industry, the occupancy rate in FY17 declined because of addition of rooms in FY16. In FY18, the occupancy level rose because of addition of only 34 rooms in FY17.

With the planned addition of 481 rooms in FY19, 281 rooms in FY20 and 577 rooms in FY21, we expect a decline in the occupancy rate from 77% in FY18 to 73% in FY21.



Exhibit 34: Premier-occupancy rate Exhibit 35: Premier- rooms added

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Brand- Lemon Tree (LT)

The charts below show that with zero room addition in FY16 and relatively lower addition in FY17 together with rising demand led to an improvement in the occupancy rate from 68% in FY15 to 77% in FY17. The addition of 199 rooms in FY18 led to a decline in the occupancy rate to 74% in FY18. With no expected room addition in FY19-FY20, we expect the occupancy rate to rise to 77% in FY19E.

Exhibit 36: LT-occupancy rate Exhibit 37: LT-rooms added

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Brand- Red Fox

We note the rise in the occupancy rate from 68% to 76% in FY18. We expect a marginal dip in the occupancy rate in FY19E before rising to 76% in FY20E.



Exhibit 38: Red Fox-occupancy rate Exhibit 39: Red Fox-rooms added

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Rising ARR

Average room rate or ARR has been rising steadily as the chart below indicates. The primary reasons for the growth in ARR have been stated earlier. They include rising domestic tourism, changing demand -supply balance in favour of hotels and a changing client mix.

ARR rose from Rs3,256/room in FY15 to Rs3,894/room in FY18. We expect continued growth in ARR during FY19-FY21, given the increasing popularity of LTHL because of its focus on ‘Value for Money’ amid rising domestic tourism.

Exhibit 40: Overall ARR Exhibit 41: Overall increase in ARR

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We have shown below the rising ARR for all three brands of LTHL in the charts below.

Brand- Premier

ARR increased by 8% in FY17 and by 16% in FY18 because of the reasons mentioned above. We have been conservative and assumed ARR increase of only 5% annually over FY19-FY21E.



Exhibit 42: Premier - ARR Exhibit 43: Premier - ARR increase

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Brand- Lemon Tree (LT)

The rate of increase in ARR has been muted relative to Premier. However, after a long period of low ARR, the increase ranged between 5% in FY16 to 9% in FY18. We expect the ARR increase to be muted in FY19-FY20E because of the increase in the number of rooms. However, we expect ARR to increase 7% YoY, given the improvement in the economy and the rising salary level accompanied by increased domestic travellers.

Exhibit 44: LT - ARR Exhibit 45: LT - ARR growth

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Brand- Red Fox

The rate of increase in ARR for Red Fox is the highest among all the three brands of LTHL. ARR increased from Rs2,179/room in FY15 to Rs2,860/room in FY18. With Red Fox being a full service hotel focused on middle-income cost- conscious domestic traveller, the attractive ARR is expected to maintain a strong occupancy rate.



Exhibit 46: Red Fox - ARR Exhibit 47: Red Fox - ARR increase

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Increase in the number of rooms

Overall, the number of rooms owned/leased by LTHL increased from 1,920 in FY13 to 3,250 rooms (currently). The number of rooms is expected to increase to 4,775 in FY21E.

Exhibit 48: Owned plus leased rooms

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Management contracts

Currently, management contracts account for 33% of the total rooms whereas owned and leased rooms represent the balance 67%. Going forward, the management aims at focusing its expansion plan through an asset-light model. The management plans to add 2,603 rooms in the next three years and increase the number of rooms by 54%. Out of the total expected room addition, 41% rooms shall be added through management contracts and the balance through owned and lease model. The management’s strategy is to successfully increase LTHL’s presence and take advantage of the upcycle without taking excess leverage.

Exhibit 49: Management contract rooms

3,250

1,593

4,775

2,671

-

1,000

2,000

3,000

4,000

5,000

6,000

Owned + Leased Management Contracts

(Rooms)

Current Rooms (FY18) Expected Rooms (FY21E) Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP

Revenues from management contracts posted a 83% CAGR over FY13-FY18. With 41% of planned room addition getting executed through the management contract route and the company’s focus on following an asset-light model, it will boost revenues from management contracts at a 25% CAGR over FY18-FY21E. Revenues from management contracts accounted for 3.6% of total revenues in FY18 and are expected to increase to 3.9% by FY21E.

