Aviation and hospitality stocks — value buy or false bottom?

The deadly coronavirus is a ‘ticking time bomb’ is what the boffins are saying, and investors around the globe would agree to that. It has been a rollercoaster year. What weakening economic growth, credit crunch and consumption slowdown together could not do in more than a year, the virus achieved within a week —triggering the sharpest fall in twenty years.

Just like the virus does not discriminate between the rich and the poor, the fear that it has caused has not discriminated between sectors. Be it defensive sectors such as FMCG and pharma or cyclical ones such as auto and infra, each one has succumbed to aggressive selloff, but may be we haven’t seen the worst yet. “There could be a significant earnings cut across the sectors as the economic growth recovery would be hampered and hence delayed,” says Rahul Singh, CIO of Tata Mutual Funds.

Most analysts fear the worst is due over the next few quarters. Axis Securities’ head of fundamental research Pankaj Bobade believes Indian equities will continue to bleed until global markets recover. “The number of (COVID) cases in India may be less when compared to the US or Europe, but these countries provide liquidity to our markets,” says Bobade. And as investors turn to cash and safe haven during these times of uncertainty, foreign investors have pulled out over Rs.580 billion from India in this month alone (as on March 26). The rupee has also not been spared either with the currency hitting a record low of 76.15 against the dollar on March 23.  

The contagious disease has forced several countries to implement a complete lockdown, making aviation and hospitality sectors the worst victims of this outbreak. “People are avoiding travel. So, hotel and aviation, which are heavily dependent on tourism (leisure and corporate), will be adversely impacted,” says Bobade. 

Stocks of companies such as IndiGo, SpiceJet, Indian Hotels and Lemon Tree Hotels have fallen anywhere between 30% and 55% over the past one month. But as legendary investor Warren Buffett says, “Be fearful when others are greedy and greedy when others are fearful,” investors can view the current scenario like a fire sale and pick good stocks once the market bottoms out.

Though the stocks are quoting 30-80% below their highs, in terms of valuations they are not exactly screaming buys.

IndiGo

Airline stocks have been facing turbulent weather for quite some time now (See: Clipped wings), especially considering what went down with Jet Airways in 2019. But Indigo was quick to capitalise and turn investor attention towards itself. The low-cost carrier was the biggest winner of Jet Airways’ fall, as it lost no time in grabbing domestic market share, which rose from 39.7% in FY18 to over 47.9% currently. The company aggressively expanded its flight service over the past one year. For 9MFY20, it reported net earnings of Rs.6.25 billion from a loss of Rs.4.33 billion in the same period in last financial year. This was driven by stable oil prices, low cost structure and aggressive pricing on new and existing select routes to boost passenger market share. This performance was reflected in its stock price, as it hit an all-time high of Rs.1,898 in September 2019. 

But the aviation business is not an easy one, as the company posted a weak Q3FY20 owing to a delay in delivery of new aircraft and volatility in fuel prices. That, followed by the onset of coronavirus severely dented business with the stock falling to a 52-week low of Rs.765 on March 24, locked in the 10% lower circuit. According to CAPA, IndiGo and SpiceJet together could suffer losses of up to $1.50 million in Q4FY20 and Q1FY21. It also stated that IndiGo’s “enviable free cash reserves may almost be wiped out”. “IndiGo with its Ebitda at Rs.19 billion is significantly below our estimate due to higher-than-expected maintenance costs,” wrote Jal Irani, an analyst at Edelweiss in his February report. Adding to its woes, Indigo’s yield was flat with 1.2% growth YoY due to increasing competition for metro routes and high base of the previous year.  

The concerns are reflected in its valuation with the stock trading at an EV/Ebitda of 5.07x, which is much below its all-time high of 13.82x, in September 2019. In fact, on March 16, its valuation fell to an all-time low at 4.97x. That is expected to re-rate once the impact of coronavirus subsides. According to analysts at ICICI Securities, “IndiGo’s competitive advantage typically widens in times of distress and results in market share gain as seen in the past.”

SpiceJet

The other low-cost carrier is flying through similar choppy weather. Besides challenges of the aviation sector, it is also facing intense competition from the likes of IndiGo and GoAir. “Deployment of capacity on highly competitive erstwhile Jet Airways routes coupled with weakness in demand resulted in a 7% decline in yields,” noted analysts at SBI Caps Securities. For 9MFY20, the company reported a loss of Rs.1.20 billion due to a combination of factors. With the company making losses, promoter and CMD Ajay Singh pledged 2.78% of his shares in November 2019 to “secure a credit”. According to reports, the company had cash and equivalents of Rs.1.15 billion in September 2019 and a negative net worth of Rs.8.50 billion.

