Will the hotel industry bounce back?

Decoding the fundamentals and revival of the hotel industry

With most of the Covid restrictions being lifted in the country and the buzz around the upcoming Oyo IPO, will the Indian hotel & tourism industry bounce back?

An important and obvious note we would like to make is that since most hotel visitors are tourists, the hotel industry bears high correlation to the tourism sector, and hence success is hugely dependent on it. 

Thanks to the geographic and cultural diversity of India, the tourism and hospitality industry contributes roughly 6.8% to the GDP of India, employing 8% of the country creating 39 million jobs. Not only does it make up a significant source of foreign exchange for the economy, it is a crucial medium of engaging in global trade. With a cumulative FDI inflow of US$ 15.65 billion between April 2000 and March 2021, international tourist arrivals are expected to generate revenue over US$ 59 billion by 2028.

An important metric here is the number of foreign tourist arrivals (FTA) a country has witnessed, and measuring the foreign earning exchange (FEE), i.e.. how much revenue is generated from these tourists. Since Indian hotels, on an aggregate, have taken a hit of more than Rs. 1.30 lakh crores (US$ 17.81 billion) in revenue due to the impact of the COVID-19 pandemic, we would consider numbers of 2019 as the latest, so as to be unbiased. 

During 2019, foreign tourist arrivals (FTAs) in India stood at 10.93 million, achieving a growth rate of 3.5% y-o-y. During 2019, FEEs from tourism increased 4.8% y-o-y to Rs. 1,94,881 crores (US$ 29.96 billion).  A better depiction of the increasing FTAs and FEEs are here:

Fundamentals

A hotel, anywhere in the world, pretty much works the same way. First, a building / establishment is constructed or leased, and travelers are offered boarding and lodging services in the broadest sense. However, services have evolved to a lot more today and hotels, along with rooms now provide food and drink, rooms for parties and conferences, and some locality specific special services. 

If classified by types, there are mainly 3:

1. Branded 

2. Unbranded or independent

3. Alternate accommodations

The local and independent make up close to 70% of the total available rooms, though international hotel chains are increasing their presence in the country. Alternate accommodations include those special categories of hotels that provide special services to their customers. Luxury camping, tent hotels and villa type residence hotels form this niche category.

Studies suggest that an increasing number of branded hotels are moving from asset heavy models (buying/leasing land) to a more consumer based business, i.e. franchising. Excellent long standing brands like Holiday Inn, Hyatt, Marriott, etc. specialize in the hotel segment and are very well versed with consumer behavior and management. They are good at running the business and leverage their brand name to gain the trust of travelers. They keep a margin of the profits from the hotel owners in exchange for their services. And new entrants who buy land or establishments with the view to run a hotel business find this arrangement perfect since all they have to do is trust the brand whom they have allowed to run the show.

Revenues, quite intuitively, are earned by room rents, food and drink, conference room rents and sometimes extra services that a few hotels provide like travel to tourist destinations, guides, etc.

Here, success of the brand is dependent on the level of customer satisfaction achieved, for both domestic as well as international tourists.

Risks

Though lucrative, the hotel business is a risky one. For starters it has a high entry barrier if you want to conduct business and own the land, both. 

Customer satisfaction is the most crucial metric that spells success in this field, and achieving that requires not only extensive investments in employing excellent staff but also upkeep of rooms, taking care of catering and a whole lot more.

Managing a hotel brand is no easy task. It requires skill, expertise in understanding human psychology and experience to build a brand people can rely on. Moreover, managing the working capital of a hotel to honor commitments to customers and staying profitable throughout is a skill not everyone can master. Excellent management is a must.

Though India attracts tourists for its beautiful landscape and diversity, it is still not that active in international business as other countries. Sporting events, concerts of international artists and other such events are much less in number compared to other countries, and such contribute hugely to their revenue and foreign exchange. 

Then came Covid, the biggest bust. Hotel and tourism are amongst the most disrupted industries. Business was zero, but certain fixed costs still had to be paid and hence losses were massive. Many of them shut down within 6 months of the lockdown due to a cash crunch and more were up for sale at meagre values. Thousands of employees were laid off and this was one of the main factors driving the Indian GDP downhill. 

Hotel brands dealing in the luxury segment still managed to stay afloat, but the wrath of covid-19 was devastating for the mid-market segment. Many of the containment zones still have restrictions for hotels to operate at full capacity. 

However, things are coming back to place and a staggered revival is fanning hope for hoteliers. Since international travel is still restricted to a few places, people have started exploring local places of interest. People tired of WFH are taking short trips and weekend getaways which has driven demand for local hotels. Also, the quarantine period for intercity and international travelers leads to extended stays of 14 days and somewhat makes up for the lost revenue. 

Not to mention the added costs to those for sanitizing the premises and maintaining other safety protocols. 

Positives

However depressed the industry looks, there is some ray of light at the other end. Since lockdowns are being lifted slowly and gradually people have started reconsidering travelling. Not only as a leisure activity,  but travelling is now being seen as a trend. The rise of  full time travel bloggers of this generation along with the advent of social media has promoted travelling as an activity extensively. People want to explore their own country and different kinds of trips like camping, stargazing, trekking are new themes that people are growing fond of. Special mention to 'staycations', where one chooses to stay at a luxurious hotel for a few days to revive themselves of stress and rejuvenate. Many hotel chains have responded by curating special experiences and selling them as staycation offers.

The NaMo impact has been great too since the government has been promoting tourism and especially  domestic tourism for quite some time now. It also incentivizes people to set up new businesses in the tourism sector.

In the time of rapid urbanization and increase in the number of working women, the disposable income of families is rising substantially contributing to more funds spent towards travel and leisure.

The hospitality sector also boasts of certain structural benefits that are not a feature of all Industries like flexible Working Capital Management.  Fixed costs are difficult to eliminate and a problem of asset heavy industries which makes them capital-intensive. However, since the main cost of hotels is the staff they employ, those costs can be pretty much managed in a more flexible way than other assets depending on the business and financial situation at hand.  Though this may sound basic, it can make a huge difference to profitability over the course of business.

Invest!

The hotel industry is not cyclical, but it is seasonal. It's likely that rooms are fully occupied during festivals or the Indian wedding season (November-May). Places hosting events also witness sufficient crowds. Other times, hotels are usually medium to sparsely populated. 

A good hotel brand makes anywhere from 15 to 40% of net income (excluding outliers). It has been proven that hotels in the luxurious segments make the highest profit margins. For an investor, an important metric to check while analyzing hotel companies is the revenue per room. This in turn along with other basic costs reflects the gross margins of the business.

Success of a good hotel chain is directly proportional to the level of customer satisfaction he or she derives. A reputed name, an excellent management are keys to a successful hospitality sector company. No doubt that IHC by Tata is regarded as one of the best chains.

In addition they should also be able to handle their working capital in an effective way. Special mention to Oberoi hotels that have a lower than industry debt to equity ratio.

In the era of the internet, having a good online presence gives rise to the number of direct bookings. Adaptability to the internet and a great User experience is vital. Oyo has done a commendable job as regards to providing at par customer service even in budget hotels and a seamless online booking workflow. Watch out for their IPO coming in the later months of this year.

All in all, the pandemic has sent some of the hotel stocks to the bottom and the gradual revival of the economy as well as travel can offer an opportunity to make handsome returns. Here are  some stocks you can bet on (analyst recommendations):

In a nutshell, the hotel industry was stalled owing to the pandemic. But adaptability and innovative solutions offered by hoteliers, along with reopening of the economy and reviving domestic demand can be drivers of growth.