Exhibit 50: Management contract revenues

0%

50%

100%

150%

200%

250%

-

50

100

150

200

250

300

350

400

FY14 FY15 FY16 FY17 FY18 FY19E FY20E FY21E

(%)(Rsmn)

Management Contracts Revenue Growth % Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP



EBITDA margin expected to improve

We expect revenue per room to post a 8% CAGR over FY18-FY21E driven by the rise in average revenue per room. Average revenue per room will increase because of the rise in demand for mid-income hotels and the shift of younger hotels into a mature phase where they can demand higher average revenue per room.

However, we forecast a modest rise in operating costs per room at 5% CAGR over FY18-FY21E based on historical operating expenses per room CAGR of 3% over FY13-FY18 and the management’s ability to maintain a low structure.

We have sub-divided major operating expenses into power and fuel, employee benefit, rent, commission, advertising and other expenses.

Employee expenses per room: Historically, employee expenses per room posted a 3% CAGR over FY13-FY18 and we expect a modest 5% CAGR in employee expenses per room over FY18-FY21E.

Rent expenses per room: Historically, rent expenses per room posted a 4% CAGR over FY13-FY18. Going forward, we expect a 7% CAGR decline in rent expenses per room over FY18-FY21E. We have considered an overall increase in rental expenses at 5% per annum, but with increased brand recognition of LTHL we believe the management will have the bargaining power to negotiate a lower rental expense per room.

Power and fuel cost per room: Historically, power and fuel costs per room posted a 4% CAGR over FY13-FY18. As a result of the rise in fuel expenses over the past one year, we have turned cautious and considered a CAGR of 8% for power and fuel costs per room over FY18-FY21E.

Advertising expenses per room: With the rise in brand presence of LTHL over the past decade, advertising and promotion expenses per room declined at a 4% CAGR over FY13-FY18. However, with expanding hotels in multiple cities over the next three years, we believe the company will incur higher advertising and promotion expenses per room, leading to advertising expenses per room posting a 8% CAGR over FY18-FY21E.

Other expenses per room: Other expenses mostly comprise printing and stationery expenses and also security and cleaning expenses. Historically, other expenses per room posted a 1% CAGR over FY13-FY18. We expect other expenses to post a 8% CAGR over FY18-FY21E.

With revenues per room posting a 6% CAGR over FY13-FY18 and operating expenses registering a 3% CAGR over FY13-FY18, EBITDA per room registered a CAGR of 16% over FY13-FY18. Healthy revenue growth and low operating cost structure led to expansion in EBITDA margin from 17% in FY13 to 27% in FY18.

Exhibit 51: Cost per room

Per room cost FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY21E

Power and fuel 124,578 118,582 132,461 134,430 135,577 148,487 166,311 177,564 187,176

Growth (%) - (5) 12 1 1 10 12 7 5

Employee benefit Expenses 293,536 276,928 303,494 310,105 342,001 335,502 352,319 371,474 393,444

Growth (%) - (6) 10 2 10 (2) 5 5 6

Rent expenses 75,307 59,533 60,070 59,858 82,831 93,827 83,836 82,022 74,292

Growth (%) - (21) 1 - 38 13 (11) (2) (9)

Commission- other than sole selling agents 6,328 5,146 8,366 13,442 19,658 21,440 23,818 25,430 26,807

Growth (%) - (19) 63 61 46 9 11 7 5

Advt+business promotion 14,214 8,325 12,127 10,225 10,678 11,646 12,938 13,813 14,561

Growth (%) - (41) 46 (16) 4 9 11 7 5

Other expenses 215,271 194,344 206,828 219,139 231,024 222,256 250,969 268,228 280,876

Growth (%) - (10) 6 6 5 (4) 13 7 5

Source: Nirmal Bang Institutional Equities, Lemon Tree DRHP



With the increase in the number of rooms from 4,697 rooms (currently) to 7,446 rooms in FY21 supported by the company’s ability to keep costs under control, we expect EBITDA margin to expand from 27% in FY18 to 34% in FY21E. LTHL is operating at ~75% occupancy rate level and we do not see any upside in the occupancy rate from here. However, we forecast a healthy rise in revenues per room primarily driven by ARR increase.

