Chalet Hotels IPO review – attractive business, but high debt a cause of concern

The initial public offer (IPO) of Chalet Hotels provides an option to invest in one of the few luxury hotel ownership chains in India with a growing presence in the segment and positioned to benefit from the current positive upcycle in the hospitality industry.

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About the company

Incorporated in 1986, Chalet, earlier know as Kenwood Hotels, is the hospitality arm of the K Raheja group. The company is the owner, developer and manager of upscale hotel properties in key cities in India. It has a brand partnership with Marriott with 90 percent of total hotel rooms managed by Marriott, and the rest self-managed by Chalet.

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What we like about Chalet Hotels

Sound operating performance – the company has reported a decent operating performance with revenue growth and operating margins of around 34 percent, higher than peers. Performance in H1FY19 was hit by foreign exchange losses.

Ownership model and favourable dynamics – Chalet is an ownership-based model, a quasi REIT structure. Majority of the profits and losses of its hotel properties come to the company with around 6-7 percent of revenue going to brand owners. Company is positioned to grab most of the benefits from the current upcycle in the hotel industry with a positive demand-supply situation.

Low-cost development and group benefits – Coming from a real estate group, the company has in-house expertise in the development of properties, procurement of land as well as low-cost material in bulk. This helps in bringing overall costs down, benefiting the margins.

Higher pricing power given the association with a strong brand – association with a strong brand like Marriott gives it a greater pricing power, which can help in fetching a premium over the average rates. Moreover, this also enables improved occupancies and RevPARs.

Reduction in FX exposure – around $70 million (Rs 500 crore) of the current debt is in the form of foreign currency loans. Consequently, adverse currency movement severely impacted profitability in H1FY19. The company plans to pay off around two-thirds of this exposure from the proceeds of the issue. This would help in reducing forex exposure.

Attractive development pipeline – the company has an attractive portfolio of new assets and expansion in existing assets scheduled to flow in from 2021. This will provide a boost to revenue.

What makes us cautious on the IPO

High debt on balance sheet – The decent topline growth has come in at the cost of accumulated debt on the balance sheet of Chalet Hotels. The company has a debt-equity ratio of 5.3 times as of September 30, 2018. After repayment of the debt from the issue proceeds, this will go down to 3.7, still much higher than the industry average. Considering the asset-heavy model and capital intensive nature of the business, the debt limits the future expansion potential of the company.

Fixed charges could impact the company’s performance in times of a slowdown and this is a major cause of concern.

Highly cyclical industry – the hotel industry is highly cyclical with a close relation to economic growth. While the company will benefit from the upcycle it is also vulnerable to the industry downcycle, especially due to its high leverage. Any mismatch with the operational cycle and an economic weakness could aggravate the debt problem. With a debt coverage of only 1.3 times, the company’s performance could be substantially hit in a downcycle.

High Occupancy – the company is already operating at a good occupancy rate of around 70 percent. Given this, there is little room for growth from the occupancy route in the future.

Peer Analysis and valuation

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On analysing the performance of the company with its listed peers we see the topline growth in the past two years has been above the average peer growth. The earnings before interest, tax, depreciation and amortisation (EBITDA) margin is also ahead of peer average. However, the growth has come at a price and the company has accumulated debt on its balance sheet. Despite repayment post issue, there would be substantial debt on the books which could be a concern in down times. The company has an interest coverage of only around 1.3 times.

At the higher price band, Chalet’s IPO is priced at an EV/EBITDA (enterprise value to EBITDA) of 25 times in line with peers.

While we find the business attractive, the asset-heavy model resulting in heavy debt on the books is a major area of caution for investors. We would recommend only high-risk appetite investors with a long term view to look at subscribing to the stock.

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