Samhi Hotels: High conviction turnaround bet

The Hotel industry is witnessing an upcycle, The demand is expected to grow at between 7-10% CAGR while the supply is expected to grow at 5-6%. You might think that that is not a very big deal, but it is.

This mismatch allows hotels to charge a premium of on the average hotel rate and also leads to a boost in Occupancy rates. The best part? this business is a fixed cost heavy business and hence all of this incremental revenue from increased rates and occupancy will flow down straight to the PAT.

To ride this supply-demand mismatch, my preferred pick is Samhi hotels. It has a lot going on with it except just the industry tailwinds. Lets understand a few basic terminologies and concepts before getting to the company.

Disc: high allocation bet.

Demand

Why is the demand for hotels increasing?

• Rise in discretionary spending: As the real GDP per capita started to increase (real meaning positive despite negating inflation factor), it was noticeable in the countries discussed above that the spending increased faster in some cases. This increased capital often translated to two things: asset investments and luxury becoming a necessity. Hotels fall in the second category. With money to spend, people opt for experiences, and hotels are ideal beneficiaries.

• Rising travel trend:India, currently the world's sixth-largest domestic travel market by spending, is expected to thrive due to its domestic travel industry. With the subcontinent's middle class growing, India's domestic market can overtake Japan's and Mexico's to be the top 4 by 2030. Domestic air passenger traffic is expected to double by 2030, boosted in part by state-subsidized initiatives. Moreover, Covid caused this pent-up demand amongst everyone, which translated to revenge travel after the economy opened up. The effects are still visible and can be seen by studying Airline businesses like Indigo and big hotel chains like EIH and Indian hotels. Source: Mckinsey.

• Foreign spending is recovering: Pre-covid, Foreigners accounted for a very high chunk of revenue for the hotels in India. However, that number has not returned to its peak yet. With the economy and income stabilising in the west, we can expect more demand from foreigners which can greatly boost demand. The current FTA spending is at 9mn and is expected to be 28mn by 2030. Source: Indian hotels presentation

• MICE (Meetings, Incentives, Conferences and Exhibitions): As India's GDP keeps growing at 7%+, we can expect businesses the thrive and hold such conventions. These will pay key roles as they also end up boosting room rates and occupancy.

Supply

If we are so confident of the demand coming up, why is it that the supply is not catching up?

The primary reason to. understand is the time to set up keys( room) and the cost of setting up keys.

• Initial cost: For Samhi, the cost to set up a room is 70-75L (including land). This number varies for company to company, brands like Taj and Oberoi spend 2-3 crores per key while lemon tree is a cheaper than that. Basically, the initial capex is expensive and it becomes difficult to spend this amount in an inflationary environment like now.

• Time taken to set up hotels: Moreover, for luxury and upper scale hotels, the average time taken is about 50 months on average. So the demand keeps increasing steadily, but the supply comes in lumps and hence there is a lot of price fluctuations in the middle. Currently, this mismatch favours the hotels and investors with vested interests.

sources: EIH, Samhi investor presentations and hotelivate.

This is all you need to understand why the sector is in favour at the moment. Lets understand a few simple variables before analyzing Samhi hotels.

Variables to track

• ARR: Average room rate. That is quite simple to understand. The room rate that is being charged by the hotel.

• Occupancy: If the hotel has a 100 rooms, how many were in use on average for the given time period? if 70 of them were used, then the occupancy rates are 70%.

• RevPAR: Revenue per average room. Basically, ARR x Occupancy is RevPAR. For example, if the ARR is 1000 rupees and the occupancy is 80%, then my RevPAR is 800 rupees. If the ARR is 1000 and the occupancy falls to 30%, then the RevPAR falls to 300 rupees which is a big down fall. Hence, RevPAR in my opinion, is the most important metric as it shows the supply demand scenario and is also what enables Operating leverage, which is generally the main thesis pointer in hotels.

• Keys and Keys being added: Keys means that capacity available. More than keys, what matters is the keys being added as a % of total keys. This is the capex that a hotel must do to grow.

• Geography: Not all cities will have a good supply demand scenario. Metro cities are doing good and out of them, Hyderabad and Mumbai are leading the pack. We need to understand that these are micro markets and hence we need to know where hotels are operating to get a better idea of the supply demand mismatch they are exposed to.

Samhi hotels

Samhi Hotels Ltd is a listed hotel chain and is the third biggest hotel chain in India. They began operations 13 years ago and currently have 4800 keys under their management, which is expected to increase to 300 keys soon (Q3 FY25). Samhi hotels stick to metropolitan cities, especially those with a higher expectation of adding office spaces and increasing air travel. Essentially, they want to focus on the middle, upper middle and upper segment, which primarily caters to business officials and companies who visit these metropolitan cities. Their core strategy has been buying distressed assets that are underperforming and under bad management at a cheap valuation and turning them around to make them profitable. This allows Samhi to have a higher ROCE and also allows them to develop the keys faster. Their advantage lies in using their management experience and brands to turn the asset around. 

Out of the 4800 rooms or so, 700 have been greenfield while the rest have been acquired. Samhi hotels have successfully managed to acquire and operate a few key brands such as Holiday inn (70% of total Holiday inn in India are under them), Fairfield by Marriott (40% of Fairfield in India are under them), Sheraton and Hyatt. This diversification between midscale, upper middle scale and upper scale with 1564 rooms, 2163 rooms and 1074 rooms respectively, showcases the company's strong capabilities and success in the industry.