We have discovered a classic case wherein operating leverage plays a major role in driving EBITDA at 31% CAGR over FY18-FY21E. Room addition and ARR increase will drive a revenue CAGR of 23% over FY18-FY21E. However, the management has been very cost-efficient and historically maintained a low-cost structure coupled with the fact that a major portion of the costs incurred by the hotels is fixed in nature which will enhance operating margin of LTHL during the upcycle. Considering a similar low-cost structure is followed over the coming years, we expect operating expenses to post a 19% CAGR over FY18-FY21E. Exhibit 52: EBITDA and EBITDA margin

375 233

507

1,012 1,164

1,327

2,085

2,451 3,003

17%

11%

17%

27% 28% 27%

32% 33%34%

0%

5%

10%

15%

20%

25%

30%

35%

40%

-

500

1,000

1,500

2,000

2,500

3,000

3,500


(Rsmn) (%)


Net income and margins

Leverage acts as a double-edged sword which worsens the returns in business during economic downturn/business downcycle and maximises the earnings potential during economic upturn/business upcycle. Assuming the hotel industry sustains the upcoming upcycle over the next three to five years for reasons stated earlier, we expect an astronomical rise in the earnings of LTHL. During the downcycle of the hotel industry, especially caused by excess room addition, a major portion of the costs for a hotel company was fixed, leading to poor/negative earnings. LTHL has been no exception, which incurred losses for the period FY13-FY17.

Going forward, we expect the earnings of LTHL to post a 72% CAGR over FY18-FY21E driven by: 1) Demand growth exceeding supply (room addition) growth, leading to higher ARR. 2) Room addition (owned+leased+management contract) over the next three years. 3) Management maintaining its low operating expense structure.



Exhibit 53: Net income and margin

(868)

(668)

(468)

(268)

(68)

132

332

532

-25%

-20%

-15%

-10%

-5%

0%

5%

10%


(Rsmn)(%)

Net Income Net Profit Margins Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP

We expect depreciation to increase to Rs1,027mn in FY21E, posting a 25% CAGR over FY18-FY21E. Rise in depreciation is because of completion of 572, 281 and 656 planned room addition in FY19E, FY20E and FY21E, respectively. Fixed assets (excluding CWIP) currently stand at Rs14,489mn in FY18, which are expected to rise to Rs 28,508mn by FY21E.

Exhibit 54: Depreciation

-

200

400

600

800

1,000

1,200


(Rsmn)


We expect interest costs to rise to Rs1,351mn in FY21E, posting a 20% CAGR over FY18-FY21E. The increase in interest costs is because of the rise in debt from Rs9,670mn in FY18 to Rs 16,670mn in FY21E. The rise in debt is on account of 1,509 room addition (owned+leased) over FY19-FY21E which is partially funded through internal accruals and the balance through debt.



Exhibit 55: Interest costs

-

200

400

600

800

1,000

1,200

1,400

1,600


(Rsmn)




Balance sheet

With the rise in operating income from Rs801mn in FY18 to Rs1,976mn in FY21E, we believe the interest coverage at 1.5x as of FY21E will be sufficient to meet rising interest costs. Interest costs are expected to rise on account of the increase in debt in order to fund the planned addition of hotels.

During the downcycle, LTHL had an interest coverage ratio of less than 1. However, with the reversal of the cycle we expect EBIT to post a 35% CAGR over FY18-FY21E leading to an increase in interest coverage ratio from 1.0x in FY18 to 1.5x in FY21E. Despite the rise in net debt to equity ratio because of the ongoing room addition, improvement in operating metrics of LTHL supported by reversal of the cycle will provide support for servicing rising interest costs.

Exhibit 56: Interest coverage

0.3

(0.2)(0.0)

0.7

0.8

1.0

1.4 1.5 1.5

(0.4)

(0.2)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6


(x)


The net debt to equity ratio is expected to increase from 1.2x in FY18 to 1.7x in FY21E. The rise in this ratio is because of the increase in debt outstanding from Rs9,670mn in FY18 to Rs16,670mn in FY21E. The increase in the number of rooms (owned and leased) from 3,250 (currently) to 4,775 in FY21E will be supported by cash generated from internal accruals and raising additional debt, thereby leading to a rise in the net debt to equity ratio.

Exhibit 57: Net debt to equity ratio

0.5 0.6

0.7 0.8

1.0

1.2

1.4 1.5

1.7

-

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8


(x)




Historically, the working capital of LTHL remained negative primarily driven by higher payable days. Payable days averaged around 180 over FY13-FY18. Average receivable and inventory days of 28 and 20, respectively, during FY13-FY18 also supported the negative working capital cycle. We believe the negative working capital cycle will continue in FY19-FY21E driven by average inventory, receivable and payable days of 15, 41 and 231, respectively.

Exhibit 58: Working capital management

-

50

100

150

200

250


(Days)

Inventory Days Receivable Days Payable Days Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP



Cash flow

LTHL has been generating healthy operating cash flow ranging from Rs838mn-Rs1,836mn over FY14-FY18. Operating cash flow is expected to post a 26% CAGR over FY18-FY21E driven by the sharp rise in earnings and negative working capital. We expect a capital expenditure of ~Rs 11,044mn over FY19-FY21E, primarily representing expansion in the number of rooms. A part of the capital expenditure will be funded through internal accruals and the balance by raising additional debt.

