Occupancy Struggles …

Bull markets are magical . It turns all and sundry into investing geniuses . In such a rising tide which lifts all boats , rarely any sector gets left out . When they do get left out , it could be for valid reasons . So is the case probably for the hospitality sector . In a market that is eager to discount prospects far far ahead , such an privileged isolation could be hinting at prolonged struggles for the hotels industry .

The industry suffers from problem of plenty . Main source of trouble for the industry arise from high degree of over capacity in prime locations . Renewed business optimism post the new govt. at the centre has scarcely touched this sector due to poor visibility of occupancy even on improved GDP outlook for the country . That probably explains the lack of enthusiasm from investors for hotel stocks in the ongoing bull run. Industry’s profitability will continue to be weak on low occupancy , muted ARR ( Average room rental) , heightened supply .

Cushman & Wakefield expects average occupancy in key markets of Delhi , Mumbai , Bangalore , Chennai and Kolkata to slide 5-7% in 2014 , even as the demand outlook improves on new govt’s policy actions to revive the economy . According to its report , several delayed hotel projects will become operational on renewed funding ( as the investment/ lending climate improves) this year adding to the already burdened supply leading to downward pressures on occupancy and rental yields. This not-so-rosy report has come at a time when the general business optimism has surged on hopes of policy actions from the new govt.

Hotel industry is a highly capital intensive one . As with any other sectors that are capital intensive , the supply hits the market in quantum while the demand growth is incremental , leading to mismatch in demand and supply . When that dynamics gets compounded further by downturn and funding constraints , the mismatch can get worse as spurt of supply gets released as the funding eases when the macro is about to turn for the general economy .

Going by the price actions in the hospitality sector , market expects the turnaround to take much longer time and hence the indifferent treatment ( relative underperformance) to this sector when all and sundry are on the rise . No surprise that many of the sector stocks are available at attractive valuations esp in mid and small cap space on many valuation metrics including price to book . This anomaly could turn to an mispriced opportunity if the demand growth takes much shorter time to catch up with the excess supply . Given the lack of value opportunities in the market that is on steroid since the election outcome , this sector could be safe place to hide even if there is time risk for the turnaround , as eventually at some point the supply pressures come off . Since book value rarely captures the hidden real estate value of hotel properties , undervaluation by this metric makes the opportunity extremely attractive .

Happy Value Investing …

ArunaGiri . N