Utilisation of new funds key for Indian Hotels
If chunk of rights offer money is used for expansion, it may prove to be earnings-dilutive
Indian Hotels’ plan to raise ~1,500 crore to fund capital expenditure, growth plans and for debt repayment has not gone down well with investors. The announcement by the company during market hours led to the stock shedding three per cent at close on Monday. The market reaction, however, may not be justified entirely.
While the company has not spelt out how the proceeds would be utilised, analysts expect it to be a mix of capex and debt repayment. Analysts say the company could use half the proceeds to fund the development of its Mumbaibased Sea Rock property while the other half could be used to retire its consolidated net debt which, as of June 30, 2017, stood at ~3,100 crore.
If this is the way things pan out, earnings will be dilutive over the medium term. Said an analyst at a domestic brokerage, “If the entire proceeds are used to repay debt, it would reduce the company’s leverage by half and will be positive, but if the company develops its Sea Rock property which is likely, earnings as well as return ratios on an expanded equity base will not improve in any meaningful manner in the near- to medium-term.” While the company has not announced the issue price and the rights offer ratio, analysts expect a double-digit dilution in equity capital but expect the property to come up only over the next two years.
For instance, if half of the proceeds or ~750 crore is used to repay debt, the overall debt will fall by 25 per cent. Given annual interest costs of ~260- 280 crore, it will save around ~70 crore annually. This should benefit the earnings as equity capital will increase by only 13 per cent at the current market price. But, a part of the savings could get offset by tax. So, the mix of the new fund utilisation is crucial.
Meanwhile, on the operational front, the company continues to be pulled down by the performance of its international hotels. Though the international subsidiaries contribute to 40 per cent of revenues, their share of operating profit is 13 per cent with margins at 5.6 per cent, which is less than a third of standalone margins. International operations posted a five per cent decline in revenues in the June quarter (Q1), prompting analysts to cut their revenue estimates for FY18 and FY19. But, they have maintained operating profit margins (at 17-17.5 per cent) given the sale of loss-making Taj Boston in FY17.
The company had earlier indicated that gross debt had peaked and it would look at reducing debt with the sale of Taj Boston being one example. It could reduce debt further if it were to sell more of its other international operations as well as monetise some of the 900 acres of land in its possession. The company had advocated that it would follow an asset-light model and focus on management contracts to keep debt in check.
In addition to debt reduction, the other trigger was the recovery in domestic demand. Rashesh Shah and Devang Bhatt of ICICI Securities expect occupancy levels to improve further due to slowing down of capacity additions coupled with a rise in spending by domestic travellers. Given higher demand, average room rents have already increased by 1.7 per cent, while occupancies increased by three per cent in FY17.
While the Indian Hotels’ stock is not expensive at an enterprise value to room metric valuation basis at ~1.9 crore per room against the industry average of ~3-3.5 crore per room, details of rights offer, quantum of earnings dilution and improvement in international operations are deciding factors going ahead.