Exhibit 59: Operating and free cash flow

-

500

1,000

1,500

2,000

2,500

3,000

3,500


(Rsmn)




Return ratios

LTHL has delivered a negative to low single-digit RoE and RoCE during FY13-FY18. Poor return ratios during this period were because of: 1) The industry going through a downcycle (excess room supply), leading to poor earnings performance. 2) The company was still in an expansion phase, leading to an increase in fixed assets.

However, we see a significant improvement in RoE and RoCE over FY19-FY21E on account of: 1) Upcycle in the hotel industry leading to a rise in demand for hotel rooms and thereby higher ARR. 2) Earnings delivery driven by operating leverage and room addition. 3) Asset-light model (room addition through management contract) leading to higher return ratios.

Exhibit 60: RoE and RoCE

(8)

(6)

(4)

(2)

0

2

4

6

8


(%)

RoE RoCE

Source: Nirmal Bang Institutional Equities, Lemon Tree DRHP

When we take a closer look into RoE by conducting a DuPont analysis, we can effectively conclude that the negative to low single-digit RoE during FY13-FY18 was on account of negative PAT margin magnified by higher financial leverage. Historical PAT margin ranged between 2.2% -(18.4)% and financial leverage was between 1.9x to 3x. Going forward, we expect the net profit margin to touch 6% by FY21E driven by the rise in ARR, room addition and a low-cost structure. The earnings growth will get magnified as the financial leverage ratio touches 3.5x by FY21E. Asset turnover is expected to increase from 0.2x in FY18 to 0.3x by FY21E because of aggressive room addition through the management contract route.

Exhibit 61: DuPont analysis

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

-25%

-20%

-15%

-10%

-5%

0%

5%

10%


(x)(%)

Net Interest Margin Asset Turnover Financial Leverage Source: Nirmal Bang Institutional Equities Research, Lemon Tree DRHP



Financial statement

Exhibit 62: Income statement


Net sales 4,119 4,843 6,427 7,371 8,948

Growth YoY (%) 12.0 17.6 32.7 14.7 21.4

COGS 1,011 1,280 1,564 1,786 2,173

Operating costs 1,289 1,510 1,815 2,030 2,431

Other expenses 654 726 963 1,105 1,341

EBITDA 1,164 1,327 2,085 2,451 3,003

EBITDA growth (%) 15.1 14.0 57.1 17.6 22.5

EBITDA margin (%) 28.3 27.4 32.4 33.3 33.6

Depreciation 510 526 710 807 1,027

EBIT 654 801 1,375 1,644 1,976

EBIT (%) 16 17 21 22 22

Interest expense 776 784 1,011 1,108 1,351

Other income 62 78 78 78 78

Others 36 48 113 42 63

Earnings before tax (24) 143 555 657 765

Tax- total 47 38 166 197 230

Rate of tax (%) N/A 26.5 30.0 30.0 30.0

Adjustments 2 (10) - - -

Net profit (82) 107 388 460 536

% growth N/A N/A 270.4 18.4 16.5

EPS (FD) (0.10) 0.14 0.5 0.6 0.7

% growth N/A N/A 270.4 18.4 16.5


Exhibit 64: Balance sheet


Share capital 7,812 7,864 7,864 7,864 7,864

Reserves and surplus 274 284 769 1,229 1,765

Net worth 8,086 8,148 8,633 9,093 9,629

Loans 7,987 9,670 12,470 13,670 16,670

Minority interest 4,284 4,286 4,286 4,286 4,286

Provisions 14 16 16 16 16

Deferred tax liability 68 43 43 43 43

Other non-current liability 213 286 286 286 286

Total capital employed 20,651 22,449 25,734 27,394 30,930

Property, plant and equipment 17,692 20,189 23,189 25,189 28,689

Investments - 26 26 26 26

Loans 109 162 162 162 162

Other non-current assets 3,513 2,823 2,823 2,823 2,823

Total non-current assets 21,314 23,200 26,200 28,200 31,700

Trade payables 604 811 991 1,132 1,377

Other current liabilities 840 1,294 1,294 1,294 1,294

Provisions (current) 23 27 27 27 27

Total current liabilities 1,467 2,132 2,312 2,453 2,698

Inventories 49 54 66 75 91

Investments 64 120 120 120 120

Trade receivables 314 525 691 792 968

Cash and bank balance 176 210 497 187 277

Loans and advances 5 3 3 3 3

Other current assets 196 470 470 470 470

Total current assets 805 1,382 1,846 1,647 1,928

Net current assets (662) (751) (466) (806) (770)

