Lemon Tree Hotels: Decent Company, stretched valuations.

Last Updated on March 5, 2020

Lemon Tree Hotels IPO Details:

• Issue size: 1,036 Cr.
• of shares: 18.5 Cr Equity Shares
• Price band: 54-56
• Bid Lot: 265 and in multiple of 265
• Issue opens on: 26^th March 2018
• Issue closes on: 28^th March 2018

Objective of the issue:

This is an offer for sale of Equity Shares by the existing shareholders; the company will not receive the proceeds of the Offer.

About Lemon Tree Hotels:

It is,

• One of the India’s largest hotel chain in the mid-priced hotel sector,
• 3^rd largest overall, on the basis of controlling interest in owned and leased rooms
• 9^th largest hotel chain in India in terms of owned, leased and managed rooms

as of June 30, 2017, according to the Horwath Report.

It operates in the mid-priced hotel sector, consisting of the upper-midscale, midscale and economy hotel segments. The company seeks to cater to Indian middle class guests and deliver differentiated yet superior service offerings, with a value-for-money proposition. Lemon Tree Hotels opened its first hotel with 49 rooms in May 2004. It operated 4,697 rooms in 45 hotels (including managed hotels) across 28 cities in India as of January 31, 2018.

Lemon Tree Hotels has created three brands –

• ‘Lemon Tree Premier’: Upper-midscale hotel segment. For Business and Leisure guests seeking hotels at strategic locations, and willing to pay premium
• ‘Lemon Tree Hotels’: Midscale hotel segment. For Business and Leisure guests seeking comfortable, cost-effective and convenient experience
• ‘Red Fox by Lemon Tree Hotels’: Economy hotel segment

MoneyWorks4me Opinion:

Lemon Tree Hotels has strategically built its hotels at locations that are near to business hubs, airports and convenient areas. Lemon Tree Hotels offers a value-for-money proposition with efficient service. We believe that due to all these factors, Lemon Tree Hotels no doubt are preferred destination for staying and corporate events.

However, hotels business is capital intensive in nature. For growth, it has to invest very large amounts. Since its very competitive industry, it may not generate a lot more than cost of capital. Since its internal cash flows will be lower vs the amount required for capex, it will always have to rely on QIP (Qualified Institutional Placement) or debt for growth. Because of this, there is a limitation on how much value growth would add.

Hotel assets typically have gestation period of 24-36 months. So, it’s given that cash flows won’t experience a linear growth. In order to make consistent cash flows, Lemon Tree Hotels has to ensure average occupancy of ~70% in all of its hotels. Hotel industry is cyclical and in down-cycle, cash flows fluctuate a lot. Hence, using high leverage is a risky proposition in this industry.

Currently, Lemon Tree Hotels has an EBITDA of 122 crores; with a margin of ~28%. It has ~4,600 rooms across ~ 47 hotels. With 24 more hotels in the pipeline, assuming consistent occupancy, we expect the revenues to go up by 13%-15% CAGR and EBITDA margins to go up to 40%. So, the future ROE of company may range from 13-17%. Current debt is ~Rs. 900 Cr.

Assuming FY20 revenues of Rs. 700 Cr and EBITDA Margin of 40%, we get Rs. 280 Cr. After interest cost, maintenance capex and taxes, it would earn Rs. 150 Cr in cash flows. This values the company at 29X FY20 earnings power. We believe these valuations are very high for a company where growth is not very high value addition and existing ROEs are average.

Our recommendation:

AVOID subscribing to the IPO of Lemon Tree Hotels. We will revisit the company if we get attractive price in future.

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