Verdict: Check-in not recommended

IPO Snapshot:

Chalet Hotels is entering the primary market on Tuesday 29^th January 2019 with a Rs. 1,641 crore IPO – split as Rs. 950 crore via fresh issue of equity shares of Rs.10 each and an offer for sale (OFS) of 2.47 crore share, both in the price band of Rs. 275 to Rs. 280 per share. Issue represents 28.59% of the post issue paid-up share capital (at upper end) with Rs. 691 crore OFS making up 41% of the total size. Closing a day ahead of the budget, on Thursday 31^st January, listing is likely on 8^th February.

Company Background:

Chalet Hotels is the owner and developer of 5 high-end hotel properties in India, a serviced apartment, commercial and retail outlet each (all co-located with hotels), aggregating 2,328 keys, operating under Marriott-owned brands. Located at Mumbai (JW Marriott Sahar, Renaissance Powai, Four Points by Sheraton, Vashi), Bengaluru (Marriott Whilefield) and Hyderabad (The Westin, Mindspace), hospitality accounted for 92% of FY18 total income (thus other businesses are only complementary in nature). 4 of the 5 hotels accounting 2,176 keys are managed by Marriott – with average daily rent of Rs. 7,980 and Rs. 7,830 for FY18 and H1FY19 respectively and average occupancy of 72% and 74%. Only 152-keys Vashi property (6% of inventory) is managed by the company. Company is developing 588 keys across 3 hotels in Mumbai and Hyderabad, along with 1.12million sq ft of commercial space (co-located), to be operational over next 2-3 years.

Objects of Issue and Shareholding:

Company has funded historic growth through debt, which, as of 30-9-18, was very high at Rs. 2,689 crore (including current debt maturities). Post Rs. 720 crore debt repayment from fresh issue proceeds current net debt to equity ratio of 5.7:1 will fall to 1.4:1, which is still steep, as annual cost of servicing this debt will be close to Rs. 200 crore. Presently, 100% equity is held by the promoters (K Raheja Corp Group) which will decline to 71.41% post listing.

Financials – healthy EBITDA but marginal net profit

Between FY14-18, company’s revenues grew at 18% CAGR to Rs. 874 crore while adjusted EBITDA rose at 22% to Rs. 338 crore, translating into a healthy EBITDA margin of 39% for FY18. Since interest outgo is massive (Rs. 212 crore in FY18), reported profit before tax (PBT) is paltry, at Rs.21 crore, which adjusted for exceptional items, would be only ~Rs. 10 crore. Needless to say, reported profit after tax (PAT) of Rs. 31 crore has inflated on account of deferred tax asset of Rs. 10 crore. FY18 cash profit stood at Rs. 153 crore.

For H1FY19, on Rs. 470 crore revenue, adjusted EBITDA margin (excluding Rs.45 crore loss on foreign exchange fluctuation) was maintained at FY18’s 38%, which may rise in H2, being seasonally stronger due to improved occupancy on account of MICE, leisure travel and wedding season. In FY17 company had exceptional gains on profit on sale of investments and forex fluctuation gain, aggregating almost Rs. 150 crore. Reported H1FY19 EBITDA was Rs. 134 crore while adjusted EBITDA came in at Rs. 180 crore. However, both PBT and PAT were in the red at negative Rs.63 crore and Rs. 44 crore respectively, thanks to interest expense of Rs. 140 crore for the 6 months as well as high depreciation of Rs. 57 crore on owned assets. Thus, while EBITDA is healthy, bottomline is in the red, which is what should worry equity investors as return on equity (RoE), a vital financial parameter, becomes negative. As of 30-9-18, Rs.467 crore networth translated into BVPS of Rs. 27. 

Valuation:

At Rs. 280 per share, company’s market cap and EV will be Rs. 5,740 crore and Rs. 7,700 crore respectively. Since PAT is negative, PE based valuation is not possible. On cash profit basis, FY18 multiple stands at 38x, while EV/sales and EV/EBITDA multiples are 9x and 23x respectively. Another popular matrix used in the hospitality sector is EV/key, which is Rs. 3.3 crore for Chalet, as against Rs. 1.4 crore/key development cost (including land) incurred by the company in 2015 for 585 key JW Marriott Sahar.  

Key positive for the company is its industry-leading EBITDA margin due to:

1. promoter’s real estate expertise coming in handy to keep capex low
2. property manager Marriott controlled opex (e.g. low employee cost vs industry).  

However, few negatives must also be highlighted here:

1. High debt pressurising margins and denting debt-equity ratio, even on post listing
2. Company does not own the brands (unlike bigger peers Indian Hotels, EIH and even Lemon Tree). Hence cannot adopt the asset-light model to fuel growth which the industry is embarking upon.
3. All future positives already priced in. 2 critical pending litigations may have sentimental negative impact. (i) Residential Bangalore project (against Hindustan Aeronautics) for height of the complex, even though promoters, in good faith, have provided funds to meet all the contingencies for the same. (ii) Pending litigation  in Supreme Court towards Vashi hotel, with dispute over land title, which if adverse, may lead to closure of the property.  
4. Aggressive pricing – EV/key of Rs. 3.3 crore appears very stretched. Last hospitality IPO, about 10 months back, was of Lemon Tree, which is currently quoting at EV/key of Rs. 1.3 crore. Even if one were to give the 100% premium for Chalet’s average daily rate being double of Lemon Tree’s ~Rs. 4,000, the latter’s occupancy rates are higher at 76% vs former’s 72% (FY18 data). Thus, a 100% premium to Rs.1.3/key i.e. Rs.2.6crore/key only appears fair and not Rs.3.3 crore for Chalet.  

On other multiples like EV/Sales and EV/EBITDA, while Chalet’s pricing may be more attractive than Lemon Tree, it fades the top 2 giants Indian Hotels and EIH who are either much lower or comparable to Chalet, with regards to trading multiples. Chalet’s RoE is also on the lower end in the peer set above.

Asian Hotels West, although smaller in size, has two luxury properties - Hyatt and JW Marriott in Mumbai and Delhi aggregating 931 keys (managed properties & not owned brand along with high average daily rates, similar to Chalet), clocked comparable margins of 35%. It is ruling at low valuation multiples (EV/key of Rs. 1.2 crore and EV/EBITDA of 8x solely due to high debt, which is also denting net margins and return ratios (similar to Chalet). On this comparison, Chalet’s offer price is quite aggressive.  

In the current conditions, when bluechips are finding the going tough, it will not be a comfortable walk for this company. While hospitality industry believes to be at an inflection point as average daily rates may rise given average occupancy achieving critical mass, a macro economic slowdown, which has affected other consumption sectors like cars, cement etc. may not hold this premise true, especially in the near term. Moreover, cyclical nature and historically low RoEs of hotel industry have been major road-blocks for investor comfort in the sector.

Conclusion:

While company’s portfolio of asset and operating profit is strong, the risk-reward is not favourable, given the negatives highlighted above. In such uncertain times, one is better-off avoiding aggressively priced midcaps and instead look to accumulate large caps in the secondary market. Hence, one can give this IPO a miss.

Grey Market Premium (GMP) of Chalet Hotels: Grey Market Premium of Chalet Hotels is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in Pathshala column.

Disclosure: No interest.