Kolkata-headquartered conglomerate ITC recently provided an indicative 15-month timeline for its proposed-to-be-demerged hotels company to be listed on the bourses and 1:10 share entitlement ratio i.e. shareholders will get 1 share of ITC Hotels for every 10 shares of ITC.

Since July 24 when ITC had officially announced the vertical demerger of its hotels business, the stock has been under pressure. In the last one month, ITC shares have lost 7 per cent, underperforming Sensex’s 2.6 per cent slide in the same period. This could be a signal that investors are finally coming to terms with the insignificant nature of ‘value unlocking’ of the hotels business.

While ITC Hotels will operate independently, it will continue to leverage ITC’s institutional strengths, brand equity and goodwill — an argument put forward by ITC to retain 40 per cent stake in it. The rest 60 per cent will be directly owned by ITC shareholders. In this structure, while ITC shareholders effectively will own 100 per cent economic interest in the hotels company, some are unhappy with this 60:40 structure.

Demerger effects

Accounting for 3 per cent of ITC’s overall EBITDA and 2-4 per cent of its sum-of-the-parts (SOTP) valuation, the hotels business, with around 11,600 rooms across 120 hotels, is a small part of ITC. Of course, given the capital-guzzling nature of hotels business, the demerger will improve ROCE and cash flows for ITC. This brightens the chance of better dividend payouts to ITC shareholders in case the company does not conserve all the cash for core business use.

More importantly, the value unlocking from the hotel business demerger is a welcome move, especially if it is eventually followed by the demerger of the other arms such as the IT Services business (same size as hotels business). If the same fructifies, re-rating of ITC will be sharper, going forward.

Unknowns

ITC Hotels business has swung back strongly, thanks to the post-Covid recovery in line with peers. Revenue exceeded ₹2,600 crore, EBITDA topped ₹850 crore and EBIT came in at ₹557 crore for FY23. ROCE is at 8 per cent (lower than 10-14 per cent for peer group). So far, ITC has not publicly announced key performance indicators of hotels business — such as average room rent, revenue per available room, occupancy data, foreign room nights, F&B revenue mix, etc. Room addition pipeline is also required to build in future earnings model. Once these numbers are known, a better assessment of ITC Hotels could be done by comparing the momentum with peers. Calculations regarding ITC Hotels’ daily revenue per room point to ₹6,200 figure, which is at 18 per cent discount to Indian Hotels. Thus, valuations will also likely bake in a discount to market leader.

The Q1 FY24 revenue growth for hotels segment coming in at just 8 per cent yoy has been attributed by the management to occupancy moderating on a high base due to relatively fewer wedding dates during the quarter and pre-planned renovations. The 8 per cent growth number is quite weak compared to Indian Hotels (up 17 per cent) and Lemon Tree (17 per cent). So, there needs to be some heavy lifting done in the rest three quarters by ITC Hotels.

To hold on to estimated valuations, ITC Hotels, as potentially the second-largest listed player, needs to come closer to consensus FY24 revenue growth estimates for peers such as Indian Hotels (14 per cent) or Lemon Tree (20 per cent). For reference, ITC Hotels clocked over 100 per cent revenue growth in FY23.

ITC Hotels stock price

The 1:10 swap ratio does not mean that each ITC Hotels share will be worth ₹44-45 i.e. 10 per cent of current ITC price. Post demerger, debt-free ITC Hotels will have 208 crore shares. Its estimated enterprise value (EV) is expected to be between ₹18,000 crore and ₹25,000 crore using hotel peer group (Indian Hotels, EIH and Lemon Tree) valuation benchmarks such as EV/EBITDA or EV/sales.

Assuming no significant cash balance other than for operational purposes, the market cap will be close to its estimated EV (market cap + net debt = EV). Based on this, ITC Hotels stock could be priced between ₹90 and ₹120 per share. It needs to be noted here that if the share swap was done in a 1:1 ratio instead of 1:10 ratio, the stock could be priced between ₹9 and ₹12 per share. This indicates how insignificant the hotels business is to the overall value of ITC (ie 60 per cent of ITC Hotels equals just around 2 to 2.6 per cent of ITC’s current share price). Thus the excitement over the demerger appears to have been overdone.

The actual price discovery will happen once the stock is listed around November 2024. If earnings continue to soften this year, ITC Hotels will likely list near the lower end of the valuation range.

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