Due to the Boeing crisis, the government had ordered the grounding of 737 Max aircraft. SpiceJet is the biggest loser with 42 of its aircrafts being grounded, that’s 37% of its fleet since March 2019. The airline also hired additional Jet Airways staff and some old planes of the defunct company, which further increased maintenance and employee cost. While fuel, power and electricity costs have gone up by 34.48% to Rs.35.31 billion, employee cost also rose by 50% to Rs.11.57 billion. That coupled with rising fuel prices did not help SpiceJet’s case over the past few months.

As dark clouds continued to loom over SpiceJet, coronavirus wreaked more havoc. With Spicejet and Indigo having exposure to international routes, they will take a hit due to the outbreak. “International air route mix remains 19% and 25% in IndiGo and SpiceJet, respectively, making it susceptible to the coronavirus outbreak,” states a report.

The only silver lining is the massive drop in crude oil price. The price war between OPEC and Russia has hammered the commodity as imbalance between supply and demand only gets worse. The weakness in demand triggered by coronavirus has also played a part in making oil cheaper. At one point in the first two weeks of March, Brent crude fell by over 40% to $33 per barrel from $62 per barrel in Q3FY20. Subsequently, ATF prices are also at their lowest since September 2017.

As fuel accounts for around 30% of its overall expense, SpiceJet is expected to benefit from the fall and expand margins. “This is a piece of good news and will provide some respite to the aviation sector,” says a market expert.  However its important to note that, despite the drop in crude prices, the fuel cost for Spicejet stood at Rs.13.41 in Q3FY20 compared with Rs.9.68 billion in Q3FY19.

The sharp fall in the stock price has pulled down valuation. From an all-time high of Rs.152 in August 2019, the stock has fallen to a 52-week low of Rs 30.65, contracting its valuation to 1.92x EV/Ebitda, on a trailing basis.

Indian Hotels

Just as it has with aviation, the virus has eaten into hospitality sector too (See: Collateral damage). The Tata Group-owned Indian Hotels has fallen 28% since the last week of February. The management last month acknowledged the impact of coronavirus on its business, but refused to quantify it.  They asserted that the company is still collecting data and will be able to give a clear picture soon. While they are counting their losses, the market has already started discounting them.

Analysts have cut their revenue forecast for Indian Hotels as travellers hibernate. “It garners only 15% of income from corporates, implying that a major chunk of revenue comes from leisure tourism. With the outbreak of the coronavirus, we believe the business could be affected with individuals cutting down their travel,” says Rashesh Shah, analyst at ICICI Securities. He estimates the company’s topline to grow in single digits at 5.9% CAGR to Rs.50.63 billion between FY19 and FY21. Occupancy across the industry was hit by 12% in the first week of March and fall in demand due to various reasons might also affect the company’s profitability in near term.

The coronavirus pandemic will add to woes of the sector that was already suffering due to fluctuating demand in FY20 on the back of weak economic growth, political unrest and the Jet Airways crisis. Despite these challenges, the company’s topline and profitability improved, indicating that underlying fundamentals remain intact. The company saw a strong performance for 9MFY20. Its revenue increased by 5.45% to Rs.34.94 billion and net profit doubled to Rs.2.83 billion. In its investor presentation, the company claimed that they saw the best nine-month performance in a decade.

The rooms under management contracts, where they operate rooms but don’t own them, have risen from 31% in March 2018 to 42% in January 2020. This asset-light model strategy along with the reduction in overhead cost has led to an expansion in margin over the past eight quarters. In Q3FY20, its Ebitda margin increased by 565 bps YoY to 31%. 

The company is also working on refinancing and reducing its debt. “We expect debt reduction to continue with lower capex and divesting non-core assets,” says Shah. Its net debt-to-equity ratio dropped from 2.11x in March 2019 to 1.76x in December 2019. The chain also opened nine hotels in the past nine months, which means its capex will reduce in the coming quarters. 

The stock currently trades at EV/Ebitda of 11x, a sharp correction from 22.75x in June 2019 – when Indian Hotels was trading at an all-time high. But it is still above its 15-year low of 4.9x EV/Ebitda seen in December 2008 but lower than its 15-year average of 19.7x.

 Lemon Tree Hotels

One of India’s largest hotels chain, which runs both economy and upscale properties, posted a steady third quarter in FY20, defying an economic slowdown with capacity expansion. Its revenue grew by 39% Rs.1.99 billion in the quarter as the number of owned, leased and managed rooms increased 7,786. At the same time, operating profitability also improved with the Ebitda margin rising by 260 bps to 35% because of a reduction in expenses and operating leverage. Meanwhile, its employee to net sales ratio has remained stable at 21% in Q3FY20. 

