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Inflation: Friend or Foe?

As per our channel checks and commentary from listed hotel companies, hotels continue to follow a strategy of keeping rates higher and sacrifice a bit of occupancy in preparation for a strong potential demand surge in H2FY23. While a long period of stagnant industry ARRs of Rs5,600 in India between FY13-18 had led to hotel owners/operators focusing on occupancy levels to maintain RevPARs, the industry had started to see the first signs of single-digit ARR growth in FY19 and most of FY20 just before the Covid impact from Feb’20 onwards snuffed out the momentum.

However, after bearing the brunt of multiple Covid waves over FY21-22, the industry saw a blowout quarter in Q1FY23 (Apr-Jun’22), driven by strong pent-up demand. While there were concerns over the initial demand surge fizzling out from Q2FY23 and hotels going back to focusing on shoring up occupancies, the Jul-Sep’22 (Q2FY23) period has seen ARRs being 8% higher than Jul-Sep’19 (pre-Covid) levels, with RevPAR being 6% higher over the same period. Further, in terms of incremental demand-supply, while incremental room supply CAGR is currently estimated at 5- 6% over FY22-26E, the actual supply addition may be in the range of 2-3% over this period with demand expected to grow 15% in FY23E and at 10% CAGR over FY23- 26E. This demand-supply gap combined with inflationary pressures, have led to hotel owners/operators pushing for a permanent reset in rates along with stringent focus on reducing fixed costs. Hence, we believe that this time around, the “Recipe for Success” will be higher ARRs with single-digit inflation acting as a “friend” rather than a “foe”. We reiterate our ADD rating on Indian Hotels Co. Ltd. (IHCL) and BUY rating on Lemon Tree Hotels (LTH).

* Consistent improvement in industry ARRs and RevPAR seen in H1FY23: As per HVS Anarock, industry occupancies fell below 50% in Jan’22 owing to Omicron impact before recovering to ~55% in Feb’22 and 61% in Mar’22. This momentum carried forward into Apr’22 with occupancies reaching ~65% (same as Apr’19) of pre-Covid levels and Apr’22 RevPAR at Rs3,803 or 103% of Apr’19 levels. May’22 industry RevPAR of Rs3,744 was 10% higher than May’19 (pre-Covid levels) while Jun’22 industry RevPAR of Rs3,803 was 12% higher than Jun’19 levels. For Q2FY23, Sep’22 industry RevPAR was 105% of Sep’19 levels, Aug’22 industry RevPAR was 109% of Aug’19 levels while Jul’22 industry RevPAR was 105% of Jul’19 levels.

* Oct’22 industry RevPAR 5% above pre-Covid levels: In Oct’22, while industry ARRs were again 11% higher than Oct’19 levels at Rs6,700, overall occupancy was lower by 300bps at 57% in Oct’22 compared to Oct’19 levels resulting in Oct’22 industry RevPAR of Rs3,820 or 105% of Oct’19 levels. In Oct’22, with the festivals of Dussehra and Diwali both falling in the same month, business travel saw a drop and demand was propped up by the leisure segment. Accordingly, while Mumbai and New Delhi recorded occupancy rates of over 65% in Oct’22 vs. Sep’22 levels of over 75%, the Goa market saw the highest ARR of over Rs10,000 in Oct’22. We expect business demand to see a strong pick up again from Nov’22 onwards. While the Apr-Jun’22 period was a blowout quarter for the hotel industry, the clear trend in Jul-Oct’22 is that hotels are holding on to higher rates in anticipation of a strong H2FY23.

* Business travel continues to see improvement: While rising costs remain a key monitorable for Indian and global corporates, with physical occupancy in offices across India’s Tier I cities continuing to rise every month and virtual events return to physical mode, we believe that the MICE segment will likely ensure robust demand in H2FY23 along with a recovery of in-bound business and leisure travel.

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