Portfolio

Thesis

• Present in the strongest markets:Samhi has strategically placed itself in growing markets facing a strong supply-demand mismatch. This ensures that the RevPAR of their hotels do not fall and that the city is ready to absorb increasing supply if needed. This has been possible due to Samhi's data-driven approach to owning properties in cities with the highest office space absorption and air traffic.

• Proven track record of turnaround bets: Samhi has been largely successful with its strategy of buying distressed properties. This aggressive but efficient method has helped it become the third largest player in a very short time. Its expertise is itself under operating leverage, as it can keep using this strategy on multiple assets by focusing on the same management tools.

• Lowest cost producer: Compared to industry average, Samhi has the lowest average cost per key and that too with the fastest development time. This helps them have better return ratios and increase profitability.

• Fast growth: The company expects to add inventory of about 10-15% every year, and also expects a RevPAR growth of double digits (13% in Q1FY25) for the year. This translates to a revenue growth of about 20-25%. Moreover, the RevPAR is exceptional as it came during a soft quarter and was the best amongst its peers (most had single digit RevPAR)

• Deleveraging: In FY23, Samhi paid interest worth 522 crores, in FY24, they paid interest costs worth 345 crores and this year, it is supposed to come down to 200 crores. This means that 150 crores flow straight to the PAT. Moreover, during an upcycle; hotel businesses can be cash rich and hence give Samhi an optionality to further reduce the burden of debt. It is a very strong thesis driver which is proving to be on track at the moment.

• Tremendous operating leverage: The Asset EBITDA stood at 37.7%, diluted by the recent acquisition of the ACIC portfolio at 35%. The management expects that the ACIC portfolio will merge with the company-level EBITDA, and hence, we can expect a margin expansion of about 300-400 basis points. The difference between ACIC and the rest has already reduced from 770 to 320 basis points. Moreover, these margins come at a seasonally weak quarter without adding renovated keys and without rebranding keys to the upper scale. Hence, there is a high probability of increasing margins, which might surprise us all. Moving on from EBITDA, the ESOP costs have fallen and will continue to do so. They were at 11.5 crores in Q1 FY24 and now are at four crores. This leads to incremental savings of 25+ crores.

  
  

  The best part: Most of the revenue, majority of the margin expansion and incremental savings from interest and ESOP will all flow down to the PAT. This is the advantage of fixed cost businesses. Operating leverage/deleverage will change the whole game.

  
  

Anti thesis

• Cycle turning: Despite a few strategies that prevent Samhi from facing a strong downcycle, they will surely suffer terribly if a downcycle occurs. Why? All of it is a product of supply and demand, which allows free cash flow for deleveraging, margin expansion, and operating leverage. Hence, there is no thesis if the cycle turns. How can the cycle turn? On the supply side, I do not see a big problem because supply can easily be tracked and predicted, and we can say with some certainty that supply growth is limited. The side of demand being affected is what can cause the downturn. Economic downturns, geopolitical events, etc, can cause people to spend less and hence reduce the demand.

• Failure to integrate the ACIC portfolio: Although I do not see this happening (since we can already see them walking the talk), failure to integrate the portfolio would mean that the ACIC portfolio ends up being a drag on the margins and the return ratios.

• High debt: The business is highly leveraged and hence, the management must be careful with how they handle the business enviornment. This too comes down to the tailwinds but the management must practice sensible capital allocation to reduce the debt of the company.

• Weak hands: If the story has been doing so well for the past few quarters, why hasn't the stock price risen? A lot of stake is held by PE funds, deemed 'weak hands' as they tend to exit after the business listing. This means that a supply overhang always exists, which prevents the price from appreciating and makes people hesitate to buy. Which could be wrong, and I do not care. For me, a stock price reaching its intrinsic value is not a question of if but when. Nothing can stop it. If Samhi performs well and keeps delivering, strong buyers will take over, and it will reach the valuation it deserves. 

Valuations

As discussed above, the weak hands have ensured that Samhi gets the lower range of multiples. I see that as an advantage and hence consider the business strongly undervalued. Moreover, the potential for exponential gains, if the business performs well, is a strong possibility. The valuation multiple band will improve (as discussed above) and so will the price appreciation owing to increased earnings, providing a solid foundation for our confidence in Samhi's future. 

Barring EIH which suffered due to a bad quarter, almost all other businesses trade a superior valuation compared to Samhi. Let us use this data by Shankar Nath who too covered this business and understand the valuation multiples.

With some of the best growth rate amongst its peer and the direction towards a stronger balance sheet, we can be fairly certain to see a multiple expansion adding to our gains (if any)

Technicals

The stock price topped out in late February and went through a time and price correction. However, the fundamentals kept improving, and the business kept getting more attractive. We can see some change in the trend as the stock price has finally started to increase. It has also crossed the 21 EMA and a few previous resistances. We can also see some improvement on the volume side. 

Do you know I wait to post this blog until I saw some improvements on the technical side? I finally see some change (could be wrong since its very early to say this) and hence have decided to write on this business.

I hope this blog was value adding and worth your time. I will be happy to answer any doubts if any. Subscribe if you learn from my content!