The Hindu Business Line : Royal Orchid Hotels: Invest at cut-off

THE stock market is about to make room for one more hotel stock — Royal Orchid Hotels. An investment in the initial public offer can be considered from a medium-term perspective. The price band of Rs 150-165 values the stock at 21-24 times its likely FY-06 per share earnings, on an expanded equity base.

The valuation is at a fair discount to that of peers such as Taj GVK and Asian Hotels. Royal Orchid, which would offer additional rooms in Bangalore, Pune and Hyderabad from October 2006, is well-placed to absorb part of the boom in demand from business travellers in these cities. Margins, too, are likely to remain strong for the next 18 months.

As with all hotel and tourism-related companies, the company's profits are vulnerable to extraneous events, ranging from natural disasters to acts of terrorism. Royal Orchid, which caters to business travellers, is likely to be less affected by such events compared to leisure properties, but will not be insulated from the impact either.

The hotel chain's presence has, so far, been restricted to Bangalore and Mysore. With the proceeds of the offer, Royal Orchid will renovate its existing properties and would also acquire a stake in an inn located near the new airport proposed in Bangalore. It also plans to diversify its presence by setting up hotels in other prime business destinations such as Hyderabad and Pune. Post-expansion, it is still likely to derive a substantial part of its revenues from Bangalore.

The high room rates that now prevail in Bangalore are due to a demand-supply mismatch and are not sustainable in the long term. The dependence on Bangalore is unlikely to pose a threat over the next one year at least. Trends in occupancy and room rates in Bangalore would have to be observed closely from 2007 onwards and a dramatic slide in rates could affect operations.

Moreover, Hyderabad and Pune now figure in the expansion plans of most hoteliers. As it moves to more competitive turfs, Royal Orchid could face pressures on occupancy and room rates and this is another risk to our recommendation. A presence across price points, low set-up costs and well-chosen locations are, however, likely to work in favour of Royal Orchid.

Royal Orchid, which started its flagship property, The Royal Orchid, at Bangalore in 2001, has grown to a Rs 58-crore company, on a consolidated basis. The company now operates two other hotels in Bangalore — Royal Orchid Central and Royal Orchid Harsha — and manages a heritage property in Mysore — The Royal Orchid Metropole.

The booming IT and BPO industry has made Bangalore one of the top destinations for business-related travel. Over the past two years, demand has far outstripped supply, resulting in hotels being sold out and room rates rising to never-before levels.

Royal Orchid has been able to fully capitalise on the boom. Although one of its properties, The Royal Orchid Harsha, is positioned at the economy segment, the other two have been able to rake in the moolah for the group.

Occupancies in FY-06 first half have been at about 80 per cent across its three properties, while the room rates at its premium hotel, The Royal Orchid, have been as high as Rs 6,100 a night.

Little wonder that Royal Orchid has managed to record operating margins of 45 per cent in FY-05. With its set up costs being much lower than that of a typical luxury hotel, it has delivered a return of 46 per cent on shareholders' funds in the same year.

While hotels in Bangalore have benefited from the supply constraint so far, new hotels are likely to come up, starting 2007. Occupancy rates have more or less stagnated, as exorbitant room rates turn away customers. Hotel consultant, HVS International, estimates a further rise in room rates in FY-07, as the demand-supply mismatch in Bangalore continues.

It, however, believes that there will be pockets of oversupply once new properties come up post-2007 and room rates could slide as much as 30-40 per cent from the current levels in 2008. The party in Bangalore, therefore, may not last beyond the last quarter of 2007.

Against this backdrop, Royal Orchid's foray into Hyderabad and Pune augurs well for the company. Admittedly, these cities are being increasingly targeted by other hotel chains that are fast expanding their presence. In Pune, however, the huge unmet demand is likely to easily accommodate the additional supply and occupancy and room rates are unlikely to suffer.

While new supply could see occupancy rates levelling off in Hyderabad, room rates are unlikely to see a significant decline, as they remain competitive despite a steep increase in recent years.

Meanwhile, the Metropole in Mysore, which has seen poor occupancy rates, is likely to see an improvement as the city gradually grows alongside Bangalore. The IT corridor is likely to speed up the travel time between Bangalore and Mysore and the latter is likely to become a more attractive destination for tourists and business travellers alike.

Offer details: About 70-lakh shares are on offer. The promoter's stake, post-offer, would be 69 per cent; Westbridge Ventures would hold a 6 per cent stake. About Rs 110 crore would be raised through the offer, of which Rs 75 crore would go towards capital expenditure. Royal Orchid has two 51 per cent subsidiaries — Icon Hospitality and Royal Orchid Hyderabad — and a 26 per cent stake in Maruti Comforts and Inn, which it plans to increase to 51 per cent. The offer closes on January 17. The lead managers are ICICI Securities and SBI Capital Markets.