The company continues to be in the growth phase, especially after completing the acquisition of Keys Hotel last year. For 2020, it has commissioned 584 rooms in the upscale and upper-midscale categories. Subsequently, the debt-to-equity ratio is touted to rise from 1.4x in FY19 to 2x by the end of FY20. It also plans to add 748 owned/leased and 1,925 managed rooms in the next two years. The rise in debt could be a matter of concern in the current situation. "Lemon Tree Hotels, being on a capex mode is significantly levered with a debt-to-equity equity of 2x, which could be a matter of concern at this point," says Shah.

All was going well for the chain, and the virus could not have come at a more inopportune time. The stock hit an all-time low of Rs.23 on March 27 well below its IPO price of Rs.57. The demand scenario is playing spoilsport. “Keys has not done well as expected because 250 rooms in Kerala and 100 rooms in Vishakapatnam are affected by coronavirus and flood,” say analysts at IDBI Capital.  So, with the growth in room capacity coming at the time of weak demand, the stock is currently trading at EV/Ebitda of 27.64x on trailing basis. Though, the stock is trading below its 15-year EV/Ebitda average of 59.44x, with poor revenue growth and high finance cost, profitability is going to under pressure. In other words, the worst is not yet over.

East India Hotels

The stock of East India Hotels (EIH), which runs the iconic luxury chains – Oberoi and Trident – has also fallen victim to the carnage triggered by coronavirus outbreak. The stock has crumbled by a whopping 49% in a month, hitting it a 52-week low of Rs.55 on March 25.

In the first nine months of FY20, the company’s revenue dropped by 8% YoY to Rs.10.66 billion. The Jet Airways crisis cause collateral damage to the company as the defunct airline contributed to 50% of EIH’s catering revenue. Its operating profit was also hurt as Ebitda fell by 27.77% YoY to Rs.1.56 billion.

EIH has seen a sharp erosion in its market value as investors believe the worst is not yet over. Before the outbreak hit the hotel industry, the company had embarked on capacity expansion with five hotels expected to be operational in the next two or three years. Now, it’s not clear what will be the impact of the expansion. The only positive is that the company is not unduly levered. With a comfortable debt-to-equity ratio of 0.2x, EIH is expecting to reduce the debt further to 0.1x by the end of the year with 18% reduction seen in overall debt in Q3FY20. "With balance sheet taking prominence over profitability in turbulent times, we have a positive stance only on EIH," say Shah Its total fixed assets stand at Rs.23.78 billion and the stock currently trades at trailing P/B value of 1.49x, which is lower than its 15-year average P/B value of 3.21x but slightly higher than the 1.05x seen in August 2013.

Chalet Hotels

The company runs renowned brands such as Westin, Renaissance, Four Points by Sheraton and all the Marriott hotels in the country. It owns four out of the five operating hotels and recently acquired Novotel Pune Nagar Road Hotel. Possibly the worst hit amongst the stocks mentioned above, Chalet Hotels has fallen below its issue price of Rs.275-280 and currently trades at Rs.204 as of March 26.

Though total income rose a marginal 2% to Rs.7.71 billion for 9MFY20, Ebitda increased by just 5% to Rs.2.91 billion. The reason behind the subdued performance is weak business travel demand. The slowdown in economic growth now coupled with coronavirus outbreak is hurting Chalet Hotel, which has hotels in high-density business areas in Mumbai, Bengaluru and Hyderabad. Since the company’s customer base includes banks, multinational companies, IT firms and airlines, the economic slowdown is a key concern. The luxury hotel chain has properties in high-density business areas such as Mumbai, Bengaluru and Hyderabad. It has 2,179 rooms in the upper-upscale and 375 rooms in the upscale categories. What gives it an edge is the fact that these properties are placed in districts with a high entry barrier; hence, it faces limited competition. At the same time, its partnership with a global player such as Marriott gives it access to management and marketing expertise of a major brand. It also has commercial and retail property spread across 0.9 million square feet in Mumbai and Bengaluru.

Moreover, the recently held IPO has also enabled the company to cut debt and strengthen its balance sheet. Its debt-to-equity ratio has dramatically fallen from 5.5x in March 2018 to 1x in December 2019. The market is vary of the effect of the coronavirus and economic slowdown since its corporate customer base includes banks, multinational companies, tech firms and airlines. Not surprising that the stock trades at EV/Ebitda of 15.30x on a trailing basis in comparison to its peak of 33x, seen in March 2019.