Lemon Tree Hotels - In a comfortable space: Buy

The company is well-positioned to benefit from the upcycle in the hotel industry

From its listing this April at ₹56 a share, the stock of Lemon Tree Hotels had a strong run, rallying more than 50 per cent to ₹85 in early August. But the market weakness over the past few months has seen the stock lose about 20 per cent since August; it now trades at ₹67 a share. This decline provides a good buying opportunity for investors with a long-term perspective.

One, valuations have moderated from nearly 85 times EV/EBITDA in August to about 50 times now.

Next, Lemon Tree’s earnings are likely to continue growing at a smart pace, thanks to favourable industry dynamics — the company’s strong positioning in the mid-market space and its expansion plans.

This should moderate valuations further. That said, exposures can be limited since the Lemon Tree stock is a small-cap one with market-cap of about ₹5,300 crore; broader market weakness, if any, in the coming months due to election and macro-economic uncertainties could take a heavier toll on smaller stocks.

Sweet spot

The hotel sector in India is an upcycle with the supply of rooms slowing down and demand growth picking pace. Lemon Tree Hotels, with its focus on the high-growth mid-priced segment, is in a sweet spot amidst helpful industry dynamics. This is reflected in the company’s good financial performance over the past two quarters since listing. In a turnaround from losses in the year-ago periods, the company posted consolidated net profit of ₹2.3 crore in the June 2018 quarter and ₹5.7 crore in the September 2018 quarter. Revenue increased about 16 per cent Y-o-Y to ₹256 crore in the half-year ended September 2018, while cash profit (net profit plus depreciation) nearly doubled to ₹35 crore.

 

 

The good financial performance has been a result of improvement in occupancy levels, average daily rates (ADR), and revenue per available room (RevPAR), and increase in hotel rooms. Lemon Tree’s occupancy levels, already superior to many competitors, improved further to 77.5 per cent in the half-year ended September 2018 from about 75 per cent in the year-ago period. ADR grew 12 per cent Y-o-Y to ₹3,919 in the half-year ended September 2018, while ReVPAR grew 17 per cent Y-o-Y to ₹3,083. The total number of rooms in the company’s inventory increased steadily to almost 5,000 as of September 2018 from about 4,400 a year ago.

Lemon Tree is the leader in the country in the mid-priced hotel sector with three brands to address different segments across the value chain — Lemon Tree Premier, Lemon Tree Hotels and Red Fox Hotels. With a pan-India presence of 51 operating hotels, the company has ambitious expansion plans to benefit from the growth prospects in the sector. It has 33 hotels under development and expects to increase its room count to nearly 8,600 by FY 2021, an increase of about 70 per cent from current levels. In the near-to-medium term, the company plans to open Lemon Tree Premier hotels in high-demand regions Mumbai and Udaipur.

With the up-cycle in the sector expected to continue for a few years, healthy operating parameters, expansion in high-growth segments, and the shift towards an asset-light model through management contracts should help Lemon Tree grow its net profit at a strong pace. Nearly 60 per cent of the additional rooms will be under the management contract model, wherein, instead of building a hotel ground-up, Lemon Tree will re-brand and manage the property of smaller players for a fee and profit share.

 

 

 

While the expansion over the past few years has also resulted in an increase in debt levels, leverage (debt-to-equity) remains comfortable at under one time. The company expects the debt cycle to peak within a year.

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