Are tier-I hotel companies good to Invest?

Last week, the performance of Hotel stocks has been out of the ordinary. Hotel Leela was up 14%, EIH was up 10% and India Hotels was up 8%. The primary reason for the frontline hotel stocks to go up is a speculation that some PE firms are eyeing a stake in Hotel Leela. That set me thinking to research on what the PE firms are doing in the hospitality sector.

This year, thus far, about $250mn dollars found way into the hospitality sector. Due to the excesses in valuation in tier-I cities based companies, they are eyeing at companies that are active in tier-2 & 3 cities. Here are a few deals that have been done:
1. Credit Suisse invested $55 mn in Apeejay Surrendra Hotels
2. Morgan Stanley invested $37.7 mn in Bharat Hotels
3. Lehman Bros invested $100 mn in Future Capital Holdings
4. Kotak Mahindra invested $8 mn in Lemon Tree
5. Kotak Mahindra invested $11 mn in Pride
6. Reliance Capital invested $8 mn in Oriental Hotels

Is this a right time to invest in these tier-I companies? The answer is NO.
If you look at the stock performance of the last one month, Hotel Leela gained as much as 51% while EIH & India Hotels gained 8%. If you look at the YTD performance, EIH gained 36% while Hotel Leel gained 8% while India Hotels lost 4%. During the same time, Sensex gained 43%. So, the short term performance has been pathetic. Even the rights issue of India Hotels has not pumped life into the stock.

The valuations indicate that the stocks are over valued. Historically, the stocks traded at a PE band of 16-20 one year forward earnings. Currently, EIH has PE FY08E of 26, Hotel Leela has 21 and India Hotels has 18. Clearly, valuations look stretched.

The financials of the companies has been choppy. Unless they show consistence performance, they will not be rerated to the level of their peers in other Asian markets where average PE FY08E is 30.

Fundamentally also, the companies are slow to increase capacities. Moreover, their expansion plans are in tier-1 cities. Though I believe Federation of Hotel and Restaurant Association when they say that 30,000 rooms are need in next three years to the current capacity of 97,000, I would not bet on these top tier hotel companies. I would wait for the PE firms to make their money in smaller hotel companies and list them in the market.