Investor's Eye: Update - Indian Hotels Company (Domestic performance subdued, consolidated performance better); Viewpoint - Hexaware Technologies (Stake sale done, potential for re-rating in the medium term)

Investor's Eye [August 26, 2013]  Sharekhan www.sharekhan.com

Summary of Contents   STOCK UPDATE Indian Hotels Company Recommendation: Hold Price target: Rs61 Current market price: Rs42 Domestic performance subdued, consolidated performance better Result highlights Q1FY2014-subdued operating performance at stand-alone level: Indian Hotels Company Ltd (IHCL) posted a subdued operating performance at the stand-alone (domestic) level in Q1FY2014. The revenues were flat and the operating profit declined by around 20% year on year (YoY). The net sales stood flat at Rs396.6 crore, largely in line with our expectation of Rs390.5 crore. The flat sales can be attributed to seasonal weakness along with flat occupancies and lower year-on-year (Y-o-Y) average room rentals (in the wake of an uncertain macro-economic environment and large room supply). With power & fuel and other operating costs remaining higher on a Y-o-Y basis, the operating profit margin (OPM) declined by 320 basis points YoY to 13.5%. The operating profit declined by 19.2% YoY to Rs53.4 crore. However, an increase of around 3x in the other income resulted in a 37.2% Y-o-Y growth in the adjusted profit after tax (PAT) to Rs14.3 crore (ahead of our expectation of Rs2.7 crore) in Q1FY2014.  Better operating performance at consolidated level: Despite a weak performance at the stand-alone level, IHCL posted a better performance at the consolidated level with a single-digit growth in the revenues and a flat OPM YoY. This gives us an indication that the international properties have started posting a better performance. The consolidated net sales grew by 6.6% YoY to Rs908.7 crore. The OPM stood flat at 11.7% and the operating profit grew by 4.8% YoY to Rs106.4 crore. The higher other income and lower interest cost helped the company to post some profit (of Rs0.5 crore) at the adjusted profit after tax (PAT) level in Q1F2014 as against a loss of Rs9.7 crore in Q1FY2013. The reported loss after the minority interest and the share of profit from associates was down to Rs19.1 crore in Q1FY2014 from Rs33.4 crore in Q1FY2013. We believe that if the international properties continue to post a better operating performance, we might see IHCL posting a better operating performance at the consolidated level in FY2014. Business fundamentals remains under pressure in the domestic market: The foreign tourist arrival in India during the period of April-June 2013 grew by just 1.9% YoY to 12.8 lakh tourists as the period is seasonally weak for tourism in India. The room supply in Q1FY2014 grew by 20% YoY while the demand for rooms increased by 17% during the same period. This put pressure on the occupancies and average room rates (ARRs), which declined by 2% and 3% respectively during the quarter. We believe IHCL's occupancies must have stood flat at close to 60% while its ARRs may have declined by 3-4% YoY in Q1FY2014. We believe Q2FY2014 will be the weakest quarter and don't expect any recovery in the performance at the operating level in this period.  H2FY2014 would give us a better picture: The second half of FY2014 will give us a much better picture as it is seasonally strong for the hotel business in India. If the government implements some constructive actions and the macro-economic uncertainties clear in the coming quarters, we might see a better performance in the second half of FY2014. Also, the rupee's depreciation against the dollar and the other major international currencies would be favourable for the tourism industry in India. Maintain Hold: We have broadly maintained our earning estimates for FY2014 and FY2015. At the current market price the stock trades at 26.0x its FY2015E consolidated earnings per share (EPS) of Rs1.6 and enterprise value (EV)/room of Rs0.5 crore. In view of the near-term uncertainties hovering over the industry, we maintain our Hold recommendation on the stock with a price target of Rs61. However, we are confident that IHCL would be a key beneficiary of the improving business fundamentals in the domestic as well as international markets in the medium to long term.      VIEWPOINT Hexaware Technologies Stake sale done, potential for re-rating in the medium term The event: Baring Private Equity Asia picks up 41.8% stake in Hexaware Technologies for a total transactional value of $431 million (at Rs135 per share) After more than two years of speculation Hexaware Technologies (Hexaware) has finally announced that Baring Private Equity Asia (Baring PE) will acquire a controlling stake of 41.8% in the company at a price of Rs126 or Rs135 per share. Atul Nishar (who owns a 27.7% stake in Hexaware) and the existing private equity (PE) investor, General Atlantic, (which owns a 14.1% stake in Hexaware) have agreed to sell their respective holdings in the company.  Highlights of the deal  As per the agreement, Baring PE will pick up a 41.8% stake from the promoter, Mr Nishar, who holds a 27.7% stake in Hexaware, and the existing PE investor, General Atlantic, which holds a 14.1% stake in the company. In total, approximately 125 million shares will be transferred. The deal is expected to close by the end of 2013 after the deal receives the required approvals from the concerned regulatory authorities. Baring PE will pay Rs126 or Rs135 per share of Hexaware to the selling parties amounting to Rs15.8-16.9 billion. However, the upper end of the price band, ie Rs135 per share, is payable by Barings PE only if its holding reaches 50% or more in Hexaware post-transaction.  The total consideration paid by Baring PE would be $249-266 million (assuming a rupee-dollar exchange rate of 63.3) for the 41.8% stake in the company. Further, in order to meet the Securities and Exchange Board of India take-over guidelines, Baring PE will make an open offer announcement to purchase additional 26% stake (7.7 million shares) from the other minority shareholders (including Chrys Capital) at Rs135 per share. Thus, the total transactional value of the deal is around Rs27.3 billion ($427 million).  The core management team likely to remain unchanged post-deal: The core management team will not change after the deal. Mr Nishar will continue as a non-executive chairman of the company while PR Chandrasekhar will continue in his role as the chief executive officer (CEO) of the company. The company's management has indicated that the feedback from the key clients has been positive on the deal and expects business to be as usual for the company after the closure of the deal.  The road ahead: This deal being the largest carried out by Baring PE in India will raise expectations of the investor community on the value addition that Baring PE can bring to table for the company. Among the priorities for Baring PE, the foremost will be to provide momentum to the inorganic initiatives of the company. It's been almost a year since Hexaware started scouting for an acquisition opportunity and with almost Rs587 crore of cash at the end of June 2013, it will be imperative for Baring PE to provide an impetus for inorganic growth. Further, any major change in the dividend pay-out policy (current pay-out stands at around 50%) will also have a detrimental impact on the stock's performance.  View and valuation-downside limited but expect some profit booking closer to open offer price; potential for re-rating over medium term: Given the run-up in the stock price in anticipation of the deal, it would not be surprising to see some profit taking closer to the open offer price. The open offer price of Rs135 per share (around 10x CY2014E earnings) seems to capture the medium-term upside in the stock.  However, the event is strategically positive for the company and could potentially lead to the re-rating of its multiples in the medium to long term. With a prudent management structure, faster decision on the inorganic initiatives (Rs587 crore in cash) and continuation of the current core management team (Mr Chandrasekhar as the CEO), investors can look at accumulating the stock at dips from a medium-term to long-term perspective. Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Regards, The Sharekhan Research Team

 

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