Fundamental Radar: 10 reasons why Lemon Tree Hotels could rally over 30% from current levels

Lemon Tree Hotels, part of the hotels industry, has fallen more than 20% from December 2022 highs but improvement in profitability, strong balance sheet as well as cost mitigation efforts will support future stock price movement.

Long-term investors can look at buying the stock after the recent fall for a target of Rs 108 in the next 12 months, suggest experts.

Lemon Tree Hotels is India’s largest hotel chain in the mid-priced hotel sector, and the third largest overall, based on controlling interest in owned and leased rooms.

“Consistent improvement in profitability will drive cash flows, which will help in strengthening balance sheet and return profile in the coming years,” Kruttika Mishra, Research Analyst at Sharekhan by BNP Paribas, said.

Lemon Tree portfolio comprises seven brands catering to both the leisure and the business segments across tier-1 and tier-2 urban centres and tourist destinations.

The Indian hotels industry witnessed strong growth in H1FY23 on the back of higher room demand after months of low occupancy and falling average rates due to the COVID-19 pandemic.

The industry upcycle is expected to last for the next 4-5 years, as room demand is expected to exceed supply in the coming years.

Lemon Tree Hotels is one of the strongest brands in the mid-market segment with a 17% market share in India and is well poised to benefit from the upcycle.

Kruttika Mishra, Research Analyst at Sharekhan by BNP Paribas highlights 10 factors why Lemon Tree is a strong buy:

Rooms:
LTHL currently operates ~8,300 rooms in 85 hotels across 52 destinations, in India and abroad, under its various brands viz. Aurika Hotels & Resorts, Lemon Tree Premier, Lemon Tree Hotels, Red Fox Hotels, Keys Prima, Keys Select and Keys Lite.

It has 8,303 rooms under various brands (including Lemon Tree, Red Fox and Keys) and is planning to add another 2,605 rooms over the next three years.

Based on the current pipeline, the company’s total operational inventory will be ~10,900 and 115 hotels by 2025 from 8,303 rooms and 85 hotels at Q2FY23-end.

Occupancy:
The company’s recovery in occupancy (on like-to-like basis; hotels operational in FY2020 and FY2023) recovered to 94% compared to 98% for overall industry in Q2.

Recovery is little less compared to industry as a large number of the company’s revenues comes from corporate/business travels which is around 52% of total revenues.

Some of key markets such as Gurgaon and Bengaluru (25% of LTHL room inventory) where 80% demand comes from corporate travellers is yet to post recovery close to pre-COVID level.

However, recovery in corporate/business travel is expected to reach 100% of pre-COVID level in H2FY2023. Further, LTHL’s owned/leased room inventory has gone up by 28% to 5,090 rooms in Q2FY2023 compared to 3,975 in Q2FY2020. New room additions also had an impact on the overall occupancy.

Average Room Rentals (ARR):
LTHL’s gross average room rentals (ARR) were up by 19% to Rs. 4,917 versus Q2FY2020 and 2% higher on a sequential basis. Key brands such as Lemon Tree Premier, Lemon Tree Hotels and Red Fox by Lemon Tree Hotels witnessed ARR growth of 16%, 22% and 23%, respectively of Rs. 3,500-6,000 per room.

The management is confident that ARRs will be ~Rs. 5,000 per room in H2FY2023 due to sustenance of strong demand from leisure and recovery in corporate travel coupled with incremental demand from foreign tourist arrival.

With room demand and occupancies expected to remain high, we expect ARR to increase by mid-to-high single digit over the next two to three years.

Asset Light Model:
In FY18, out of LTHL’s total room inventory of 4,870 rooms, 32.7% rooms were under management contracts while the remaining 67.3% were owned or leased.

However, the company has adopted a change in its operating model and is now planning to expand its portfolio by entering into management contracts to achieve inorganic growth.

Management contracts enable the company to achieve expansion in an asset light way and thus will not lead to a stress on the company’s balance sheet.

Revenue:
LTHL’s revenues grew at a CAGR of 18% over FY2018-20 largely driven by an 18% increase in the room inventory over the same period.

RevPar remained almost stable over the same period as the pandemic hit occupancies at fag-end of FY2020 (grew in double digits in FY20 versus FY19).

With strong and sustained demand for rooms after two years of lull, the RevPar growth is expected in double-digits for LTHL. This along with increase in the room inventory will help the company to clock a 44% CAGR in revenues over FY2022-25.


Cost Mitigation:
Cost mitigation efforts taken during the pandemic period will continue to throw benefits in the upcycle years as well. Thus, we expect EBIDTA margins to reach 49% in FY2023E (EBIDTA margins stood at 46% in H1FY2023; expected to improve to 50% in H2FY2023).

With an uptick in occupancies and expected improvement in ARRs, EBIDTA margins will further improve by ~200 bps over the next two years to 51% in FY2025E.

Cash flows:
With strong improvement in the profitability, the company will generate higher cash flows (it clocked operating cash of Rs. 130 crore in H1FY2023), which will take care of funding of the capital expenditure over the next two years.

Reduction in Debt:
The company plans to reduce debt on books by Rs. 100-150 crore per annum from FY2025 (debt will remain stable at Rs. 1,700 crore over FY2022-24).

Improvement in Profitability:
With strong improvement in the profitability and higher cash flows, the company’s return profile is expected to in the coming years with RoE/RoCE standing at 19.2%/12.1% in FY2025 versus 13.8%/9.2% in FY2023.

Valuation:
Consistent improvement in profitability will drive cash flows, which will help in strengthening the balance sheet and return profile in the coming years.

The stock has corrected by 20% from its recent high and is trading at 15x/11.6x/9.6x its FY2023E/24E/25E EV/EBIDTA, which provides a strong opportunity to enter the emerging hospitality play.

“We initiate a viewpoint on LTHL with a positive view and a target of Rs 108,” said the Sharekhan note.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)