Book a room and wait out the renovations

The split A and B share structure of the specialist hotel fund caters for two very different types of investors. The A shares are essentially a low-risk option for those looking for a predictable and steadily rising dividend stream as A shares have a preferential claim to earnings with growth virtually guaranteed at a capped 5%/year. Hospitality A is trading at an attractive forward yield of more than 9%, a substantial discount to the listed property sector’s average 6,5%. But it is the more volatile B shares that are looking particularly cheap at close to 13%, which places them as the highest-yielding among all 40-odd counters that comprise the JSE’s R365bn listed property sector. However, the B shares are suited only to investors who have a high risk appetite as they share in the income only after A shareholders have been paid. So B shares are effectively a geared play on hotel operating earnings, which tend to be highly cyclical.

Hospitality is SA’s biggest multi-branded hotel owner, with 26 hotel and resort properties in its R4,8bn portfolio. Flagships include the Arabella Hotel & Spa in the Cape Winelands, the Mount Grace Country House & Spa in the Magaliesberg, the Radisson Blu Waterfront in Cape Town and the Crowne Plaza in Johannesburg’s Rosebank.

Last year, Hospitality B was the JSE’s worst-performing property stock, with a total negative return of -58%. The share, which used to trade around R12 during the 2010 soccer World Cup heydays, dipped to a five-year low of R1,70 in December. That followed the release of a trading update in which Hospitality CEO Andrew Rogers warned that industry conditions for the six months to December were “tighter” than anticipated.

Occupancies came under pressure due to reduced international travel as a result of the Ebola epidemic and fewer arrivals from Asian countries on the back of stricter visa requirements. Foreign tourism makes up about a third of the fund’s business. Restricted government spending on business travel in line with cost-saving measures imposed by the finance ministry also contributed to lower demand for hotel rooms, said Rogers.

As a result, the distribution payout for B shares is expected to be at least 45% lower than forecast when Hospitality announces its interim results later this month. The A shares will still receive the usual 5% growth in payouts.

Notwithstanding the negative trading update, the B shares have recovered about 30% over the past month after a number of high-value trades. For example, Kagiso Asset Management and Peregrine Equities increased their respective stakes in the B shares.

While earnings growth has been temporarily dampened, there is an expectation that the local hotel industry will continue to record a steady rise in occupancies and revenues over the next few years.

According to research group STR Global’s latest SA hotel review, overall occupancies for the four months ending October rose 1,8% year-on-year to 63.7%. That’s up from around 56% in 2011 when local hotel occupancies hit a post-World Cup slump.

Average daily rates increased by 5,8% to R973 in the four months to October, resulting in revenue per available room growing by 7,8% to R620.

Industry players say there is a limited number of new hotel projects in the pipeline for SA, which bodes well for continued revenue and occupancy growth over the next few years. Foreign tourists are also likely to resume travel to SA thanks to a still-weak rand and a subsiding of the perceived Ebola threat.

Hospitality B shares are a good bet for bargain hunters who can afford to sit tight for the next two to three years while the fortunes of the local hotel industry improve.