Total capital employed 20,651 22,449 25,734 27,394 30,930


Exhibit 63: Cash flow


Profit after tax (82) 107 388 460 536

Depreciation 510 526 710 807 1,027

Finance costs 776 784 1,011 1,108 1,351

Other income 62 78 78 78 78

Working capital changes 211 123 2 31 53

Operating cash flow 1,353 1,462 2,032 2,327 2,889

Capital expenditure (3,301) (3,031) (3,710) (2,807) (4,527)

Net cash after capex (1,948) (1,570) (1,677) (480) (1,638)

Other income/(expense) 941 739 78 78 78

Issue/(buyback of equity) 57 51 - - -

Proceeds/repayment of borrowings 1,739 1,683 2,800 1,200 3,000

Finance costs 776 784 1,011 1,108 1,351

Dividend & dividend distribution tax - - - - -

Others 24 (86) 96 - -

Cash flow from financing 1,044 865 1,886 92 1,649

Total cash generation 38 34 287 (310) 89

Opening cash balance 138 176 210 497 187

Closing cash & bank balance 176 210 497 187 277


Exhibit 65: Key ratios

Y/E March FY17 FY18 FY19E FY20E FY21E

Profitability and return ratios EBITDA margin (%) 28.3 27.4 32.4 33.3 33.6

EBIT margin (%) 15.9 16.5 21.4 22.3 22.1

Net profit margin (%) (2.0) 2.2 6.0 6.2 6.0

RoE (%) (1.0) 1.3 4.5 5.1 5.6

RoCE (%) 3.2 3.6 5.3 6.0 6.4

Working capital & liquidity ratios

Recievable (days) 29 41 41 41 41

Inventory (days) 18 15 15 15 15

Payable (days) 218 231 231 231 231

Current ratio (x) 0.5 0.6 0.8 0.7 0.7

Valuation ratios

EV/sales (x) 16 13 10 9 7

EV/EBITDA (x) 56 49 31 27 22

P/E (x) (700) 534 147 124 107

P/BV (x) 7.1 7.0 6.6 6.3 5.9




DISCLOSURES

This Report is published by Nirmal Bang Equities Private Limited (hereinafter referred to as “NBEPL”) for private circulation. NBEPL is a registered Research Analyst under SEBI (Research Analyst) Regulations, 2014 having Registration no. INH000001436. NBEPL is also a registered Stock Broker with National Stock Exchange of India Limited and BSE Limited in cash and derivatives segments. NBEPL has other business divisions with independent research teams separated by Chinese walls, and therefore may, at times, have different or contrary views on stocks and markets. NBEPL or its associates have not been debarred / suspended by SEBI or any other regulatory authority for accessing / dealing in securities Market. NBEPL, its associates or analyst or his relatives do not hold any financial interest in the subject company. NBEPL or its associates or Analyst do not have any conflict or material conflict of interest at the time of publication of the research report with the subject company. NBEPL or its associates or Analyst or his relatives do not hold beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of this research report. NBEPL or its associates / analyst has not received any compensation / managed or co-managed public offering of securities of the company covered by Analyst during the past twelve months. NBEPL or its associates have not received any compensation or other benefits from the company covered by Analyst or third party in connection with the research report. Analyst has not served as an officer, director or employee of Subject Company and NBEPL / analyst has not been engaged in market making activity of the subject company. Analyst Certification: I/We, Amit Agarwal the research analysts, and Mr. Akash Mehta research associates are the authors of this report, hereby certify that the views expressed in this research report accurately reflects my/our personal views about the subject securities, issuers, products, sectors or industries. It is also certified that no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst(s) principally responsible for the preparation of this research report and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations.



Disclaimer

Stock Ratings Absolute Returns

BUY > 15%

ACCUMULATE -5% to15%

SELL < -5%

This report is for the personal information of the authorized recipient and does not construe to be any investment, legal or taxation advice to you. NBEPL is not soliciting any action based upon it. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any such transaction. In preparing this research, we did not take into account the investment objectives, financial situation and particular needs of the reader.

This research has been prepared for the general use of the clients of NBEPL and must not be copied, either in whole or in part, or distributed or redistributed to any other person in any form. If you are not the intended recipient you must not use or disclose the information in this research in any way. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. NBEPL will not treat recipients as customers by virtue of their receiving this report. This report is not dire

institutional equities lemon tree hotels · 2018. 7. 12. · institutional equities 3 lemon tree...

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